TEXT-S&P removes Ainsworth Lumber from watch negative, affirms ratings
Overview -- We are removing all our ratings on Ainsworth Lumber Co. Ltd. from CreditWatch, where they had been placed with negative implications Jan. 13, 2012. -- At the same time, we are affirming all our ratings on Ainsworth, including our 'B-' long-term corporate credit rating on the company. -- The negative outlook reflects our expectations that while the company's liquidity will not deteriorate as severely as we had expected previously, its credit metrics will remain weak with slightly negative free cash generation. -- Ainsworth is an oriented strand board manufacturer with four mills in Canada with a total operating capacity of 2.5 billion square feet per year. Rating Action On April 19, 2012, Standard & Poor's Ratings Services removed all its ratings on Ainsworth Lumber Co. Ltd. from CreditWatch, where they had been placed with negative implications Jan. 13, 2012. At the same time, Standard & Poor's affirmed all its ratings on Ainsworth, including its 'B-' long-term corporate credit rating on the company. The negative outlook reflects our expectations that while the company's liquidity will not deteriorate as severely as we had expected previously, its credit metrics will remain weak with slightly negative free cash generation. Rationale The ratings on Ainsworth reflect Standard & Poor's view of the company's exposure to cyclical housing construction markets and to volatile commodity oriented strandboard (OSB) prices, limited asset and product diversification, and a highly leveraged capital structure. We believe these risks are partially mitigated by the company's low-cost position stemming from strong Canadian assets, higher revenues generated through value-added products, and what we consider adequate liquidity to weather weak industry conditions. Ainsworth is a leading OSB producer in North America, with total annual operating capacity of about 2.5 billion square feet of OSB at its four mills in Canada, although production at its High Level, Alta., mill has been curtailed since 2007. We consider Ainsworth's business risk profile vulnerable because the company sells commodity OSB into the cyclical U.S. housing construction market. The three Canadian mills Ainsworth is still running are operating at 96% of stated capacity. While the company has been substituting shipments to Asian markets (mostly Japan) away from North America, and introducing value-added products, for the most part it sells commodity product, with the U.S. housing construction market representing just under 60% of its revenues. While in our view the long-term fundamentals for the North American housing industry are favorable, we believe the near-term outlook is neutral. Standard & Poor's expects U.S. housing starts to rise 20% in the near term, with about 740,000 starts expected in 2012 and increasing to 1 million in 2013, which is significantly below the historical average of approximately 1.5 million annually. This will mean modest improvement in OSB demand and pricing in the coming years. While about 40% of OSB industry capacity remains curtailed, we believe there is considerable flex capacity in the industry. We expect this flex capacity to come online when there are inventory shortages and keep prices from moving up appreciably. In 2011, the company's cost profile improved due to slightly higher production volumes thanks to fewer days lost to downtime; capex spend in 2010 reduced production volumes. Its three operating mills are considered to be in the lower end of the industry cost curve, have flexible mill technology, and have sufficient fiber supply through long-term licenses. Furthermore, Ainsworth has more than 860 million square feet of incremental capacity that could be brought online when demand does rebound. This excludes 620 million square feet of capacity at Grande Prairie, Alta., which would require a year to complete and about C$100 million-C$120 million in cash costs and additional fiber sources. We don't expect management to go ahead with the completion of the second line at Grande Prairie in the near term. Standard & Poor's considers the company's financial risk profile as highly leveraged. Subsequent to Ainsworth's 2008 recapitalization, which reduced debt by C$441 million, the company remains highly leveraged, with Standard & Poor's adjusted total debt of C$538 million and a leverage ratio of 43x as of Dec. 31, 2011. We expect leverage to recover to about 17x by year-end and to drop below 10x by 2013, given modestly stronger OSB prices. Ainsworth is likely to continue operating its three mills at full capacity and we conservatively forecast realized OSB prices to increase by 8% in 2012, followed by a 10% increase in 2013. Western OSB prices have increased by 35% since December 2011. Our model results in slightly negative free operating cash flows for 2012 and cash flow protection levels, as measured by funds from operations to debt, below 10% in the next two years. Liquidity Ainsworth has adequate liquidity in our view, which reflects cash on hand, break-even cash flow from operations, and minimal capital expenditure and debt maturity in the next year-and-a-half. The company's only source of liquidity is cash on hand and short-term investments, which stood at C$63 million as of Dec. 31, 2011. We expect a slight decline in liquidity in 2012 to just below C$60 million. We believe the company's debt maturity profile is manageable, with no major debt due until 2014. Furthermore, Ainsworth's unsecured notes incur payment-in-kind (PIK) interest, allowing for further reduction in cash interest expense and enhancing liquidity; however, at the same time, this situation increases the debt burden. We expect the company to continue to incur PIK interest on these unsecured notes in the near term. Ainsworth's secured asset-backed loan and unsecured notes have no covenants; the company breached its minimal liquidity covenant of its equipment financing loan at Dec. 31. It was required to prepay C$269,000 in related interest expense in 2012. Recovery analysis Standard & Poor's rates the company's US$102.6 million senior secured debt 'B+' (two notches higher than the corporate credit rating on Ainsworth), with a '1' recovery rating, indicating an expectation of very high (90%-100%) recovery in the event of default. We also rate the company's US$350 million unsecured debt 'B-' (the same as the corporate credit rating on Ainsworth), with a recovery rating of '4', indicating average (30%-50%) recovery in a default scenario. Outlook The negative outlook on Ainsworth reflects Standard & Poor's expectations that while the company's liquidity will not deteriorate as severely as previously expected, its credit metrics will remain weak with slightly negative free cash generation. Overall, we believe profitability will be moderately stronger in 2012 given the recovery in commodity OSB prices seen so far this year. For the next year, we expect the company to continue operating at full capacity, and for EBITDA to be sufficient to cover cash interest expense, resulting in slightly negative free operating cash flows. We could lower the ratings if average realized OSB prices fall to C$180 per thousand square foot in 2012, leading to a decline in liquidity to below C$30 million. An upgrade in the near term in unlikely but would require improvement in Ainsworth's profitability, with sustained leverage below 5x. Related Criteria And Research -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ainsworth Lumber Co. Ltd. Ratings Affirmed And Removed From CreditWatch To From Corporate credit rating B-/Negative/-- B-/Watch Neg/-- Secured debt B+ B+/Watch Neg Recovery rating 1 1 Unsecured debt B- B-/Watch Neg Recovery rating 4 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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