DBRS Upgrades Canfor Corporation to BBB (low) and Changes Trend to Stable

DBRS has today upgraded the Issuer Rating and Senior Notes rating of Canfor Corporation (Canfor or the Company) to BBB (low) from BB (high) and has changed the trend on both ratings to Stable from Positive. As a result of the current rating action, DBRS has also discontinued the recovery rating previously assigned to the Company’s Senior Notes. The upgrade reflects Canfor’s credit metrics, which have remained solid in the investment-grade range since the Company was placed on Positive trend last year. It also reflects the improvement in Canfor’s business profile: better operating efficiencies due to targeted capital spending, disposition of underperforming non-core joint ventures and material diversification in Asia. The Stable trend reflects DBRS’s expectation of sustainable credit metrics in the foreseeable future driven by continuing recovery in the U.S. housing market. Furthermore, Canfor’s low-debt financial profile provides additional support to the BBB (low) rating.

Since DBRS placed Canfor on Positive trend in August 2013 (see the press release dated August 8, 2013, for details), North American lumber market conditions have continued to improve, in line with steady improvement in the U.S. housing market. As a result, Canfor’s operating results and credit metrics have continued to remain solid. Specifically, Canfor’s 2013 U.S. lumber results were significantly stronger than the previous year due to higher average prices and volumes. Regarding offshore markets, demand in China was steady, with a continuing shift to higher-value products, while demand in Japan was stronger. Moreover, better operating efficiencies due to recent capital upgrades and lower export duty taxes on Canadian lumber exported to the United States due to higher lumber prices also contributed to the stronger results. On the pulp and paper side, the results were positively affected by higher pulp prices and higher volumes. The global pulp market improved in 2013, driven by increased demand from Europe and the United States, while demand from China remained stable. Furthermore, with approximately 85% of sales in export, Canfor’s results were positively affected by a weaker Canadian dollar.

Over the past few years, Canfor has continued to improve operating efficiencies with targeted capital spending at its saw mills. As a result, DBRS now views Canfor as a top-quartile lumber producer in the industry in terms of operating margins. Moreover, significant capital projects have been completed at the pulp and paper facilities largely targeted at renewal of aging recovery boilers, which will translate into reduced maintenance costs over the next few years and result in shorter planned outages.

In May 2013, Canfor sold its interest in the underperforming non-core oriented strand board (OSB) joint venture, which is considered a more volatile product line and also contributed negatively during the last downturn. DBRS views the divestiture as positive for Canfor’s business profile, reducing volatility in the Company’s earnings, especially during a downturn.

Canfor’s lumber geographic sales mix has changed dramatically in the last five years. The Chinese market has become a material business for Canfor, accounting for approximately 20% of 2013 lumber sales versus 2% in 2007. Together with Japan, Asia sales accounted for approximately 30% of 2013 lumber sales. Moreover, China has recently been purchasing an increased proportion of higher-value prime-grade lumbers. DBRS views the Chinese demand as sustainable (driven by ongoing construction-related usage) and the added diversification as positive for Canfor’s business profile.

DBRS expects U.S. housing starts to be approximately 1.1 million to 1.2 million units in 2014 (923,400 units in 2013) and to continue strengthening steadily, which bodes well for Canadian lumber exports and the U.S. lumber market. To put the matter into perspective, U.S. housing starts are still well below the 1980 to 2008 average of 1.5 million units or the projected 1.6 million to 1.9 million units required to accommodate population growth and new households, according to the Harvard University Joint Center for Housing Studies. In terms of prices and volumes, DBRS expects slightly weaker prices driven by additional lumber supplies. On the other hand, offshore lumber markets are expected to remain solid, supported by sustained demand from China and Japan. In terms of pulp and paper, DBRS expects the pulp market to be under pressure due to significant new South American hardwood pulp capacity projected to come online in 2014, which would likely have negative effects on global pulp prices. Overall, 2014 results are expected to be similar to 2013 levels, driven by solid results in lumber that will more than offset the weaker results in pulp and paper. Moreover, the high likelihood of continued weakness in the Canadian dollar could further benefit earnings. As a result, Canfor is expected to be able to sustain its credit metrics at the current level and remain compatible with the current rating going forward.

Canfor has continued to maintain a low-debt financial profile, with adjusted debt leverage (including operating leases as debt) below 26% since 2009 – currently at 17% at the end of 2013 – which adds additional support for the rating. Going forward, capital expenditures are expected to be funded internally and free cash flow is expected to remain at strong levels.

DBRS notes that Canfor exhibited an added degree of volatility in its earnings in the last downturn, which was one of the worst U.S. housing cycles in history. As a result, Canfor was downgraded into the high-yield rating category and stayed in that category for an extended period of time. With better operating efficiencies due to targeted capital spending, disposition of underperforming non-core joint ventures and material diversification in Asia, DBRS expects Canfor’s results to be less volatile during the next downturn.

On top of everything, Canfor has been working on several green energy turbine projects at its pulp mills, and it has secured agreements with British Columbia Hydro & Power Authority to sell incremental power. This has the potential of translating into a material source of income, which DBRS views positively.

In conclusion, DBRS expects the credit metrics of Canfor to remain solid in the investment-grade range for the foreseeable future, based on the anticipation of continuing recovery in the U.S. housing market.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Companies in the Forest Products Industry, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.