TEXT - S&P revises Potlatch Corp outlook to stable

Mon Oct 29, 2012 1:00pm EDT

Related Topics

Overview
     -- Improving housing markets combined with good demand and pricing for 
wood products have resulted in better-than-expected earnings for U.S. timber 
real estate investment trust (REIT) Potlatch Corp. 
     -- We are revising our outlook to stable from negative and affirming all 
existing ratings, including our 'BB' corporate credit rating.
     -- The stable rating outlook reflects our expectations that improving 
housing and lumber markets will result in Potlatch's leverage declining to 4x 
over the next several quarters.
 
Rating Action
On Oct. 29, 2012, Standard & Poor's Ratings Services revised its outlook on 
Spokane, Wash.-based Potlatch Corp. to stable from negative. At the same time, 
we affirmed all existing ratings, including our 'BB' corporate credit rating 
on the company.

Rationale
The outlook revision and affirmation reflects our improved view for Potlatch's 
EBITDA performance in light of recovering housing markets and better than 
previously anticipated wood products segment earnings. As a result, we now 
expect Potlatch's leverage to decline to approximately 4x at year end 2012 and 
be maintained below 4x in 2013.

The ratings on Potlatch reflect what Standard & Poor's considers to be the 
company's "fair" business risk as a midsize forest products company with 
cyclical earnings and cash flow-primarily in wood products manufacturing-and 
modest geographic diversity. In addition, we have revised our assessment of 
Potlatch's financial risk as "significant" from "aggressive" given our view 
that leverage over the next several quarters will decline to 4x or below.

Under our baseline scenario, we expect Potlatch's 2012 EBITDA to be relatively 
in line with the $119 million of EBITDA generated in 2011. For 2013, we 
estimate EBITDA to be comparable with 2012's forecasted level. Key assumptions 
to our EBITDA forecast include:

     -- U.S. housing starts improve to 750,000 in 2012 and 950,000 in 2013;
     -- Annual harvest volumes remain in-line with management's guidance for 
about 3.5 million tons, compared with 2011's level of about 4.1 million tons; 
     -- Favorable demand and pricing conditions for manufactured wood products 
continue throughout 2013; and
     -- A material decline in its real estate segment's sales following the 
disposal of most of its non-strategic timberland over the past three years 
(non-strategic timberland sales constituted over $30 million of sales in 2011 
and $70 million of sales in 2010).

A key downside risk to our near-term forecast would be weaker-than-expected 
pricing or demand for the company's timber and wood products if the expected 
recovery in housing markets were to reverse in 2013. A key upside risk is if 
better-than-anticipated log pricing conditions were to result in annual 
harvest levels returning to 4 million tons or more.

Potlatch's debt (including $123 million of operating leases and 
pension-related adjustments) was about $470 million as of June 30, 2012. Based 
on our operating assumptions, we forecast debt to EBITDA could approximate 4x 
at the end of 2012, a level we view as consistent with the 'BB' rating given 
its "fair" business risk. In addition, we expect funds from operations (FFO) 
to debt could be in the high-teens range in 2012, compared with nearly 19% and 
4x for 2011, respectively. For 2013, we anticipate credit metrics 
approximating 2012's forecasted levels.

Potlatch is a U.S. timber REIT that owns and manages approximately 1.43 
million acres of timberlands in Arkansas, Idaho, and Minnesota. It is our view 
that the carrying value of these timberlands (about $651 per acre) materially 
understates the economic value of these holdings. For example, Potlatch's 
debt-to-capital is 76% on a book value basis. However, debt-to-capital is 
closer to 18% if we adjust these holdings closer to market value using an 
estimated market value of approximately $1,720 per acre. We derived this 
estimated value using a range of recent timberland transactions as reported by 
publicly traded timber REITs and the appraised value of Potlatch's Idaho 
timberlands pledged to secure its bank credit facility. The values per acre 
ranged from about $2,000 per acre in Idaho to $750 per acre in the Lake States 
to $1,550 per acre in the U.S. South. This analysis did not ascribe additional 
value to the 220,000 to 250,000 acres of property held for higher or better 
uses other than timberlands.

In addition to its timberlands operations, Potlach also conducts a land sales 
and development business and operates wood products manufacturing facilities 
through its taxable REIT subsidiary. While the company's end markets are 
cyclical, the degree of cyclicality varies, as log prices generally are more 
stable than lumber due to its more diversified end markets. The company is 
committed to expanding its land holdings where it currently has a geographic 
footprint and regional expertise (Idaho and the central South). However, our 
rating and outlook do not incorporate significant debt-financed timberland 
acquisitions in the next several quarters given the current market environment.

Liquidity
Our assessment of Potlatch's "adequate" liquidity is based on the following:

     -- We expect that sources of liquidity (including cash, forecasted funds 
from operations, and availability on its revolving credit facility) over the 
next year will exceed its uses by 1.2x or more.  
     -- We expect that net sources would be positive even with a 15% drop in 
EBITDA.
     -- Covenant compliance would also survive a 15% drop in EBITDA. 
Potlatch's credit agreement requires a funded indebtedness to capitalization 
ratio of 70% or less, collateral coverage of 3x or more, a minimum interest 
coverage ratio of 2x, and a minimum liquidity requirement of $60 million.

As of Sept. 30, 2012, the company's sources of liquidity included cash and 
short-term investments of approximately $62 million and an undrawn $150 
million revolving credit facility due Dec. 8, 2013. Our ratings assume cash 
balances and FFO will be used for near-term debt retirement, including $8 
million of maturities in 2013, annual capital expenditures requirements of 
about $15 million, and supporting the approximately $50 million annual 
dividend. Based on our EBITDA forecast, we expect the company to generate free 
cash flow in excess of its dividend in 2012 and 2013. We expect the company to 
address the 2013 maturity of its revolving credit facility in a timely manner 
and that any future acquisitions or share repurchases would not constrain the 
company's liquidity position.

Recovery analysis
The company's senior secured debentures are rated 'BBB-' with a '1' recovery 
rating, indicating our expectation for very high (90% to 100%) recovery in the 
event of a payment default. The company's senior unsecured notes are rated 
'BB' with a '3' recovery rating, indicating our expectation for meaningful 
(50% to 70%) recovery in the event of a payment default. For the complete 
recovery analysis, please see our recovery report on Potlatch published 
shortly after this report, on RatingsDirect.

Outlook
The stable rating outlook reflects our expectations that improving housing and 
lumber markets will result in Potlatch's leverage declining to 4x over the 
next several quarters. In addition, we expect the company to maintain its 
adequate liquidity position and address the 2013 revolver maturity in a timely 
manner.

We could lower the rating if a housing recovery stalls resulting in financial 
measures more indicative of an aggressive financial risk profile, or if the 
company's financial policy becomes more aggressive with regard to dividends, 
share repurchases, or debt-financed timberland purchases. Specifically, we 
would view leverage approaching 5x and FFO to debt in the low teens area on a 
sustained basis as consistent with a lower rating.

An upgrade could occur if a continued improvement in log and lumber markets 
results in the company sustaining EBITDA approximately 20% above our projected 
2013 level such that FFO to debt increases to 25% and debt to EBITDA declines 
to the mid-3x area. 

Related Criteria And Research
     -- Methodology And Assumptions: Liquidity Descriptors For Global 
Corporate Issuers, Sept. 28, 2011
     -- Key Credit Factors: Criteria For Rating The Forest Products Industry, 
Dec. 11, 2009
     -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008

Ratings List

Ratings Affirmed; Outlook Action
                                        To                 From
Potlatch Corp.
 Corporate Credit Rating                BB/Stable          BB/Negative

Ratings Affirmed

Potlatch Corp.
 Senior Secured                         BBB-               
  Recovery Rating                       1                  
 Senior Unsecured                       BB                 
  Recovery Rating                       3
FILED UNDER:
Comments (0)
This discussion is now closed. We welcome comments on our articles for a limited period after their publication.