Fitch Ratings has assigned a 'B+/RR4' rating to KB Home's (NYSE: KBH)
proposed offering of $250 million of senior unsecured notes due July
2023. The new issue will be equal in right of payment with all other
senior unsecured debt. The company intends to use the proceeds of this
issuance for general corporate purposes, including land acquisitions and
development and/or possible debt redemption.
The Rating Outlook is Stable.
A complete list of ratings 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 criteria as a
key element of its operating model. The company did a good job in
reducing its inventory exposure and generating positive operating cash
flow during the last severe industry downturn. Since its peak in the
third quarter of 2006 (3Q'06), homebuilding debt has been reduced from
$7.89 billion to $2.58 billion. Early in the recovery, KBH was somewhat
conservative in committing to incremental land purchases. It has
accelerated its spending more recently but should not become stressed so
long as it maintains its minimum return parameters for real estate that
it purchases. If the economy and housing were to experience a downturn
in 2015 or 2016, KBH has access to the liquidity to sustain itself,
primarily utilizing its current cash position and revolving credit
facility.
The ratings also reflect the following events:
--The housing recovery continued through 2014 and should persist in 2015
and 2016;
--KBH is successfully mining the trade-up market and more affluent
first-time buyers and has been de-emphasizing low-end entry-level
customers (note the 12.6% increase in average sales price in 2014);
--The South Edge legal issues and liabilities have been dealt with;
operating and financial comparisons for the full-year 2014 were much
improved (especially average sales price, unit and dollar backlog, gross
profit margin, EBITDA and homebuilding and corporate pretax
profitability) but metrics were more challenged in 4Q'14);
--The deferred tax asset valuation allowance was largely reversed in
4Q'14;
--Perhaps most important, the company has been successful in refinancing
a substantial portion of the $1 billion of debt scheduled to mature in
2014 and 2015. However, the company does continue to lag its peers in
certain operational and financial categories.
The ratings reflect KBH's business model and marketing prowess. The
ratings also take into account its leadership role in constructing
energy-efficient homes, its reemphasis of the value-engineered Open
Series of home designs, its conservative building practices, its capital
structure and the cyclicality of the U.S. housing market.
THE INDUSTRY
Housing metrics grew in 2014 due to more robust economic growth during
the last three quarters of the year (prompted by improved household net
worth, industrial production and consumer spending), and consequently,
acceleration in job growth slowed (as unemployment rates decreased to
6.2% for 2014 from an average of 7.4% in 2013), despite modestly higher
interest rates, as well as more measured home price inflation. A
combination of tax increases and spending cuts in 2013 shaved about 1.5
percentage points (pp) off annual economic growth, according to the
Congressional Budget Office. Many forecasters estimate the fiscal drag
in 2014 was only about 0.25%.
Single-family starts in 2014 improved 4.9% to 648,000 as multifamily
volume grew 16.4% to 357,800. Thus, total starts in 2014 were 1.006
million. New home sales increased 1.2% to 435,000, while existing home
volume was off 3.1% to 4.93 million largely due to fewer distressed
homes for sale and limited inventory.
New home price inflation moderated in 2014, at least partially because
of higher interest rates and buyer resistance. Average new-home prices
rose about 3.5% in 2014, while median home prices advanced approximately
4.5%.
Housing activity is likely to ratchet up more sharply in 2015 with the
support of a steadily growing, relatively robust economy throughout the
year. Considerably lower oil prices should restrain inflation and leave
American consumers with more money to spend. The unemployment rate
should continue to move lower (5.8% in 2015). Credit standards should
steadily ease moderately throughout 2015. Demographics should be more of
a positive catalyst. More of those younger adults who have been living
at home should find jobs and these 25-35 year olds should provide some
incremental elevation to the rental and starter home markets.
This year single-family starts are forecast to rise about 17.5% to
762,000 as multifamily volume expands about 7% to 383,000. Total starts
would be in excess of 1.1 million. New home sales are projected to
increase 18% to 513,000. Existing home volume is expected to approximate
5.14 million, up 4.3%.
New home price inflation should further taper off with higher interest
rates and the mix of sales shifting more to first-time homebuyer
product. Average and median home prices should increase 2.2%-2.7%.
Challenges remain including the potential for higher interest rates and
restrictive credit qualification standards.
IMPROVING FINANCIAL RESULTS AND CREDIT METRICS
KBH's corporate revenues expanded 14.5% to $2.401 billion during 2014.
Homebuilding revenues increased 14.6% to $2.390 billion as home
deliveries edged up 1% to 7,215 and the average selling price increased
12.6% to $328,400. Deliveries improved in the Central (+9%) and
Southeast U.S. region (+5.8%) but decreased on the West Coast (-12.2%)
and Southwest (-0.3%). KBH's efforts to maximize prices in California
affected western delivery (and order) comparisons.
Housing gross profit grew 23.5% to $429.53 million during 2014 from
$347.78 million for 2013. Housing gross profit margin (excluding
inventory and land option charges) reflected improvement, growing 181
basis points (bps) to 18.67% during 2014. For 2013, KBH's housing gross
profits included warranty-related charges of $31.96 million for water
intrusion-related repairs of homes.
SG&A expenses rose 12.6% in 2014. SG&A expense as a percentage of
homebuilding sales declined from 12.27% to 12.05%.
Homebuilding pretax income (before real estate charges) was $86.40
million, much improved as compared to the $28.18 million pretax profit
realized in 2013. The Financial Services segment revenues decreased 7%
to $11.31 million, while segment pretax profits of $8.55 million showed
a decline of 16.1%. Net income was $918.35 million in 2014 versus profit
of $39.96 million in 2013. 2014 net profits benefited from an $825.2
million deferred tax asset valuation allowance reversal.
Net unit orders and the value of orders expanded 6.2% and 19.6%,
respectively, for 2014. As of Nov. 30, 2014, unit backlog increased
13.8% to 2,909 and the backlog average sales price improved 17.7% to
$314,206. The value of backlog gained 33.9% to $914.02 million. Net unit
orders were 1,499 quarter-to-date through Feb. 6, 2015, a 25% increase
over the 1,201 net unit orders reported through Feb. 7 in the first
quarter of last year. The net order value for the 2014 quarter-to-date
period rose 26% compared with last year. (The company's 2015 fiscal
first quarter ends Feb. 28, 2015.)
KBH's most recent credit metrics, while improving, remain stressed.
Debt-to- EBITDA at the end of fiscal 2014 was 10x compared with 11.2x at
the end of 2013 and 17.5x at the conclusion of 2012. EBITDA to interest
coverage was 1.5x for fiscal 2014 and 1.4x and 0.7x at fiscal year-end
2013 and 2012, respectively.
LIQUIDITY AND CAPITAL ISSUES
The company ended 4Q'14 with $356.37 million in unrestricted cash and
equivalents and $27.24 million in restricted cash.
KBH has a $200 million senior unsecured revolving credit facility (RCF)
that will mature on March 12, 2016. The credit facility contains an
uncommitted accordion feature under which its aggregate principal amount
can be increased up to $300 million under certain conditions and the
availability of additional bank commitments. It also has a sublimit of
$100 million for the issuance of letters of credit (LOCs), which may be
used in combination with or to replace KBH's LOC facilities. As of Nov.
30, 2014, there were no cash borrowings or LOC outstanding under the RCF
and KBH had $200 million available for cash borrowings, and up to $100
million of that amount available for the issuance of LOCs.
The company maintains LOC facilities with various financial institutions
to obtain LOCs in the ordinary course of operating its business. As of
Nov. 30, 2014, the company had $26.7 million of LOCs outstanding under
the LOC facilities.
KBH had $2.58 billion of debt outstanding at the end of November 2014.
The company's debt maturities are well-laddered, with about 18% of its
senior notes (as of Nov. 30, 2014) maturing through 2017. Shareholders'
equity totaled $1.596 billion at the end of 2014.
The company regularly accesses the capital markets and in 2Q'14 did a
public issuance of $400 million in aggregate principal amount of 4.75%
senior notes due 2019, which generated net cash proceeds of $394.6
million. KBH also did a public issuance of 7,986,111 shares of common
stock for net cash proceeds of $137 million during the May quarter.
Proceeds from these offerings were used for general corporate purposes,
including land acquisition and land development.
HOMEBUILDING
KBH is primarily a single-family homebuilder, and ranked as the fifth
largest homebuilder in the U.S. in 2008 through 2013, based on home
closings. KBH operates in four regions comprising 10 states serving 40
major markets. The company delivered its first homes in California in
1963, Nevada in 1993, Colorado in 1994, Texas in 1996, Arizona in 1998,
Florida in 2001, North Carolina in 2003, and greater Washington D.C.
(Maryland/Virginia) in 2005. At present, the company is most heavily
weighted to the California and Texas markets.
KBH has typically focused on entry-level home buyers and, to a lesser
extent, on first-step move-up buyers in the U.S. In 2014, trade-up
buyers and more affluent first-time buyers dominated the sales mix. The
fiscal 2014 average price was $328,400 for 7,215 homes delivered. The
average price varies considerably by market, ranging from $223,800 in
the Central region to $569,700 on the West Coast (California) during
4Q'14. KBH employs what it calls its KBnxt operational business model.
This strategy includes regular detailed product preference surveys,
primarily acquiring partially or fully developed and entitled land in
markets with high growth potential. Construction is generally began only
after a purchase contract has been signed, establishing an even flow of
production, pricing homes to compete with existing homes and using
design centers to customize homes to the preferences of homebuyers. KBH
strives to be among the top five builders or, in very large markets, top
10 homebuilders, in order to have access to the best land and
subcontractors.
REAL ESTATE
At the end of 4Q'14, KBH controlled 52,198 lots, a 14.6% decrease from
the end of 2013 and a 73.5% drop from a peak of 197,000 lots at the end
of 1Q'06 (February 2006). Based on latest 12 month (LTM) closings, the
company controlled 7.2 years of land (up from 5.1 years at the end of
2005); KBH has 5.7 years of owned land. The current options share of
total lots controlled (20.7%) is down sharply from the peak of 53.7%
(4Q'15). KBH spent $272 million on land and development in 4Q'14 and
$1.47 billion for the full year. The company has indicated that it will
expend less on real estate in fiscal 2015 - projecting $1.1 billion-$1.4
billion. KBH invested $1.14 billion on land and development activities
in 2013 and $564.9 million in 2012.
The company reported negative $443.5 million in cash flow from
operations (CFFO) during 2013 and negative $630.7 million in 2014. As
noted above, KBH currently plans to reduce land and development spend by
5%-25% in 2015, following a 28.9% increase in 2014.
KEY ASSUMPTIONS
Fitch's key assumptions within its rating case for the issuer include:
--Total industry housing starts improve 13.8%, while new home sales
increase 18% and existing home sales grow 4.3% during fiscal 2015;
--Land and development spending of approximately $1.1 billion-$1.4
billion during fiscal 2015;
--KBH will continue to have negative CFFO during fiscal 2015, although
at a lower amount compared with fiscal 2014 levels;
--Liquidity (unrestricted cash plus revolver availability) remains above
$300 million;
--Continued EBITDA margin expansion in fiscal 2015;
--Further improvement in leverage and coverage metrics in fiscal 2015.
RATINGS SENSITIVITIES
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), 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 (combination of cash
and equivalents and availability on the RCF). In particular,
debt-to-EBITDA would need to approach 4x, debt-to-capitalization should
approximate 55%, 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 or if there is a meaningful shortfall in KBH's financials
(revenues, profitability) and the company maintains an overly aggressive
land and development spending program that meaningfully diminishes its
liquidity position (i.e. to below $300 million).
Fitch currently rates KBH with a Stable Outlook as follows:
--Issuer Default Rating 'B+';
--Senior unsecured debt 'B+/RR4'.
RECOVERY RATING
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 debtholders.
Fitch applied a going concern valuation analysis for this RR.
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (May 28, 2014);
--'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
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
Liquidity Considerations for Corporate Issuers
http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=328666
Additional Disclosure
Solicitation Status
http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=979533
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