TEXT-S&P revises Ainsworth Lumber outlook to stable
Overview -- We are revising our outlook on Ainsworth Lumber Co. Ltd. to stable from negative based on the company's comprehensive refinancing transaction plan aimed at improving its capital structure. -- At the same time, we are affirming our ratings on Ainsworth, including our 'B-' long-term corporate credit rating on the company. -- In addition, we are assigning our 'B' issue-level rating and a '2' recovery rating to the company's proposed US$350 million senior secured notes. We understand that the proceeds from the proposed debt, in conjunction with funds raised through an equity rights offering, will be used to repay current and outstanding term loan and senior unsecured notes. Rating Action On Nov. 9, 2012, Standard & Poor's Ratings Services revised its outlook on Vancouver-based Ainsworth Lumber Co. Ltd. to stable from negative. At the same time, Standard & Poor's affirmed its ratings on Ainsworth, including its 'B-' long-term corporate credit rating on the company. Standard & Poor's also assigned its 'B' issue-level rating and '2' recovery rating to Ainsworth's proposed US$350 million senior secured notes. A '2' recovery rating reflects our expectation of substantial (70%-90%) recovery in a default scenario. We base our outlook revision on what we consider a credit positive deleveraging transaction that will result in an improved capital structure. In particular, the comprehensive refinancing transaction highlights that the proceeds from the proposed debt, in conjunction with funds raised through an equity rights offering, will be used to repay Ainsworth's current and outstanding term loan and senior unsecured notes. Rationale The ratings on Ainsworth reflect what Standard & Poor's views as the company's vulnerable business risk profile and highly leveraged financial risk profile. In our view, credit risks include 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 efficient Canadian assets, higher revenues generated through value-added products, and what we consider strong 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 currently operating are running at full capacity. Although 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. In our view, the long-term fundamentals for North American housing construction are favorable, and we've observed a significant rebound in housing starts through 2012. Standard & Poor's expects U.S. housing starts to rise 23% in the near term to about 750,000 starts in 2012; increasing further to 950,000 starts in 2013. While these estimates are significantly below historical averages of approximately 1.5 million starts annually, the near-term increases have boosted demand in an otherwise balanced market. 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 in the medium term (ramp-up periods are typically six to 12 months) and keep prices from moving up appreciably. In the meantime, we expect OSB prices to remain elevated creating very favorable operating environments for producers. Standard & Poor's considers Ainsworth's three operating mills to be in the lower end of the industry cost curve. Their facilities have flexible mill technology and have sufficient fiber supply through long-term licenses. Furthermore, the company 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 Grande Prairie's second line in the near term; the restart at the company's High Level, Alta., mill is more likely. Standard & Poor's considers the company's financial risk profile highly leveraged. We view the refinancing plan as a credit positive transaction, as it will result in a reduction of total debt outstanding as well as the elimination of payment-in-kind (PIK) interest. Ainsworth's adjusted total debt at Sept. 30, 2012, is C$533 million; underfunded pension obligations, operating lease adjustments, and asset retirement obligations total C$14.4 million. Pro forma for the comprehensive refinancing plan, our model includes the following assumptions: -- Current and outstanding term loan and senior unsecured notes (including accrued interest) are repaid in full in 2012; -- US$350 million in proposed senior secured notes issued in 2012; -- C$175 million in equity raised in 2012 through a backstopped rights offering; -- Sales in 2012 to increase 34% and remain flat in 2013 and 2014; -- EBITDA margins to average 23% for the next two years; and -- Capital expenditures of C$10 million per year. Based on our forecasts, we expect adjusted debt-to-EBITDA to decline from its current level of 7.9x, to 4.0x by year-end. The repayment of current senior unsecured notes will result in the elimination of PIK interest debt, and so our model forecasts relatively stable and unchanged debt. Ainsworth's earnings are highly sensitive to changes in commodity OSB prices; our model predicts a C$10 per thousand-square-foot increase (or decrease) in OSB results in a C$17 million increase (or decrease) to EBITDA. We expect cash flow protection levels, as measured by funds from operations to debt, to increase to the low-teens by year-end. Liquidity Ainsworth has adequate liquidity in our view. The company has cash on hand and short-term investments of C$92 million available for use. In addition, we've assumed the company secures an asset-based loan (ABL) credit facility in the near future as part of its comprehensive refinancing transaction. Our opinion on Ainsworth's liquidity would not be affected if an ABL agreement is not signed. In our forecasts, we expect: -- A liquidity sources-to-uses ratio greater than 1.2x for the next three years; and -- Liquidity sources are greater than uses when a 30% haircut is applied to EBITDA in each of the next two years. Subsequent to the refinancing plan, Ainsworth's debt maturity profile is favorable, with no major debt due before 2017. Capital expenditures are minimal, at about C$10 million annually, and working capital peaks at about C$15 million in first quarter when inventory build occurs. Ainsworth's proposed senior secured notes have no financial covenants; the ABL will likely have a spring-forward covenant not applicable at close. Recovery analysis For the complete recovery analysis, see the recovery report on Ainsworth to be published on RatingsDirect on the Global Credit Portal following this report. Outlook The stable outlook on Ainsworth reflects Standard & Poor's expectation that as the company completes its comprehensive refinancing plan it will have reduced debt and improved its capital structure. Furthermore, through 2012 a moderate rebound in U.S. housing construction has resulted in higher OSB prices and stronger free operating cash flow for Ainsworth. Higher cash flows from operations combined with the company's plans to sign an ABL facility help maintain adequate liquidity to fund operations. For the next year, we expect Ainsworth to continue operating at full capacity, with a slight weakening of OSB prices from current highs, although we expect free operating cash flows to remain positive. We could raise the ratings if forecasted U.S. housing starts materialize to about 1 million starts, which we do not expect until 2014, accompanied by supplier discipline leading to higher EBITDA and reduced leverage below 5x on a sustained basis. Alternatively, we could lower the ratings if the housing market does not recover as expected or if realized OSB prices fall to C$185 per thousand square foot, leading to negative free operating cash flows and a liquidity decline below C$30 million. 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 Ainsworth Lumber Co. Ltd. Outlook Revised To From Corporate credit rating B-/Stable/-- B-/Negative/-- Rating Assigned US$350 million sr secured notes B Recovery rating 2 Ratings Affirmed/Unchanged Senior secured debt B+ Recovery rating 1 Senior unsecured debt B- Recovery rating 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.