By HARRY KOZA | Friday, November 11, 2005 | Globe and Mail
Shed a tear for the vanishing Canadian lumberjack. It's tough work in the woodlot at the best of times, and these days, what with the strong Canadian dollar, softwood tariffs, and soaring energy costs, companies that employ lumberjacks are in rough shape.
It's not a sector that I usually pay a lot of attention to, as most of the bonds issued by domestic forest products companies are U.S. dollar-denominated high-yield debt, and we seldom see any of it trade up here in the Great White North.
Still, the papers are full of the travails of the forest sector lately. Jobs are being clear-cut, stock analysts are doing the earnings-estimate limbo every quarter (How low can they go?) and politicians are promising new subsidies and handouts and rattling their, er, chainsaws. As if any of our Solons in Ottawa knows one end of a chainsaw from the other.
Actually, that's something I'd really like to see: Paul Martin down in Washington to talk to the U.S. Senate about softwood lumber and he puts on a goalie mask and fires up the old McCulloch and cuts the podium in half. That'd get their attention.
Anyway, I hadn't realized just how sweaty the bonds issued by forest companies are getting these days, but then I looked at a Canadian forest industry report card that the credit boffins over at Standard & Poor's released this week. If this was your kid's report card, little Johnny would be permanently grounded, and you'd be considering sending him to military school.
S&P rates 13 Canadian forest firms and four building materials companies. Fifteen out of the 17 companies are rated as junk -- or non-investment grade. Of the forest firms, two are triple-B, which is the low end of investment grade; four are double-B-plus, which is the high end of the junk spectrum; one double-B, two double-B-minus, two B-plus, one B, and one triple-C-plus.
Even worse, eight of the companies have negative ratings outlooks, and none of them have positive outlooks. The best that bondholders can hope for is that the companies' credit quality doesn't get any worse. It's like your doctor telling you there's good news and bad news: The bad news is that you are sick as hell and not getting any better, and the good news is, at least you aren't getting any worse.
Yet the individual company ratings are a litany of the same endemic problems: "credit metrics remain stretched as the appreciation of the Canadian dollar and rising energy costs will hurt earnings." ". . . energy and resin costs have increased." " . . . remains under pressure from the Canadian dollar and energy costs." ". . . continues to face a strong Canadian dollar and rising energy costs." ". . . compounding the problem is the rising Canadian dollar and energy costs" ". . . cost reduction initiatives . . . are absolutely critical for long-term survival." Gee, I'm beginning to see a pattern here.
The big burden for these companies has been the loonie. Most of the industry's costs are in Canadian dollars, and most of their revenues are in U.S. dollars. For pulp and paper companies it's an even more bitter pill: While pulp and paper prices, denominated in U.S. dollars, have been rising for more than two years, the appreciation of the Canadian dollar has wiped out the gains.
That's really harsh -- you're in a cyclical business and when the up-cycle comes, it still isn't enough to cover your currency losses. In Canadian-dollar terms, prices have gone nowhere.
It gets worse, though. Energy costs have risen too, for oil, gas, and -- especially in Ontario -- electricity. That's had a nasty impact on direct costs, but it has also raised costs for freight, chemicals and resins.
Meanwhile, the softwood lumber dispute goes on and on and on, despite the macho posturing and tough talk from Ottawa. It's about $5-billion in duties, and counting. If that ever gets resolved, the return of those duties will be a shot in the arm for a lot of these companies. But no one can predict how long it will take before any refunds are forthcoming, and the dispute continues without any resolution, so we could be talking geological time here, folks.
There's a couple of other fundamental problems with the industry, too. One is a lack of pricing power. Costs rise, and the companies can't raise prices to cover them, because there is too much overcapacity. And every year, they have to haul the logs further to the mill.
S&P says these conditions will continue, and thus credit quality will "decrease in the near term." Gee, if you're already rated triple-C-plus, any further decrease in credit quality will put you in receivership.
Maybe it's high time someone does put on a goalie mask and trims a few slabs off the West Wing.
Harry Koza is senior Canadian markets analyst at Thomson Financial and a columnist for GlobeinvestorGOLD.com.
