NEW YORK--(BUSINESS WIRE)--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.
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, homebuilding debt has been reduced from $7.89 billion to $2.57 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 2014 or 2015, 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 has continued into 2014 and should persist through the balance of this year and at least 2015;
--KBH is successfully mining the trade up market and more affluent first time buyers and de-emphasizing low end entry level customers (note the 11.2% increase in average sales price so far in 2014);
--The South Edge legal issues and liabilities have been dealt with; operating and financial comparisons so far in 2014 are much improved (especially average sales price, unit dollar backlog, gross profit margin, EBITDA and homebuilding and corporate pretax profitability);
--The deferred tax asset valuation allowance is likely to be reversed in the fiscal 2014 fourth quarter;
--Perhaps most importantly, the company has been successful in refinancing a substantial portion of the $1 billion of debt that was 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. Additionally, 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.
Industry housing metrics should increase in 2014 due to faster economic growth (prompted by improved household net worth, industrial production and consumer spending), and consequently some acceleration in job growth (as unemployment rates decrease to 6.4% for 2014 from an average of 7.4% in 2013), despite somewhat higher interest rates, as well as more measured home price inflation. A combination of tax increases and spending cuts in 2013 shaved about 1.5pp off annual economic growth, according to the Congressional Budget Office. Many forecasters expect the fiscal drag in 2014 to be only 0.25%. Single-family starts in 2014 are projected to improve 9.5% to 677,000 as multifamily volume grows about 11.7% to 343,000. Thus, total starts this year should top 1 million. New home sales are forecast to advance about 8% to 465,000, while existing home volume is likely to decline to 4.835 million due to fewer distressed homes for sale and limited inventory.
New home price inflation should moderate in 2014, at least partially because of higher interest rates. Average and median new home prices should rise about 3.5% in 2014.
Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing economy throughout the year. The unemployment rate should continue to move lower (5.8% in 2015). Credit standards should steadily, moderately ease throughout next year.
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- to 35-year-olds should provide some incremental elevation to the rental and starter home markets. Single-family starts are forecast to rise 21% to 819,000 as multifamily volume expands about 6.5% to 366,000. Total starts would be approaching 1.2 million. New home sales are projected to increase 20.4% to 560,000. Existing home volume is expected to approximate 5.075 million, up 5%.
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 2.5-3%.
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 9.2% to $1,015.69 million during the first six months of 2014. Homebuilding revenues increased 9.3% to $1,016.66 million as home deliveries declined 2.7% to 3,193 and the average selling price increased 11.2% to $313,200. Deliveries improved in the Central (+12.6%) and Southeast (+7.6%) but decreased on the West Coast (-24.8%) and Southwest (-4.3%). KBH's efforts to maximize prices in California affected western delivery (and order) comparisons.
The homebuilding gross profit grew 33.9% to $185.62 million during the first six months of 2014 from $138.62 million for the first two quarters of 2013. The homebuilding gross profit margin (excluding inventory and land option charges) reflected healthy improvement, growing 338 bps to 18.37% during the first half 2014. For the six months of 2013, KBH's housing gross profits included a net warranty charge of $17.5 million for water intrusion-related repairs of homes.
SG&A expenses rose 2.8% ytd in 2014. SG&A expense as a percentage of homebuilding sales declined from 13.97% to 13.14%.
The six months pretax income (before charges) was $38.48 million, much improved as compared to the $16.25 million loss realized in 2013. Net income was $37.19 million in 2014 vs. a loss of $15.43 million in 2013.
Net unit orders and the value of orders expanded 5.2% and 18.9%, respectively, for the first six months of 2014. As of May 31, 2014, unit backlog increased 8.6% to 3,398 and the backlog average sales price improved 14.2% to $301,906. The value of backlog gained 24.1% to $1,025.88 million.
KBH's most recent credit metrics, while improving, remain stressed. Debt-to-LTM EBITDA at the end of the May 2014 quarter was 11.0x compared with 11.2x at the end of 2013 and 17.5x at the conclusion of 2012. EBITDA to interest coverage was 1.4x for the LTM period ending May 31, 2014 and 1.3X and 0.7X at fiscal year-end 2013 and 2012, respectively. Fitch expects these credit metrics will further improve by the conclusion of 2014, with leverage declining to 8.9x and interest coverage of about 1.8x.
LIQUIDITY AND CAPITAL ISSUES
The company ended the second quarter of 2014 with $484.47 million in unrestricted cash and equivalents and $44.24 million in restricted cash.
KBH has a $200 million senior unsecured revolving credit facility 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, as well as a sublimit of $100 million for the issuance of letters of credit (LOC), which may be used in combination with or to replace KBH's LOC facilities. As of May 31, 2014, there were no cash borrowings or LOC outstanding under the credit facility and KBH had $200 million available for cash borrowings, and up to $100.0 of that amount available for the issuance of LOC.
The company maintains LOC facilities with various financial institutions to obtain LOCs in the ordinary course of operating its business. As of May 31, 2014, the company had $43.8 million of LOC outstanding under the LOC facilities.
KBH had $2.57 billion of debt outstanding at the end of May 2014. The company's debt maturities are well-laddered, with about 18% of its senior notes (as of May 31, 2014) maturing through 2017. Shareholders' equity totaled $709.67 million at the end of the second quarter 2014.
The company regularly accesses the capital markets and in the second quarter 2014 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 will be used for general corporate purposes, including land acquisition and land development.
KBH is primarily a single family homebuilder. It ranked as the fifth largest homebuilder in the U.S. in 2008 through 2013, based on home closings. KBH operates in four regions comprised of 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 typically has primarily focused on entry level home buyers and, to a lesser extent, on first step move-up buyers in the U.S. So far in 2014 trade up buyers and more affluent first time buyers dominated the sales mix. The first half 2014 average price was $313,200 for 3,193 homes delivered. The average price varies considerably by market, ranging from $216,900 in the Central region to $532,600 in the West Coast (California) during the 2014 first half. 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, generally commencing construction of a home only after a purchase contract has been signed, establishing an even flow of production, pricing homes to compete with existing homes and utilizing design centers to customize homes to the preferences of home buyers. KBH strives to be among the top 5 builders or in very large markets top 10 homebuilders in order to have access to the best land and subcontractors.
At the end of the second quarter of 2014, KBH controlled 57,377 lots, an 8.8% increase from the end of the second quarter of 2013 but a 70.9% decrease from a peak of 197,000 lots at the end of 1Q'6 (February 2006). Based on LTM closings, the company controlled 8.1 years of land (up from 5.1 years at the end of 2005); KBH has 5.9 years of owned land. The current options share of total lots controlled (approximately 27%) is down sharply from the peak of 53.7% (4Q'5). KBH is expected to maintain substantial land spending this year. KBH spent $505 million on land and development in the second quarter and $860 million for the first six months of the year. For the full year Fitch estimate that the company will expend approximately $1.6 billion on real estate and development activities. KBH invested $1.14 billion in land and development activities in 2013 and $564.9 million in 2012.
The company reported negative $443.4 million of cash flow from operations (CFFO) during 2013 after investing roughly $1.1 billion in land and development during the year. For all of fiscal 2014, Fitch expects KBH will meaningfully increase its land and development spending relative to 2013 as it continues its 'going on offense' initiative. CFFO could approach negative $600 million if KBH is able to spend as planned on land and development this year.
Fitch is comfortable with this strategy given the company's liquidity position. Fitch expects KBH to end fiscal 2014 with homebuilding unrestricted cash of $450-500 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 (combination of cash and equivalents and availability on the credit facility). 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 shortfall in KBH's financials (revenues, profitability) and KBH maintains an overly aggressive land and development spending program that meaningfully diminishes its liquidity position (below $300 million).
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 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
Liquidity Considerations for Corporate Issuers