DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and Unsecured Debentures rating of West Fraser Timber Co. Ltd. (West Fraser or the Company) at BBB (low), both with Stable trends.
With this review, DBRS Morningstar removed West Fraser's ratings from Under Review with Developing Implications, where they were placed on November 20, 2020, following the definitive agreement to acquire Norbord Inc. (Norbord) in an all-stock transaction. The rating confirmations follow DBRS Morningstar's expectations that the transaction will have no impact on West Fraser's overall ratings if the deal is completed as described in the arrangement agreement.
The combination with Norbord, expected to close during Q1 2021, will create a larger, diversified forest products company that produces lumber, oriented strand board (OSB), other panels and related wood products, pulp, and newsprint with operations in the U.S., Canada, the U.K., and Europe. The combined entity will have one of the lowest cost operations in the industry in most of its primary products with operating margins in the top industry quartile. West Fraser obtains approximately 80% of its Canadian log requirements from long-term timber-cutting rights in public lands. Norbord, given the flexibility in log specification requirements for OSB production, sources the majority of its fibre from open markets and thus is exposed to fluctuations in regional fibre prices which is the largest component in operating expenses. That said, the geographic diversity of regional fibre baskets mitigates this input pricing risk. DBRS Morningstar notes that the deciduous logs utilized in OSB production are generally easier to source than the specified coniferous logs required for lumber production. The addition of Norbord's assets in the U.S. lowers West Fraser's overall exposure to potential supply disruptions from mountain pine beetle infestation and wildfires in western Canada. The proximity of the entities' operations in several regions offers scope for efficiency improvements in transportation, logistics, and elimination of duplication. The combined entity expects to generate $80 million in annual synergies within two years of transaction close. As of the last 12 months (LTM) ended Q3 2020, the combined entity (pro forma) reported EBITDA of $1,506 million, had $1,582 in total lease-adjusted debt, and had $637 million in cash and cash equivalents.
The transaction, upon completion, adds significantly to West Fraser's size. The combined entity will own and operate 33 lumber mills, five pulp and paper mills, 14 OSB plants, 10 other engineered wood product plants, and one furniture plant and will employ approximately 10,000 people worldwide. However, the acquisition of Norbord will increase the Company's overall exposure to the inherent cyclicality in the housing construction market. The historical earnings and operating cash flow of Norbord are highly correlated to those of West Fraser, as the majority stems from Lumber and Panels segments. In effect, DBRS Morningstar expects that the acquisition will amplify West Fraser's potential upside in a favourable market environment and the larger size of the combined entity should help modestly to withstand volatility and weakness in an unfavourable market environment. DBRS Morningstar also notes that the acquisition improves West Fraser's diversification in terms of products offerings and geographic exposure.
Both West Fraser and Norbord had strong liquidity at the end of Q3 2020 with significant cash balances and undrawn capacity on their revolving credit facilities. DBRS Morningstar notes that the credit facilities at Norbord will be terminated as part of the arrangement agreement and that the noteholders at Norbord hold mandatory put option upon change of control. As part of the transaction, West Fraser has secured USD 1.3 billion in committed credit facilities, which are available upon closing. The debt maturities at the combined entity are reasonably spread out, including USD 315 million Norbord debt maturing in 2023 and USD 500 million West Fraser debt maturing in 2024. DBRS Morningstar expects West Fraser to refinance Norbord notes with debt at West Fraser when the opportunity arises.
DBRS Morningstar notes that although the leverage for the combined entity at the end of Q3 2020 was modestly weaker than West Fraser on a standalone basis, it remains strong for the rating category. Following the dramatic improvement in lumber and panel prices from the depressed levels in 2019 and early 2020, the earnings and operating cash flow of both companies have improved significantly, some of which has been used towards debt reduction. The sharp changes in operating earnings and cash flows over the last couple of years underscore the cyclical and volatile nature of the forest products industry. Nevertheless, the recent improvement has helped to shore up the financial position to better handle any potential deterioration in the market environment. DBRS Morningstar expects the combined entity's key credit metrics to stay strong for the rating category, at least in the near term.
DBRS Morningstar may consider upgrading the ratings if the Company adds exposure to segments/products that reduce volatility in earnings and cash flow or if the improvement in the market environment is sustained, leading to strong credit metrics without excessive deterioration in downturns. DBRS Morningstar also expects the Company to remain committed to its conservative financial policy. However, a ratings downgrade is possible if the market environment deteriorates significantly, leading to expectations for sustained weak credit metrics that no longer support the current ratings.
ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
Notes:
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Forest Products Industry (March 19, 2020) and DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding the structured finance rating approach and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/359905.
The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at info@dbrsmorningstar.com.
This rating was not initiated at the request of the rated entity.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at info@dbrsmorningstar.com.
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Ratings
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15-Dec-20 Issuer Rating Confirmed BBB (low) Stb CA
15-Dec-20 Unsecured Debentures Confirmed BBB (low) Stb CA
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