Research

Domtar’s Strong Cash Profile Warrants An Upper Medium Investment Grade

Summary

  • Moody’s Baa3 credit rating on Domtar Corporation overstates the company’s credit risk.
  • We rate the company three notches higher as an upper medium investment grade credit, given their strong cash profile, robust recovery rate, and favorable management alignment.
  • Cash bond markets are also slightly overstating credit risk with a cash bond YTW of 3.840%, relative to our Intrinsic YTW of 3.140%.

Cash Flow Profile

Moody’s is overstating the credit risk of Domtar Corporation (NYSE:UFS) with its Baa3 rating. Our fundamental analysis highlights a much safer credit profile for UFS, whose strong cash flows cover all their obligations including debt maturities, except in 2022. Moreover, their sizable expected cash build should allow them to service all obligations including debt maturities in 2022. We therefore rate UFS three notches higher at an IG3- credit rating, or an A3 equivalent using Moody’s ratings scale.

Cash bond markets are also slightly overstating credit risk with a cash bond YTW of 3.840% relative to an Intrinsic YTW of 3.140%, while CDS markets are accurately stating UFS’ credit risk with a CDS of 191bps relative to an Intrinsic CDS of 187bps.

We produce a Credit Cash Flow Prime chart for Domtar Corporation, as we do for every company we evaluate. The chart provides a far more comprehensive view of credit fundamentals than traditional ratio-based analyses. It shows the cash flow generation and cash obligations related to the credit of the firm, adjusted for non-cash financial statement reporting distortions from GAAP. The blue line indicates the gross cash earnings (Valens’ scrubbed cash flow number) expected to be generated based on consensus analyst estimates and Valens Credit’s own in-house research team. The blue dots above that line include the cash available at that time while the blue triangles indicate that same amount plus any existing, available lines of credit.


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