March 29, 2012 / 6:30 PM / 8 years ago

TEXT-S&P revises Millar Western outlook to negative

Overview	
    -- We are revising our outlook on pulp and lumber producer Millar Western 	
Forest Products Ltd. to negative from stable. 	
    -- We are also affirming our 'B-' long-term corporate credit rating on 	
the company, as well as our 'B-' issue-level rating on Millar Western's senior 	
unsecured notes due 2021.  The '4' recovery rating on the debt is unchanged.	
    -- The outlook revision reflects our concerns about the company's 	
deteriorating profitability stemming from lower bleached 	
chemi-thermomechanical pulp prices and negative cash flow generation.	
	
Rating Action	
On March 29, 2012, Standard & Poor's Ratings Services revised its outlook on 	
Calgary, Alta.-based Millar Western Forest Products Ltd. to negative from 	
stable. 	
	
Standard & Poor's also affirmed its 'B-' long-term corporate credit rating on 	
the company, as well its 'B-' issue-level rating on Millar Western's senior 	
unsecured notes due 2021. The '4' recovery rating on the debt is unchanged.	
	
The outlook revision reflects our concerns about the company's deteriorating 	
profitability stemming from lower bleached chemi-thermomechanical pulp (BCTMP) 	
prices and negative cash flow generation.	
	
Rationale	
The ratings on Millar Western reflect what Standard & Poor's views as the 	
company's highly leveraged financial risk profile; participation in the highly 	
cyclical, fragmented, and competitive pulp and lumber industries; competition 	
in hardwood pulp from South American producers; exposure to changes in 	
volatile exchange rates; and limited geographic diversity. These weaknesses 	
are partially offset, in our opinion, by the company's modern, efficient 	
assets, and high degree of fiber and energy self-sufficiency. 	
	
Millar Western is a small, privately held pulp and lumber producer. It 	
operates three sawmills with a combined annual capacity of 540 million board 	
feet, and one pulp mill with an annual capacity to produce 320,000 metric tons 	
of BCTMP. 	
	
We consider Millar Western's financial risk profile as highly leveraged. The 	
company's adjusted debt is about C$242 million as of Dec. 31, 2011, and we 	
expect it to remain flat in the near term. Standard & Poor's adjusted leverage 	
ratio is about 6.6x as of Dec. 31, and expected to remain at elevated levels 	
in near term. Given our expectations of weaker BCTMP prices and the absence of 	
lumber hedges in 2012, leverage is likely to increase in 2012 to about 8.5x 	
before improving in 2013 to about 5.0x on a recovery of lumber and pulp 	
prices. Our forecasts assume pulp mill nets will be between C$450 and C$500 	
for 2012 and 2013. Millar Western's cash flow protection levels, as measured 	
by funds from operations (FFO) to debt, remain weak in our view, at about 8% 	
at Dec. 31. However, we do not expect FFO to debt to be negative in 2012 or to 	
weaken from current levels. 	
	
Standard & Poor's views the company's business risk profile as vulnerable. 	
Millar Western's profitability is volatile, we believe, due to the highly 	
cyclical nature of pulp and lumber prices. The excess capacity of North 	
American pulp manufacturers has increased sales to Asia recently, where 	
growing demand and bulk discounts are widespread. The company's BCTMP 	
operation is exposed to the competitive threat of increasing low-cost 	
eucalyptus pulp production, mainly from very large South American pulp 	
producers. Bleached eucalyptus (BEK) pulp has become a major source of 	
hardwood pulp because of its lower production costs and desirable performance 	
features. That said, BCTMP is somewhat protected from substitution risk 	
because it adds certain performance characteristics to paper board and tissue 	
(primarily bulk and opacity). BCTMP prices generally tend to follow BEK price 	
trends. We expect operating profitability from Millar Western's BCTMP segment, 	
which has been responsible for almost all of the company's EBITDA generation 	
in recent years, to decline moderately in 2012 on lower pulp prices. 	
	
The company's lumber operations are being affected by weak lumber demand and 	
prices given historically low U.S. housing starts. Subsequent to the 	
completion of its state-of-the-art Fox Creek sawmill, Millar Western's 	
operating efficiency will improve; however, the company's weak market position 	
has exposed it to volatile lumber prices. While we expect lumber prices to 	
increase about 4% from 2011 levels and shipments to increase by 25%, the 	
positive momentum will be mitigated by the absence of lumber hedges in 2012, 	
resulting in lower segment EBITDA. In 2011, the company's lumber business 	
benefited by C$14 million from these lumber hedges.	
	
Millar Western's operating assets are located within 200 kilometers of 	
Edmonton, Alta. The company's limited geographic diversity of assets has 	
resulted in foreign exchange rate risks, as sales are predominantly in U.S. 	
dollars and costs in Canadian dollars. These weaknesses are partially offset 	
by its competitive cost position, which we believe has insulated Millar 	
Western from the worst of the energy and fiber cost increases that most of its 	
peers have experienced. The company's ability to generate better margins than 	
its competitors is particularly important at the bottom of the cycle. Its pulp 	
and sawmills benefit from a low-cost fiber supply; a high degree of energy 	
self-sufficiency provided through a long-term power purchase agreement; 	
modern, cost-efficient equipment; and a non-unionized workforce. The company's 	
new Fox Creek sawmill and pulp mill in Whitecourt, Alta., use state-of-the-art 	
technology and automation and consistently operate above design-capacity 	
levels. 	
	
Liquidity	
We consider Millar Western's liquidity to be adequate based on our criteria. 	
As of Dec. 31, 2011, the company had about C$78 million in liquidity, which 	
consisted of C$31.6 million in cash and C$46.4 million available on a C$50.0 	
million revolving credit facility net of letters of credit. We forecast a cash 	
sources-to-uses ratio of 3.8x in the next year as no major capex or debt 	
maturities are expected. The revolving facility matures in November 2013, and 	
is subject to a borrowing base determined by accounts receivable and 	
inventory, which insures access at all points in the cycle. Under current 	
criteria, we do not give credit to the availability of the revolver maturing 	
within 12 months, and so liquidity will decline to less-than-adequate by 	
November if the revolver is not extended. The credit facility contains a 	
working-capital ratio financial covenant under which the company has ample 	
headroom. Standard & Poor's expects Millar Western's liquidity to decline 	
early in 2012 due to working-capital growth from inventory build up during the 	
winter months and the ramp up of Fox Creek. Nevertheless, we expect liquidity 	
to remain above C$45 million in the near term.	
	
Recovery analysis	
For the complete recovery rating analysis, see the recovery report on Millar 	
Western to be published on RatingsDirect on the Global Credit Portal following 	
this report.	
	
Outlook	
The negative outlook reflects what we view as Millar Western's deteriorating 	
profitability stemming from lower BCTMP prices and negative cash flow 	
generation. While we expect the company will generate negative cash from 	
operations, liquidity should remain in the C$45 million-C$60 million range in 	
2012. A negative rating action would likely occur if cash burn accelerates, 	
resulting in a weakening of Millar Western's fixed charge coverage ratio below 	
1x. 	
	
A positive rating action in the near term is unlikely but would require the 	
company to demonstrate improved profitability in the coming quarters resulting 	
in a debt-to-EBITDA ratio of below 5x on a sustained basis. The ratings are 	
constrained to the 'B' category by Millar Western's business risk profile, 	
including its small market position in the highly competitive pulp and lumber 	
industries, exposure to volatile pulp and lumber prices and exchange rates, 	
and limited operating diversity.	
	
	
Ratings List	
Millar Western Forest Products Ltd.	
Outlook Revised To Negative	
                         To                From	
Corporate credit rating  B-/Negative/--    B-/Stable/--	
	
Ratings Affirmed/Recovery Rating Unchanged	
Senior unsecured debt      B-	
 Recovery rating           4
0 : 0
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