CHICAGO--()--Fitch Ratings has downgraded the foreign and local currency Issuer Default Ratings (IDRs) of Celulosa Arauco y Constitucion S.A. (Arauco) to 'BBB' from 'BBB+', as well as its national scale rating to 'AA-(cl)' from 'AA (cl)'. In a related move, Fitch has downgraded the foreign currency IDR of Arauco's Argentine operating subsidiary, Alto Parana S.A., to 'BBB' from 'BBB+'. The unsecured debt issued by Arauco and Alto Parana has also been downgraded, to 'BBB' and 'AA- (cl)', respectively, from 'BBB+' and 'AA (cl)'. Arauco and Alto Parana's ratings have been removed from Rating Watch Negative, and a Stable Outlook has been assigned.
These downgrades follow the closing of Arauco's acquisition of Flakeboard Company Limited, a panel company in the North American market for $242 million plus the assumption of debt. They reflect an aggressive approach to growth over the past couple of years that has resulted in a leveraging of the company's capital structure. In addition to Flakeboard, Arauco has increased its leverage through the funding structure of its Uruguay pulp joint venture, Montes del Plata; the acquisition of additional board assets in Moncure, North Carolina; and the purchase of land in Brazil through a joint venture. The downgrades factor in Fitch's expectation for sluggish pulp prices in the next few years, which should prevent a material reduction in the company's debt through the use of cash flow from operations. They also factor in Fitch's expectation that the company's capital structure will not be managed to the levels that it was between 2002 and 2011, when its net debt-to-EBITDA ratio averaged 2.2x.
Arauco generated $1.065 billion of EBITDA, including business interruption insurance, during the last 12 months (LTM) ended June 30, 2012. As of June 30, 2012, the company had $4.3 billion of total debt, including $339 million of guaranteed debt at its Montes del Plata pulp joint venture. Fitch projects Arauco's net debt to increase to about $3.8 billion at the end of 2012, from $2.9 billion as of Dec. 31, 2011. Adjusted net debt, including 50% of the off-balance-sheet debt at Montes del Plata that the company guarantees, should climb to about $4.3 billion from about $3 billion during this same time period.
Fitch projects Arauco will generate nearly $1 billion of EBITDA during 2012, including projected insurance receipts for business interruption. This would result in growth of the company's net debt-to-EBITDA ratio to about 3.8x at the end of 2012 from 2.2x in 2011, and its adjusted net debt/EBITDA ratio to about 4.4x from about 2.3x in 2011. For 2013 and 2014, Fitch is cautious on pulp price projections, which could limit the EBITDA growth of Arauco's pulp division. The company's panels and sawn timber businesses should benefit from stronger economic growth in Latin America, as well as a gradually improving U.S. housing market. The addition of 12 months of operations from the company's recent acquisitions - Moncure and Flakeboard - should increase baseline EBITDA levels by more than $100 million.
The debt of Montes del Plata that Arauco guarantees should peak at around $650 million in 2013, when construction of this pulp mill is completed. Arauco is expected to actively manage its capex and investment activities in the near future to lower its debt level. Net leverage should begin to reduce from above 3.0x during 2014 as the company benefits from 12 months of output from the Montes del Plata mill. Fitch is cautious about the pulp environment during the next three years, as several mills will become operational in Latin America. The increase in global market pulp supply as a result, plus sluggish demand, will likely lead to depressed prices that would hinder operating cash flow throughout the sector. Over time, supply and demand should become more balanced as high-cost producers in the Northern Hemisphere exit the industry.
Arauco has been aggressive during the past year as it sought to purchase assets during a period of market weakness. The company's Brazilian joint venture (49% owned by Arauco and 51% by Klabin) acquired 107,000 hectares of land in the Brazilian state of Parana for $473.5 million during November 2011. The company made purchases during 2012 that will give it a strong position in the North American board market and will complement its imports of plywood and moulding. During January, Arauco purchased MDF and HDF production lines in Moncure, North Carolina, as well as a particleboard plant, for $56 million plus $6 million of working capital. These assets, plus those of Flakeboard, will give the company about 3 million cubic meters of board capacity in North America and will give the company an MDF market share of about 35%.
A positive rating action is not likely in the near term because of Fitch's view that pulp prices will remain at low levels, which limits operating free cash flow. A return to debt levels closer to those maintained by the company historically for a period of time would be viewed positively and could lead to an upgrade of the company's ratings. A negative rating action is not likely in the near- to medium-term. Arauco is considering replacing an old pulp mill with a new line. If this project goes forward, it is expected to have a capital structure that would not result in a negative rating action.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 12, 2011);
--'National Ratings - Methodology Update' (Jan. 19, 2011).
Applicable Criteria and Related Research:
Corporate Rating Methodology
National Ratings Criteria