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