Fitch affirms B+ IDR for KB Home; rating outlook stable
August 27, 2013
– Fitch Ratings has affirmed KB Home's (NYSE: KBH) Issuer Default Rating (IDR) at 'B+' and senior unsecured rating at 'B+/RR4'. The Rating Outlook is Stable.
A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings and Outlook for KBH are based on the company's geographic diversity, customer and product focus, conservative building practices and effective utilization of return on invested capital (ROIC) criteria as a key element of its operating model, as well as the on-going housing recovery. The company did a good job in reducing its inventory exposure and generating positive operating cash flow during the severe industry downturn. Since its peak in the third quarter of 2006 (3Q'06), homebuilding debt has been reduced from $7.89 billion to $1.94 billion currently.
The ratings also reflect KBH's business model and marketing prowess. The ratings take into account the company's current primary exposure to entry-level and, to a lesser degree, first-step trade-up housing (the deepest segments of the market), its leadership role in constructing energy-efficient homes, its reemphasis of the value-engineered Open Series of home designs, its conservative building practices, utilization of ROIC criteria as a key element of its operating model and its capital structure.
Housing metrics have all showed improvement so far in 2013. For the first seven months of the year, single-family housing starts improved 20.1%, while existing home sales increased 12.0%. New-home sales improved 21.8% for the first seven months of 2013. The most recent Freddie Mac 30-year interest rate was 4.58%, 127 bps above the all-time low of 3.31% set the week of Nov. 21, 2012. The NAHB's latest existing home affordability index was 172.7, moderately below the all-time high of 207.3.
Fitch's housing forecasts for 2013 assume a continued moderate rise off the bottom of 2011. New-home inventories are at historically low levels and affordability is near record highs. In a slowly growing economy with still above-average distressed home sales competition, less competitive rental cost alternatives and low mortgage rates (on average), the housing recovery will be maintained this year.
Fitch's housing estimates for 2013 follow: Single-family starts are forecast to grow 18.3% to 633,000, while multifamily starts expand about 19% to 292,000; single-family new-home sales should grow approximately 22% to 448,000 as existing home sales advance 7.5% to 5.01 million.
Average single-family new-home prices (as measured by the Census Bureau), which dropped 1.8% in 2011, increased 8.7% in 2012. Median home prices expanded 2.4% in 2011 and grew 7.9% in 2012. Average and median home prices should improve approximately 5.0% and 4.0%, respectively, in 2013.
As Fitch noted in the past, the housing recovery will likely occur in fits and starts.
At the end of the second quarter of 2013, KBH controlled 52,725 lots, an 18.0% increase from the end of the second quarter of 2012 but a 73.2% decrease from a peak of 197,000 lots at the end of 1Q'06 (February 2006). Based on LTM closings, the company controlled 7.4 years of land (up from 5.1 years at the end of 2005); KBH has 5 years of owned land. The current options share of total lots controlled (32.0%) is down sharply from the peak of 53.7% (4Q'05). KBH is expected to maintain substantial land spending this year, targeting finished lots and when possible taken down on a just-in-time basis with a minimum option deposit. The company expended about $575 million on land and land development in the first half of 2013. For the full fiscal year 2013, KBH is currently projected to spend up to $1.2 billion for the combination of land and development. The company expended $564.9 million on land and development in 2012, $553 million in 2011 (including the $75 million South Edge JV investment), $560 million in 2010, and $375 million in 2009.
FINANCIAL METRICS AND LIQUIDITY
KBH's most recent credit metrics, while improving in certain cases, remain stressed. Debt-to-capitalization was 82.1% as of year-end 2012. The ratio was 80.5% as of May 31, 2013. Net debt (debt less unrestricted homebuilding cash)-to-capitalization was 74.9% at the end of 2Q'13, down from 76.1% as of Nov. 30, 2012. Debt-to-LTM EBITDA, excluding real estate impairments, was 12.8x at May 31, 2013, and 28.0x at the same date last year. Interest coverage was 1.1x as of May 2013 and 0.5x as of May 2012.
During 2012, KBH refinanced a substantial amount of debt scheduled to mature in 2014 and 2015. In February 2012, the company issued $350 million of senior unsecured notes maturing in 2020 and applied the proceeds to the tender of $340 million for a portion of the $1 billion in debt due in 2014 and 2015. In early August 2012, KBH issued another $350 million of senior unsecured notes maturing in 2022, tendered for $244.9 million of 2014 and 2015 debt. This activity reduced 2014 public debt maturities to less than $76 million. It also boosted liquidity by adding $105 million of unrestricted cash to the balance sheet.
On Feb. 4, 2013, the company reported that it issued an underwritten public offering of $230 million in aggregate principal amount of its 1.375% convertible senior notes due 2019. Also, on Feb. 4, 2013, KBH reported that it completed the sale of 6.325 million shares of its common stock. The company received total net proceeds of $332.9 million from the convertible and stock offerings.
KBH currently has solid liquidity with unrestricted homebuilding cash of $538.6 million as of May 31, 2013. In addition to its cash and equivalents, KBH has once again established a revolving credit facility. On March 18, 2013, the company announced its closing of a new $200 million unsecured revolving credit facility. The credit facility, which closed on March 12, contains an accordion feature under which the aggregate commitment may be increased up to $300 million, subject to certain conditions and the availability of additional bank commitments. KBH previously had an unsecured credit facility that it voluntarily terminated March 31, 2010 in order to reduce costs associated with the facility.
The company reported negative $267.6 million of cash flow from operations (CFFO) during the first half of 2013 after investing roughly $575 million in land and development during the first six months of 2013. For all of fiscal 2013, Fitch expects KBH will significantly increase its land and development spending as it continues its 'going on offense' initiative. CFFO could approach negative $500 million if KBH is able to spend in excess of $1 billion on land and development this year.
Fitch is comfortable with this strategy given the company's liquidity position. Fitch expects KBH to end fiscal 2013 with homebuilding unrestricted cash approaching $300 million.
Future ratings and Outlooks will be influenced by broad housing market trends as well as company specific activity, such as trends in land and development spending, general inventory levels, speculative inventory activity (including the impact of high cancellation rates on such activity), gross and net new order activity, debt levels, free cash flow trends and uses, and the company's cash position.
KBH's ratings are constrained in the intermediate term because of relatively high leverage metrics. However, a positive rating action may be considered if the recovery in housing is meaningfully better than Fitch's current outlook, KBH shows continuous improvement in credit metrics, and maintains a healthy liquidity position. In particular, debt leverage would need to approach 4x and interest coverage would need to exceed 4x in order to take a positive rating action.
Negative rating actions could be triggered if the industry recovery dissipates, if there is a shortfall in KBH's financials, and if KBH maintains an overly aggressive land and development spending program which meaningfully diminishes its liquidity position (below $300 million).
Fitch has affirmed KBH's ratings as follows:
--IDR at 'B+';
--Senior unsecured debt at 'B+/RR4'.
The Rating Outlook is Stable.
The Recovery Rating (RR) of 'RR4' on KBH's senior unsecured notes indicates average recovery prospects for holders of these debt issues. KBH's exposure to claims made pursuant to performance bonds and joint venture debt and the possibility that part of these contingent liabilities would have a claim against the company's assets were considered in determining the recovery for the unsecured debt holders. Fitch applied a going concern valuation analysis for these RRs.
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
Robert Rulla, CPA
Media Relations: Sandro Scenga, New York, Tel: +1 212-908-0278, Email: email@example.com.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 5, 2013);
--'Liquidity Considerations for Corporate Issuers' (June 12, 2007).
Applicable Criteria and Related Research:
Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage
Liquidity Considerations for Corporate Issuers