TEXT-S&P raises Resolute Forest Products debt ratings
Overview -- We are raising our issue-level rating on Montreal-based Resolute Forest Products Inc.'s US$850 million senior secured notes to 'BB' from 'BB-', and revising our recovery rating on the debt to '2' from '3'. -- We base the revision to the recovery rating on the company's lower debt levels due to recent voluntary debt repayments from internally generated cash flows. -- At the same time, we are affirming our 'BB-' long-term corporate credit rating on the company. -- The stable outlook on Resolute reflects our view that, despite lower demand for commercial printing papers, prices should remain stable in the near term and the company will continue to generate positive free cash flows driven by operating efficiencies. Rating Action On Oct. 9, 2012, Standard & Poor's Ratings Services raised its issue-level rating on Montreal-based Resolute Forest Products Inc.'s US$850 million senior secured notes to 'BB' from 'BB-'. At the same time, Standard & Poor's revised its recovery rating on the debt to '2' from '3'. A '2' recovery rating reflects our expectations of a substantial (70%-90%) recovery in a default scenario. We base the revision to the recovery rating on the enhanced recovery prospects following the announcement of another voluntary debt repayment (US$85 million) toward the company's 10.25% senior secured notes funded from internally generated cash flows. At the same time, Standard & Poor's affirmed its 'BB-' long-term corporate credit rating on the company. The outlook is stable. Rationale The ratings on Resolute reflect what Standard & Poor's views as the company's weak business risk profile and significant financial risk profile. Resolute maintains strong market positions in the North American newsprint, and uncoated and coated papers sectors; a considerably improved cost structure; capital expenditure projects to expand its current portfolio of cogeneration assets; and significantly lower debt levels and fixed charges after emerging from bankruptcy. These strengths are somewhat offset, in our opinion, by the continuing declining demand in North America for the company's paper products, the inherent volatility in pulp and paper prices, a growing underfunded pension obligation, and Resolute's exposure to the cyclical U.S. housing construction market through its wood products business. Resolute is North America's largest newsprint producer, with about 3 million metric tons of operating capacity. The company also produces a wide range of commercial printing and packaging papers, market pulp, and wood products. It operates 21 pulp and paper mills and 22 wood products facilities in the U.S., Canada, and South Korea. Standard & Poor's considers Resolute's business risk profile as weak because of the company's large exposure to newsprint and uncoated paper markets, and pulp production subsequent to its Fibrek Inc. (not rated) acquisition. Resolute is the largest global newsprint producer by capacity, with approximately 39% of North America capacity. However, despite its strong market position and large economies of scale, the company's core newsprint business is in secular decline in North America, with an annual decline in demand forecast at 4% in 2012. We expect future newsprint demand to fall 4%-5% annually. Newsprint consumption has dropped by almost 50% since 2006, with producers continually closing mills to adapt to shrinking demand. We believe that Resolute's coated and uncoated paper businesses will also continue to face weak demand, with declines in uncoated mechanical papers about 11% in 2012 and coated mechanical demand falling 4%. Waning demand is a result of weak U.S. print advertisements and electronic substitution. Furthermore, Resolute is exposed to the volatile pulp market, particularly after its recent acquisition of Fibrek. Pulp prices have remained low throughout 2012 despite strong global demand. We expect recovery in pulp prices in the medium term, contingent on the general economic recovery of western Europe, the largest consumer of market pulp. Resolute's wood products business has performed better than last year, following a substantial recovery in U.S. housing construction markets this year. We expect housing starts of about 760,000 in 2012, a 25% increase compared with 2011, and expect starts of about 940,000 in 2013, a forecasted increase of 24%. As a result, lumber prices are likely to remain at current, if not higher, prices in the near term. Resolute's cost position has improved in the past year due to its continuous efforts to close high-cost capacity and renegotiate labor agreements. Most of the company's newsprint mills are now considered to be in the first and second quartiles of the industry cost curve. Furthermore, Resolute has undertaken multiple cogeneration expansion projects that will come online in the next year and boost EBITDA about 10%. However, profitability can change quickly if newsprint prices do not materialize as expected or if they decline; a US$25 per metric ton change in newsprint prices can have about a US$67 million impact on EBITDA. Now that Resolute has acquired Fibrek, we expect a US$25 change in pulp prices to result in a US$45 million impact on EBITDA. Standard & Poor's considers Resolute's financial risk profile as significant. New management appears committed to reducing debt, as demonstrated by the company's US$354 million repayment of debt in 2011, and more recent US$85 million repayment announced in September 2012. Standard & Poor's total adjusted debt (adjusted for underfunded pension obligations) at June 30, 2012, is US$1.9 billion. Adjustments total US$1.2 billion for underfunded pension obligations, asset retirement obligations, operating leases, and a qualified special purpose entity. Pension adjustments have increased substantially due to lower discount rates on obligations. Resolute estimates a 1% increase in discount rates will decrease pension deficits by US$450 million. Adjusted EBITDA for the last 12 months ended June 30, 2012, is US$440 million, resulting in an adjusted-debt-to-EBITDA ratio of 4.3x. Our financial model assumes the following: -- Fibrek's debt repaid (full consolidation effective May 2012) in third-quarter 2012, and a US$85 million repayment on the 2018 senior secured notes; -- Commercial printing paper prices are stable, with volume declines in the single digits; -- Pulp volumes increase from the addition of Fibrek, and a slow price recovery; -- Revenues decline 5% to US$4.5 billion in 2012, and operating costs decline almost 5% in 2012; -- EBITDA margins in the single digits for 2012 and 2013; and -- Pension contributions of about US$90 million in 2012 and increasing thereafter. We expect that adjusted debt-to-EBITDA will peak in 2012 to about 4.5x and then decline to below 4.0x in 2013. Our forecasts are highly sensitive to prices and costs in the newsprint, specialty papers, and pulp segments, and any changes in market dynamics can have sizable effects on ratios. We expect Resolute will generate positive cash flows, after consideration for the acquisition of Fibrek, debt repayments, and share repurchases. Cash flow protection, as measured by funds from operations to debt, was 18% at June 30, 2012, which we expect to increase to about 20% by year-end. Liquidity We consider the company's liquidity position as strong based on our following expectations: -- A sources-to-uses ratio greater than 3x in the medium term; and -- A positive sources-minus-uses calculation if EBITDA declines 30%. As of June 30, 2012, Resolute had US$510 million cash on hand and has a US$600 million asset-based loan (ABL) facility of which US$472 million remains available. The ABL facility matures in October 2016, and we expect the borrowing base will have increased slightly with the acquisition of Fibrek. We expect cash flow from operations to be positive in 2012, and thus we expect liquidity to remain above the company's target of US$600 million and capital expenditure to be modest in the near term. Debt maturities are favorable, as the nearest occurs in 2016. Recovery analysis For the complete recovery analysis, see the recovery report on Resolute to be published on RatingsDirect on the Global Credit Portal following this report. Outlook The stable outlook on Resolute reflects our view that, despite lower demand for commercial printing papers, prices should remain stable in the near term and the company will continue to generate positive free cash flows driven by operating efficiencies. We expect the company to use some of the excess cash to continue to pay down debt in 2013, as it did in 2012, and for leverage to improve below its current levels of about 4x. We could lower the ratings on Resolute under a number of possible scenarios including: if a greater-than-expected decline in paper demand combined with newsprint prices below US$575 per metric ton lead to leverage above 4.5x, if cash on hand is used for large shareholder-friendly initiatives that would reduce liquidity, or if a change in financial policy leads to an aggressive financial risk profile. An upgrade in the near term could occur if the firm's operations continue to diversify into stable margin segments, if actuarial assumptions reduce underfunded pension liabilities resulting in smaller funding requirements, or if voluntary debt repayments result in an adjusted debt-to-EBITDA ratio 3x on a sustainable basis. 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 Resolute Forest Products Inc. Rating Raised/Recovery Rating Revised To From Senior secured notes BB BB- Recovery rating 2 3 Rating Affirmed Corporate credit rating BB-/Stable/-- 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.