Sept 17 - Overview -- Chile-based forest-products company Arauco's currently weak performance is due to soft pulp prices, rising costs, and several nonrecurring adverse events. -- Debt rose significantly due to the construction of its new pulp mill and a recent acquisition. -- We are revising the outlook to negative and affirming our 'BBB' rating on the company. -- We expect debt to remain high until 2014, with some improvements in 2013 due to more-conservative financial policies and enhanced results. Rating Action On Sept. 17, 2012, Standard & Poor's Ratings Services revised its outlook on Celulosa Arauco y Constitucion S.A. (Arauco) to negative from stable. At the same time, we affirmed our 'BBB' long-term corporate credit rating on the company. Rationale The outlook revision reflects Arauco's deteriorating financial risk profile during the past few quarters that stemmed from weaker results and high debt levels. Although we acknowledge that Arauco has traditionally been able to reduce debt despite some volatility of its businesses, we believe it would take at least 12-18 months for its credit metrics to be in line with the ratings, given our expectations of soft pulp prices in the next several quarters. A failure to bring the adjusted debt-to-EBITDA ratio to less than 3.5x by the end of 2013 will likely to result in a one-notch downgrade. The ratings continue to reflect the company's "satisfactory" business risk profile and "intermediate" financial risk profile. During the first half of 2012, Arauco's performance weakened from softer pulp prices and rising costs of labor, wood, and chemicals. The loss of a 450,000 cubic meter plywood facility and 4,000 planted hectares in a wildfire in late 2011 and a breakdown of a power generator caused operating profits to drop, by at least $150 million in the first half of 2012. Also, during the first half of 2012, Arauco purchased two U.S.-based wood-panel producers with an aggregated capacity of 2.9 million cubic meters, doubling the size of its panel division and gaining control of an estimated 30% of the U.S. panels market. In addition, its new 50%-owned pulp mill in Uruguay--Montes del Plata, which is currently under construction--took on part of the debt that its financing structure demanded. All of this caused adjusted debt to grow by about $500 million. Poorer results and higher debt caused the adjusted debt-to-EBITDA ratio to slip to 3.9x, and the funds from operations (FFO)-to-debt ratio to weaken to 14.9% in the 12 months ended June 30, 2012, compared with 2.0x and 44.7%, respectively, a year ago. We don't expect these metrics to improve significantly by the end of the year, as adjusted debt should remain around $4 billion (including the debt from Montes del Plata). Although we expect the company's profits to recover in the second half of the year due to incremental profits from the recently acquired panel facilities and insurance payments on loss profit, EBITDA will likely remain around $1 billion on a rolling 12-month basis. We expect the debt-to-EBITDA ratio to improve to at least 3.5x in 2013 and the FFO-to-debt ratio to improve to 22% due to Montes del Plata's expected contribution of at least $100 million to adjusted EBITDA (assuming its completion in June 2013). In the next 12-18 months, we expect Arauco to reduce capital expenditures significantly, keeping its robust financial flexibility. We also expect the company to complete the integration of its acquired businesses: We believe the acquired U.S. assets may contribute around $150 million to annual EBITDA). Industry conditions may remain challenging, especially for hardwood pulp, as we expect supply to expand by 2.5%-3.0% in 2013 and 2014 and demand to remain volatile. Prospects for softwood pulp (around two-thirds of Arauco's pulp division) are slightly better in the next 12 months, as no material expansion in capacity is expected, and global demand could increase. The company's "satisfactory" business risk profile continues to reflect its cost-efficient operations, good market positions in global market pulp and in the American wood-panels markets, large and highly productive asset base, and business resilience. Despite currently high debt and recent aggressive investments, we still view Arauco's financial risk profile as "intermediate" thanks to its strong capitalization, as seen in its 36.3% debt-to-capital ratio as of June 2012 and its historic averages in the 25%-35% range, ample ability to generate operating cash flows, and adequate liquidity. Liquidity We consider Arauco's liquidity "adequate" because we expect cash sources to exceed uses by at least 20%. Cash sources should also cover uses even if EBITDA were to decline by 20% in the next 12 months. We also assume that cash flow from operations will be around $650 million in 2012 and closer to $700 million in 2013, and that capital expenditures including acquisitions will peak at around $1 billion in 2012 and drop to less than $500 million in 2013. We computed dividend payments at 40% of net income and manageable debt maturities of $151 million in the second half of 2012 and $397 million in 2013. Other factors we included in our liquidity analysis were Arauco's good access to international and domestic debt markets and sound relationships with banks. The company is likely to secure committed credit facilities in excess of $300 million to offset cash-flow volatility. Outlook The negative outlook reflects our expectation that Arauco will continue posting weak credit metrics for the rating category in 2012 and 2013, but will improve in 2014 when Montes del Plata's EBITDA contribution (on an adjusted basis) and cash flows move credit ratios in line with its "intermediate" financial risk profile. We expect Arauco to start benefiting from its acquired businesses in the U.S. panels sector, reduce capital expenditures, and secure financial flexibility. A slower-than-expected recovery in its financial performance would not be consistent with Arauco's financial risk profile at the current rating level, and therefore will merit a one-notch downgrade. In such a scenario, we would expect the debt-to-EBITDA ratio to be less than 3.5x by the end of 2013. An upgrade is unlikely at this point due to high leverage and Arauco's exposure to cyclical pulp prices. Related Criteria And Research -- Will Pulp Projects Hamper The Financial Profiles Of Latin American Forest Products Companies?, Aug. 15, 2012 -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Business Risk/Financial Risk Matrix Expanded, May 27, 2009 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed; Outlook Action To From Celulosa Arauco y Constitucion S.A. Corporate Credit Rating BBB/Negative/-- BBB/Stable/-- Ratings Affirmed Celulosa Arauco y Constitucion S.A. Senior Unsecured BBB Alto Parana S.A. Senior Unsecured BBB Senior Unsecured raAAA Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.