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The Tembec softwood lumber plant in in Senneterre, Que.Jacques Boissinot/The Canadian Press

Moody's Investors Service downgraded Tembec's liquidity rating and lowered its outlook Friday over concerns about its high debt, weak operating performance and capital spending related to a major boiler and turbine expansion at its specialty cellulose pulp mill.

The agency said it lowered the Quebec-based forestry company's liquidity rating to SGL-4 from SCL-2 and changed the rating outlook to "negative" from "stable." However, it affirmed Tembec's corporate family and senior secured bond ratings.

"The negative rating outlook reflects the company's liquidity pressures and the execution risk of completing the company's significant co-generation project at its Temiscaming mill in Quebec," it said in a news release.

Moody's said Tembec's ratings could be downgraded if pulp market conditions deteriorate, leading to a further deterioration in liquidity. An upgrade would be considered, however, if it generates more cash flow and the ratio of cash flow to capital spending improves.

Tembec has about $305-million (U.S.) of rated debt.

Moody's anticipates some financial improvement by Tembec over the next 12 to 18 months, but says the company could delay the mill upgrade to meet its debt obligations because it has little liquidity cushion.

The company had about $56-million (Canadian) in unrestricted cash and $22-million available on its $200-million revolving credit facility as of December. Moody's estimates Tembec will use about $35-million of cash over the next year, excluding any further spending on the $190-million co-generation project. About $78-million has been spent to date.

The company is also negotiating the sale of its British Columbia NBSK pulp mill, which would fund its "aggressive capital spending plans."

Paul Quinn of RBC Capital Markets expects the sale could generate up to $135-million.

Most of the company's assets are encumbered but it only has "modest" debt maturities of $16-million over the next 12 months and no significant maturities until 2016, Moody's noted.

Tembec recently missed expectations even though its net loss was cut by more than a third to $10-million in the first quarter, despite a 6 per cent drop in sales.

The company lost 10 cents per share for the period ended Dec. 29, compared to a 16 cents per share loss in the prior year. Adjusting for one-time items, it lost five cents per share.

Tembec said the results were in line with its expectations, but analysts had expected a $3-million loss on $373-million of sales, according to analysts polled by Thomson Reuters.

Revenues fell $25-million to $376-million and adjusted pre-tax operating income (EBITDA) was $19-million, up from $12-million in the 2012 quarter, but down from $23-million in the prior quarter.

Tembec expects the first quarter will probably be the "low water mark"' for the fiscal year.

The company also said the pullback in metal prices that prompted mining companies to slow down huge expansion projects in Quebec could help reduce mounting construction costs for its Temicaming upgrade.