By Ross Marowits, The Canadian Press

MONTREAL - 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 Toronto-based ratings 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 (TSX:TMB.TO - News) has about US$305 million 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 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.

Tembec 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.

Tembec vice-president Linda Coates said the company publicly acknowledged its liquidity concerns during an October conference call with analysts and is managing accordingly.

She said the company still has $90 million of liquidity, decided to sell the Skookumchuck mill which will return liquidity to above target levels and is seeing business conditions stabilize or improve in most segments.

"Our poor 2012 results are due to paper pulp segment. We will have much smaller exposure to this segment going forward," Coates wrote in an email.

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 six 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 Temiscaming upgrade.

On the Toronto Stock Exchange, Tembec's shares gained five cents to close at $3.03 in Friday trading