TEXT - S&P revises Cascades Inc outlook to negative
Overview -- We are revising our outlook on Kingsey Falls, Que.-based Cascades Inc. to negative from stable. -- At the same time, we are affirming our ratings on Cascades, including our 'BB-' long-term corporate credit rating on the company. -- The outlook revision reflects on what we consider a weaker-than-expected financial performance in the company's containerboard and boxboard segments, leading to a slower pace of deleveraging than previously expected. Rating Action On Nov. 29, 2012, Standard & Poor's Ratings Services revised its outlook on Kingsey Falls, Que.-based packing and tissue manufacturer Cascades Inc. to negative from stable. At the same time, Standard & Poor's affirmed its ratings on the company, including its 'BB-' long-term corporate credit rating. We base the outlook revision on what we consider a weaker-than-expected financial performance in the company's containerboard and boxboard segments, leading to a slower pace of deleveraging than previously expected. Rationale The ratings on Cascades reflect what Standard & Poor's views as the company's fair business risk profile and aggressive financial risk profile. The strengths are visible in Cascades' good market position in a consolidated industry, diverse revenue stream, and vertical integration. These strengths are partially offset, in our opinion, by what we see as the company's exposure to the cyclical boxboard and containerboard markets, volatile recycled fiber prices, and high debt levels. Cascades is an integrated packaging and tissue company that manufactures, converts, collects, and processes recycled paper. It is the No. 1 containerboard producer in Canada, the second-largest producer of coated recycled boxboard in Europe, and fourth-largest tissue producer in North America. The company operates facilities in Canada, the U.S., and Europe. Standard & Poor's bases its fair business risk profile on Cascades' sizable market share in consolidated markets. The top five producers control a large majority of the market share, with a good market position in the Canadian containerboard, European boxboard, and North American tissue segments. The company's operations are fairly diverse, in our opinion, with no one segment representing more than one-third of Cascades' overall revenues and EBITDA. While we view the company's tissue business as fairly stable with steady growth in demand, price increases appear unlikely as a moderate amount of new tissue capacity is set to come online in the near term. Its other two key businesses--containerboard and, to a lesser extent, boxboard--are cyclical. Cascades' acquisition of a controlling share in Reno De Medici SpA (RdM; not rated), resulting in full consolidation, combined with two existing operating mills in France and Sweden, has increased its boxboard segment's exposure to Europe, which at present appears vulnerable. Overall, the company's profitability depends on its ability to pass through recycled fiber costs, which represent about one-third of its production costs. While sale prices do move up with increases in recycled fiber prices, there is often a lag of a few months. Recycled fiber prices tend to be volatile and influenced by demand from China. While Cascades' upstream integration into Metro Waste Paper Recovery Inc. (not rated) provides it with one-third of its recycled fiber needs, this does not insulate the company from volatility in recycled paper prices, because the prices it paid for most of the collected paper are based on spot recycled paper prices. Through 2012, recycled fiber prices have dropped substantially from relative highs in 2011; however, Cascades' earnings to date have not reflected the full benefit and operating costs appear to be rising. Cascades' aggressive financial risk profile reflects, in our opinion, a large amount of leverage held in its capital structure. As of Sept. 30, 2012, Standard & Poor's adjusted debt for Cascades is C$1.8 billion; adjustments total C$250 million and adjust for underfunded pension obligations, operating lease adjustments, and asset retirement obligations. The higher debt levels reflect draws on its revolver used to fund: an investment in Cascades' Greenpac joint venture, the acquisition of Bird Packaging Ltd. (not rated), and investments in upgrades to its enterprise resource planning systems, among other things. Trailing 12-month adjusted EBITDA is C$283 million, resulting in an adjusted debt-to-EBITDA ratio of 6.4x. Our financial model assumes the following: -- Revenue declines 2% to C$3.55 billion; -- EBITDA margins remain in the single digits for 2012 and 2013; -- Break-even working capital changes in 2012; -- Capital expenditures average about C$150 million in 2012, and declining in 2013; and -- Dividends of C$16 million per year. Based on our forecasts, we expect adjusted debt-to-EBITDA to improve to about 5.6x by year-end, and improve to about 5.2x in 2013. If we treat Cascades' interests in RdM as an equity investment and deconsolidate its financials, credit metrics weaken slightly to 5.7x and 5.4x. These metrics are slightly worse than we expected at the beginning of the year, as weaker-than-expected earnings resulted in leverage stabilizing at a rate higher than expected. The credit metrics are on the outskirts of the acceptable range for an aggressive risk profile; however, we do expect metrics to improve throughout 2013. Cash flow protection levels (as measured by funds from operations to adjusted debt) are in the low teens at the moment and we expect them to remain at about the same level in the next 12 months. Liquidity Cascades has adequate liquidity in our view, with C$13 million cash on hand (excluding cash in RdM) and about C$360 million (excluding RdM and Metro Waste Paper) available under its C$750 million credit facility. This credit facility was renewed recently and matures in 2016. For 2012, we expect: -- A sources-to-uses ratio of above 1.2x; -- A positive sources-minus-uses calculation in the event expected EBITDA declines 15%; and -- Cascades' likely ability to absorb--with limited need for refinancing--high-impact, low-probability events. With a favorable debt maturity profile, we believe revolver availability and cash from operations to be sufficient to fund capex, acquisitions, investments in associates, dividends, and share repurchases in the near term. For the most recent quarter, Cascades remains compliant with its financial covenants with adequate headroom. Recovery analysis We rate Cascades' secured debt 'BB+' (two notches above the corporate credit rating on the company), with a recovery rating of '1', which indicates our expectations of very high (90%-100%) recovery in the event of default. We rate the company's senior unsecured debt 'B+' (one notch below the corporate credit rating on Cascades), with a '5' recovery rating, which indicates our expectation of modest (10%-30%) recovery in default. Outlook The negative outlook reflects our view that Cascades' weaker-than-expected earnings through 2012 have resulted in slower deleveraging than previously expected. While we believe the company will improve earnings and adjusted leverage metrics commensurate with an aggressive financial risk profile in the next year, it will require a favorable operating environment to continue through 2013. Based on our expectation of recycled input prices, we believe Cascades' EBITDA generation will improve in 2013 and adjusted debt-to-EBITDA will decline to about 5.2x. Standard & Poor's would likely lower the ratings on the company if margins do not recover as expected in the first half of 2013, leading to lower-than-expected EBITDA and a stabilized leverage greater than 5x. Given our expectations, an upgrade is unlikely in the near term but would require substantial repayment of debt demonstrating its ability to sustain a leverage of 3.5x. Related Criteria And Research -- Methodology and Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Our Rating Process, April 15, 2008 Ratings List Outlook Revised To Negative To From Cascades Inc. Corporate credit rating BB-/Negative/-- BB-/Stable/-- Ratings Affirmed Cascades Inc. Secured debt BB+ Recovery rating 1 Senior unsecured debt B+ Recovery rating 5 Norampac Inc. Senior unsecured debt B+ Recovery rating 5
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