TEXT - S&P cuts Potlatch debentures to 'BB'

Wed Dec 19, 2012 11:40am EST

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Overview
     -- U.S. timber real estate investment trust (REIT) Potlatch Corp.   
 entered into a new unsecured revolving credit facility and released
collateral securing its existing secured debt.
     -- We are lowering our issue-level rating on the company's 6.95% 
debentures to 'BB' from 'BBB-' and revising the recovery rating to '3' from 
'1', as they are now unsecured.
     -- We are affirming all other 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 Dec. 18, 2012, Standard & Poor's Ratings Services lowered its issue-level 
rating on Spokane, Wash.-based Potlatch Corp.'s 6.95% debentures' to 'BB' 
(same as the corporate credit rating) from 'BBB-' and revised the recovery 
rating to '3', which indicates our expectation of meaningful (50% to 70%) 
recovery for lenders in the event of a default, from '1'. 

At the same time, we affirmed all other ratings, including our 'BB' corporate 
credit rating, on Potlatch. The outlook is stable.

Rationale
The issue-level rating action and corporate credit rating affirmation follow 
Potlatch Corp.'s entry into a new $250 million unsecured revolving credit 
facility and reflect the release of collateral securing the debentures 
according to the company's latest 8-K report. The 'BB' issue-level for the 
6.95% debentures is in line with our 'BB' corporate credit rating on the 
company and our notching guidelines for a '3' recovery rating.

The ratings on Potlatch reflect Standard & Poor's assessment of the company's 
"fair" business risk. Potlatch is a midsize forest products company with 
cyclical earnings and cash flow--primarily in wood products manufacturing--and 
modest geographic diversity. The ratings also incorporate our assessment of 
Potlatch's "significant" financial risk, given our view that the company's 
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 
flat with the $119 million it generated in 2011. For 2013, we estimate that 
the company's EBITDA will be comparable to our forecasted 2012 level. Key 
assumptions in our EBITDA forecast include:
     -- U.S. housing starts improve to 770,000 in 2012 and to 1.05 million in 
2013.
     -- Annual harvest volumes are in line with management's guidance of about 
3.5 million tons (compared with about 4.1 million tons in 2011).
     -- Favorable demand and pricing conditions for manufactured wood products 
continue throughout 2013.
     -- The company's real estate segment's sales decline materially, 
following the disposal of most of its nonstrategic timberland over the past 
three years. (Nonstrategic timberland accounted for more than $30 million of 
sales in 2011 and $70 million in 2010.)

A key risk to our near-term forecast is the potential for weaker-than-expected 
pricing or demand for the company's timber and wood products if the expected 
recovery in the housing markets should reverse in 2013. Conversely, the 
company's results could benefit if better-than-anticipated log pricing results 
in annual harvest levels returning to four million tons or more.

Potlatch's debt (including $123 million of operating leases and 
pension-related adjustments) totaled about $470 million as of Sept. 30, 2012. 
Based on our operating assumptions, we forecast that the ratio of debt to 
EBITDA at the end of 2012 could approximate 4x--a level we view as consistent 
with the 'BB' rating, given the company's fair business risk profile. In 
addition, we believe that Potlatch's funds from operations (FFO) to debt could 
be in the high-teens area in 2012. These ratios compare with nearly 19% and 
4x, respectively, in 2011. For 2013, we anticipate that credit metrics will 
approximate our forecast for 2012.

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 their economic value. For example, Potlatch's debt to capital 
ratio is 76% on a book value basis. However, debt to capital is closer to 22% 
if we adjust these holdings closer to market value, using an estimated market 
value of approximately $1,400 per acre. (We derived this estimate by reviewing 
a range of recent timberland transactions, as reported by publicly traded 
timber REITs, and by considering the appraised value of Potlatch's timberlands 
as required by its new credit agreement. The values ranged from about $1,500 
per acre in Idaho to $750 per acre in the Lake States and $1,550 per acre in 
the U.S. South. Our analysis does not ascribe additional value to the 220,000 
to 250,000 acres of property held for higher or better uses than timberlands).

In addition to its timberlands operations, Potlatch conducts a land sales and 
development business and operates wood products manufacturing facilities 
through its taxable REIT subsidiary. Although the company's end markets are 
cyclical, the degree of cyclicality varies, as log prices are generally more 
stable than those for lumber, owing to 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, given the current market environment, our ratings and outlook do not 
incorporate significant debt-financed timberland acquisitions in the next 
several quarters.

Liquidity
We view Potlatch's liquidity as "strong," based on the following factors:
     -- Sources of liquidity (including forecasted FFO, cash balances, and 
availability on its revolver) will exceed uses by 1.5x or more over the next 
year.
     -- Liquidity sources will continue to exceed uses, even if forecasted 
EBITDA declines by 30%.
     -- Sufficient covenant headroom exists for forecasted EBITDA to decline 
by 30% without the company breaching coverage tests. 
     -- Potlatch's credit agreement requires leverage to be 5x or less, 
timberland collateral coverage of 3x or more, and a minimum interest coverage 
ratio of 3x. The maximum leverage requirement declines to 4.5x on March 31, 
2015. 

The company's sources of liquidity included cash and short-term investments of 
approximately $62 million, as of Sept. 30, 2012, and an undrawn new $250 
million revolving credit facility due 2017. Our ratings assume that the 
company will use cash balances and FFO for near-term debt retirement 
(including $8 million of maturities in 2013) and annual capital expenditure 
requirements of about $15 million, as well as to support 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 payments in 2012 and 
2013. 

Recovery analysis
We rate Potlatch's debentures and senior unsecured notes 'BB', with a recovery 
rating of '3', indicating our expectation of meaningful (50% to 70%) recovery. 
For our complete recovery analysis, see Standard & Poor's recovery report on 
Potlatch published shortly after this report on RatingsDirect.

Outlook
The stable rating outlook reflects our expectation that improving housing and 
lumber markets will result in Potlatch's leverage declining to 4x over the 
next several quarters. 

We could raise the rating if a continued improvement in the log and lumber 
markets results in the company's 2013 EBITDA being approximately 20% higher 
than our current projection--in turn, increasing its FFO to 25% and causing 
its debt to EBITDA to decline to the mid-3x area.

We could lower the ratings if the expected housing recovery stalls, rendering 
Potlatch's financial measures more indicative of an "aggressive" financial 
risk profile, or if the company's financial policy becomes more aggressive 
with respect 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.

Related Criteria And Research
     -- Top 10 Investor Questions For 2013: Global Forest Products, Dec. 5, 
2012
     -- Business Risk/Financial Risk Matrix Expanded, Sept. 18, 2012
     -- 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

Temporary telephone contact numbers: Tobias Crabtree (917-539-4614); James 
Fielding (917-734-3477)

Ratings List
Ratings Affirmed

Potlatch Corp.
 Corporate Credit Rating                BB/Stable/--       
 Senior Unsecured                       BB                 
  Recovery Rating                       3          

Downgraded
                                        To                 From
Potlatch Corp.
 Senior Unsecured                       BB                 BBB-
  Recovery Rating                       3                  1
FILED UNDER:
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