NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for M.D.C. Holdings, Inc. (NYSE: MDC), including the company's Issuer Default rating (IDR) at 'BBB-'. The Rating Outlook is Stable.
A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
MDC's ratings and Outlook are based on the company's execution of its business model in the current moderately recovering housing environment, cautious land policies and solid liquidity. During the past cycle the company noticeably improved its capital structure, pursued conservative capitalization policies, and positioned itself to withstand the recently concluded sharp, long-lasting housing correction. Significant insider ownership of 25% aligns management's interests with the long-term financial health of MDC.
MDC underperformed relative to other low investment-grade industrial companies in recent years in an admittedly very harsh housing environment and trailed its homebuilding peers for much of 2011 in certain metrics. But, the company came up with an effective strategy to close its relative performance gap and move to consistent profitability. Its financial and operating execution during the past seven quarters indicates clear progress in meeting its expense containment and profitability objectives.
Industry challenges (although somewhat muted) remain, including continued relatively high levels of delinquencies, potential of short-term acceleration in foreclosures, and consequent meaningful distressed sales, restrictive credit qualification standards and limited availability of developed lots in certain markets.
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 and especially free cash flow trends and uses, and the company's cash position.
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 4.51%, 120 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 166.0, 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 near historically low levels and affordability remains very attractive. 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.
First Half 2013
Home sales revenue for the first half of 2013 gained 65.1% to $733.9 million as home deliveries during the first half expanded 48.7% to 2,201 and the average sales price improved 11.6% to $332,610. Land sales for the first two months of 2013 were $1.8 million, down from $3.4 million a year ago.
The housing gross profit margin, excluding the effect of impairment charges and interest in cost of sales, increased 371 bps. The margin benefitted from the company's focus on increasing pricing and decreasing incentives as its markets improved since the start of 2012. Total specs rose 31.8% to 813 from the second quarter 2012 to the second quarter 2013. Completed specs were 185 as of June 30, 2013, up from 138 at June 30, 2012. The spec margin now exceeds pre-sold margin for the first time in years due to company focus and market improvement.
SG&A expense rose 36.5% yoy to $100.1 million. The SG&A expense/sales ratio was 13.64% for the first half of 2013, down from 16.50% on the first half of 2012. The improvement was a result of operating leverage created by the substantial increase in home sales revenue which was slightly offset by a yoy increase in legal expenses driven by various significant legal recoveries in the first half 2012 which did not recur in the first half of 2013.
The company reported a home building pretax profit of $44.6 million during the first two quarters of 2013 as compared to a nominal pretax profit of $240,000 in 2012. Excluding asset impairments and option write-offs, the homebuilding pretax profit was $45.1 million in 2013 and $551,000 in 2012. The corporate pretax profit was $60.6 million ($61.1 million excluding real estate charges) in the first half of 2013, up from a pretax profit of $11.8 million ($12.1 million excluding real estate charges) in the first half of 2012. Including a $187.6 million income tax benefit related to a reversal of a portion of MDC's deferred tax asset valuation allowance, first half 2013 net income was $247.4 million. Net profits for the first two quarters of 2012 were $12.9 million.
Net orders for the first six months of 2013 totaled 2,651, up 7.5%. (second quarter 2013 orders decreased 3.6% yoy.) The decline was precipitated by a 21.8% decrease in the average community count.
Debt to capitalization at the end of the second quarters of 2013 and 2012 were 49.0% and 46.1%, respectively. Net debt to capitalization was 19.5% at June 30, 2013. A year earlier cash and marketable securities exceeded debt levels. Interest coverage was 2.2x at the conclusion if the second quarter 2013 which compares to 0.7x at the end of the second quarter 2012.
The company employs conservative land and construction strategies. MDC's priority is to acquire finished lots using rolling options, finished lots in phases for cash or, if the potential returns justify the risk, land for development. MDC does not typically buy more than a three-year supply of land in any market and when it acquires lots, the company currently focuses on land that it can start building on within a short time. The long-term goal is to maintain a 2-3 year supply of land, increase land under option, and reduce land owned. At the end of the June 2013 quarter, MDC controlled 14,721 lots, a 44.1% increase from the year-ago period. 81.9% of the total lots are owned with the remaining 18.1% controlled through options. This represents a 3.3-year supply of total lots controlled and a 2.7-year supply of owned land based on trailing 12-month deliveries. The community count averaged 142 for the second quarter of 2013 as compared to 180 averaged for the second quarter of 2012.
The company's policy of, whenever possible, purchasing predominantly finished lots and lots available for immediate development enhances balance sheet liquidity, which has been reflected in solid inventory turnover averaging 1.4x over the 2002 to 2012 period and averaging 1.0x during the past three years.
MDC has been re-building its land position, supported by its strong liquidity. MDC spent approximately $227 million on land and development in 2009. The company purchased about $380 million of land and expended $40 million on land development in 2010, and $280 million on land and development in 2011 and $370 million in 2012. Fitch projects that MDC will spend $730-800 million on land and development in 2013 with 85% or more for land and the balance for development activities.
Fitch is comfortable with MDC's growth strategy given the company's cash position, existing land supply, debt maturity schedule and proven access to the capital markets. Fitch expects management to pull back on its land spending if market conditions deteriorate from current levels. Additionally, management is expected to be disciplined with the uses of its cash, refraining from significant share repurchases or one-time dividends to its stockholders that would meaningfully deplete its liquidity position. In December 2012, MDC declared a dividend of $1.00 per share to accelerate payment of calendar-year 2013 dividends. This dividend is in lieu of declaring and paying regular quarterly dividends in 2013.
MDC successfully managed its balance sheet during the severe housing downturn, allowing the company to accumulate cash as it pared down its inventory. As of June 30, 2013, MDC had homebuilding unrestricted cash of $208.9 million and marketable securities totaling $610.4 million compared to total debt of $1,095.2 million.
During the first half of 2013, the company had negative cash flow from operations of $146.2 million and LTM cash flow from operations was negative $239.4 million. Fitch currently expects MDC will be about $100 - 150 million cash flow negative for all of 2013, leading to a cash and equivalents and marketable securities balance in excess of $800 million.
Effective June 30, 2010, MDC voluntarily terminated its $50 million revolving credit facility. Consistent with Fitch's comment on certain homebuilders' termination and reduction of revolving credit facilities, in the absence of a revolving credit line a consistently higher level of cash and equivalents than was typical should be maintained on the balance sheet, especially in these still uncertain times. As the housing market continues its recovery, Fitch expects MDC will establish a revolving credit facility to enhance its liquidity position.
MDC's ratings are constrained in the intermediate term because of relatively high leverage metrics. However, positive rating action may be considered if the recovery in housing is stronger than the agency's current outlook, if the company's operating and credit metrics are well above Fitch's expectations for 2013 and 2014, and liquidity is largely maintained. In particular, debt leverage would need to approach 2 times (x) and Funds from operations (FFO) interest coverage would need to exceed 7x in order to consider positive rating actions.
A negative rating action could be triggered if the industry recovery dissipates; MDC's 2014 revenues drop sharply while pretax income approaches break-even levels; and MDC's liquidity position falls meaningfully, perhaps below $500 million.
Fitch has affirmed the following ratings for MDC with a Stable Outlook:
--Issuer Default Rating at 'BBB-';
--Senior unsecured debt at 'BBB-'.
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 - Effective from 8 August 2012 - 5 August 2013
Liquidity Considerations for Corporate Issuers