(The following statement was released by the rating agency)Overview
-- We are raising our issue-level rating on Montreal-based ResoluteForest Products Inc.'s US$850 million senior secured notes to 'BB' from 'BB-',and revising our recovery rating on the debt to '2' from '3'.
-- We base the revision to the recovery rating on the company's lowerdebt levels due to recent voluntary debt repayments from internally generatedcash flows.
-- At the same time, we are affirming our 'BB-' long-term corporatecredit rating on the company.
-- The stable outlook on Resolute reflects our view that, despite lowerdemand for commercial printing papers, prices should remain stable in the nearterm and the company will continue to generate positive free cash flows drivenby operating efficiencies.
Rating ActionOn Oct. 9, 2012, Standard & Poor's Ratings Services raised its issue-levelrating on Montreal-based Resolute Forest Products Inc.'s US$850 million seniorsecured notes to 'BB' from 'BB-'. At the same time, Standard & Poor's revisedits recovery rating on the debt to '2' from '3'. A '2' recovery ratingreflects our expectations of a substantial (70%-90%) recovery in a defaultscenario.
We base the revision to the recovery rating on the enhanced recovery prospectsfollowing the announcement of another voluntary debt repayment (US$85 million)toward the company's 10.25% senior secured notes funded from internallygenerated cash flows.
At the same time, Standard & Poor's affirmed its 'BB-' long-term corporatecredit rating on the company. The outlook is stable.
The ratings on Resolute reflect what Standard & Poor's views as the company'sweak business risk profile and significant financial risk profile. Resolutemaintains strong market positions in the North American newsprint, anduncoated and coated papers sectors; a considerably improved cost structure;capital expenditure projects to expand its current portfolio of cogenerationassets; and significantly lower debt levels and fixed charges after emergingfrom bankruptcy. These strengths are somewhat offset, in our opinion, by thecontinuing declining demand in North America for the company's paper products,the inherent volatility in pulp and paper prices, a growing underfundedpension obligation, and Resolute's exposure to the cyclical U.S. housingconstruction market through its wood products business.
Resolute is North America's largest newsprint producer, with about 3 millionmetric tons of operating capacity. The company also produces a wide range ofcommercial printing and packaging papers, market pulp, and wood products. Itoperates 21 pulp and paper mills and 22 wood products facilities in the U.S.,Canada, and South Korea.
Standard & Poor's considers Resolute's business risk profile as weak becauseof the company's large exposure to newsprint and uncoated paper markets, andpulp production subsequent to its Fibrek Inc. (not rated) acquisition.Resolute is the largest global newsprint producer by capacity, withapproximately 39% of North America capacity. However, despite its strongmarket position and large economies of scale, the company's core newsprintbusiness is in secular decline in North America, with an annual decline indemand forecast at 4% in 2012. We expect future newsprint demand to fall 4%-5%annually. Newsprint consumption has dropped by almost 50% since 2006, withproducers continually closing mills to adapt to shrinking demand. We believethat Resolute's coated and uncoated paper businesses will also continue toface weak demand, with declines in uncoated mechanical papers about 11% in2012 and coated mechanical demand falling 4%. Waning demand is a result ofweak U.S. print advertisements and electronic substitution. Furthermore,Resolute is exposed to the volatile pulp market, particularly after its recentacquisition of Fibrek. Pulp prices have remained low throughout 2012 despitestrong global demand. We expect recovery in pulp prices in the medium term,contingent on the general economic recovery of western Europe, the largestconsumer of market pulp. Resolute's wood products business has performedbetter than last year, following a substantial recovery in U.S. housingconstruction markets this year. We expect housing starts of about 760,000 in2012, a 25% increase compared with 2011, and expect starts of about 940,000 in2013, a forecasted increase of 24%. As a result, lumber prices are likely toremain at current, if not higher, prices in the near term.
Resolute's cost position has improved in the past year due to its continuousefforts to close high-cost capacity and renegotiate labor agreements. Most ofthe company's newsprint mills are now considered to be in the first and secondquartiles of the industry cost curve. Furthermore, Resolute has undertakenmultiple cogeneration expansion projects that will come online in the nextyear and boost EBITDA about 10%. However, profitability can change quickly ifnewsprint prices do not materialize as expected or if they decline; a US$25per metric ton change in newsprint prices can have about a US$67 millionimpact on EBITDA. Now that Resolute has acquired Fibrek, we expect a US$25change in pulp prices to result in a US$45 million impact on EBITDA.
Standard & Poor's considers Resolute's financial risk profile as significant.New management appears committed to reducing debt, as demonstrated by thecompany's US$354 million repayment of debt in 2011, and more recent US$85million repayment announced in September 2012. Standard & Poor's totaladjusted debt (adjusted for underfunded pension obligations) at June 30, 2012,is US$1.9 billion. Adjustments total US$1.2 billion for underfunded pensionobligations, asset retirement obligations, operating leases, and a qualifiedspecial purpose entity. Pension adjustments have increased substantially dueto lower discount rates on obligations. Resolute estimates a 1% increase indiscount rates will decrease pension deficits by US$450 million. AdjustedEBITDA for the last 12 months ended June 30, 2012, is US$440 million,resulting in an adjusted-debt-to-EBITDA ratio of 4.3x. Our financial modelassumes the following:
-- Fibrek's debt repaid (full consolidation effective May 2012) inthird-quarter 2012, and a US$85 million repayment on the 2018 senior securednotes;
-- Commercial printing paper prices are stable, with volume declines inthe single digits;
-- Pulp volumes increase from the addition of Fibrek, and a slow pricerecovery;
-- Revenues decline 5% to US$4.5 billion in 2012, and operating costsdecline almost 5% in 2012;
-- EBITDA margins in the single digits for 2012 and 2013; and
-- Pension contributions of about US$90 million in 2012 and increasingthereafter.
We expect that adjusted debt-to-EBITDA will peak in 2012 to about 4.5x andthen decline to below 4.0x in 2013. Our forecasts are highly sensitive toprices and costs in the newsprint, specialty papers, and pulp segments, andany changes in market dynamics can have sizable effects on ratios. We expectResolute will generate positive cash flows, after consideration for theacquisition of Fibrek, debt repayments, and share repurchases. Cash flowprotection, as measured by funds from operations to debt, was 18% at June 30,2012, which we expect to increase to about 20% by year-end.
We consider the company's liquidity position as strong based on our followingexpectations:
-- A sources-to-uses ratio greater than 3x in the medium term; and
-- A positive sources-minus-uses calculation if EBITDA declines 30%.
As of June 30, 2012, Resolute had US$510 million cash on hand and has a US$600million asset-based loan (ABL) facility of which US$472 million remainsavailable. The ABL facility matures in October 2016, and we expect theborrowing base will have increased slightly with the acquisition of Fibrek. Weexpect cash flow from operations to be positive in 2012, and thus we expectliquidity to remain above the company's target of US$600 million and capitalexpenditure to be modest in the near term. Debt maturities are favorable, asthe nearest occurs in 2016.
Recovery analysisFor the complete recovery analysis, see the recovery report on Resolute to bepublished on RatingsDirect on the Global Credit Portal following this report.
The stable outlook on Resolute reflects our view that, despite lower demandfor commercial printing papers, prices should remain stable in the near termand the company will continue to generate positive free cash flows driven byoperating efficiencies. We expect the company to use some of the excess cashto continue to pay down debt in 2013, as it did in 2012, and for leverage toimprove below its current levels of about 4x. We could lower the ratings onResolute under a number of possible scenarios including: if agreater-than-expected decline in paper demand combined with newsprint pricesbelow US$575 per metric ton lead to leverage above 4.5x, if cash on hand isused for large shareholder-friendly initiatives that would reduce liquidity,or if a change in financial policy leads to an aggressive financial riskprofile. An upgrade in the near term could occur if the firm's operationscontinue to diversify into stable margin segments, if actuarial assumptionsreduce underfunded pension liabilities resulting in smaller fundingrequirements, or if voluntary debt repayments result in an adjusteddebt-to-EBITDA ratio 3x on a sustainable basis.
Related Criteria And Research
-- Methodology and Assumptions: Liquidity Descriptors For GlobalCorporate Issuers, Sept. 28, 2011
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008Ratings ListResolute Forest Products Inc.Rating Raised/Recovery Rating RevisedTo FromSenior secured notes BB BB-Recovery rating 2 3Rating AffirmedCorporate credit rating BB-/Stable/--
Complete ratings information is available to subscribers of RatingsDirect onthe Global Credit Portal at
. All ratings affectedby this rating action can be found on Standard & Poor's public Web site at. Use the Ratings search box located in the leftcolumn.(New York Ratings Team)