DBRS Confirms Potlatch Corporation at BB (high)

DBRS has today confirmed the rating of the Senior Unsecured Debt of Potlatch Corporation (Potlatch or the Company). The company has performed as expected with stable revenues in a challenging environment. These challenges include lower lumber prices as a result of the downturn in the U.S. residential housing market as well as higher costs of energy, wood chips, fibre, chemicals and transportation. The Company has a diversified asset base, somewhat reducing the impact of cyclical operating earnings and cash flows associated with product lines in any one market segment. As a result, business risk is in line with industry averages, justifying the current rating. However, the Company’s history of volatile and negative free cash flow increases financial risk and is the fundamental reason for maintaining the rating one notch below investment grade.

The Company has been focusing its business model to put more emphasis on timberlands and consumer products. This is expected to stabilize earnings and offset the impact of lower selling prices for lumber.

The company converted to a more tax-efficient REIT structure in 2006. This produced a one-off tax benefit, but it also has a long-term impact on liquidity now that the Company is required to distribute most of its earnings to maintain the tax-efficient structure. Earnings for 2006 benefited positively from higher selling prices for paperboard and consumer products, but they were tempered by lower lumber prices. As well, the Resource segment earnings were reduced by increased harvesting costs for timber.

Earnings for the Real Estate segment reflected fewer strategic land sales in 2006 as land sales activity was put on hold pending the initial assessment of all land for alternative values. Potlatch had combined cash and available credit facilities of $152 million at March 31, 2007, so liquidity should not be a problem in the near term. The Company has additional financial flexibility in the form of timberland assets that can be easily monetized. The estimated market value of the U.S. private timberland is more than $1.5 billion (about three times the value of the Company’s total debt), providing support to Potlatch’s long-term debt.

As a REIT, the Company intends to derive most of its income through investments in real estate including the sale of standing timber. As a result of this strategy, the Company must grow through acquisition. A period of weak earnings and debt-financed acquisitions would negatively impact credit quality and therefore the rating.

Notes:
All figures are in U.S. dollars unless otherwise noted.
This rating is based on public information.