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.
KEY RATING DRIVERS
MDC's ratings 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.
Excluding non-cash inventory impairments, the company only lost money on an EBITDA basis in 2008 ($7.3 million) and was modestly profitable during the other years of the pronounced housing contraction. The company generated $63.0 million in pretax profits in 2012 and $144.8 million in 2013. During the housing downturn MDC's cash and marketable securities consistently exceeded its debt.
MDC underperformed relative to other low investment grade industrial companies in the later part of the downturn and early in the recovery and trailed its homebuilding peers for much of 2011 in certain metrics. But the company came up with effective strategy to close its relative performance gap and move to solid profitability. Its financial and operating execution during the past eleven quarters indicates clear progress in meeting its expense containment and profitability objectives.
Risk factors include the cyclical nature of the homebuilding industry and MDC's more recent sporadic underperformance relative to its peers in certain operational and financial categories.
Comparisons were challenging through first-half of calendar 2014, and so far this year most housing metrics seem to have defied expectations and fallen somewhat from a year ago. Though the severe winter throughout much of North America restrained some housing activity, nonetheless, there was an absence of underlying consumer momentum this spring, perhaps due to buyer sensitivity to home prices and finance rates and the slowing of job growth at year end. But demographics, attractive affordability/housing valuations, and a slow, steady easing in credit standards should sustain and ultimately accelerate the upturn.
To reflect the subpar spring selling season, as well as the more guarded expectation for the following few months, Fitch recently tapered its macro housing forecast. Single-family starts are now projected to improve 9.5% to 677,000 (down from Fitch's previous forecast of a 15% improvement) and multifamily volume grows almost 12% to 343,000. Total starts this year should still slightly exceed 1 million. New home sales are forecast to advance about 8% to 465,000 (down from Fitch's prior forecast of 500,000), while existing home sales volume is expected to decline 5% to 4.835 million (down from Fitch's earlier estimate of 5.1 million), largely due to fewer distressed homes for sale.
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 - 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.
MDC Holdings, Inc. and its subsidiaries have been building new homes under the name Richmond American Homes for over 40 years. The company currently has 159 active communities in 11 states. MDC was the 11th largest homebuilder based on 2013 closings and revenues and has been consistently among the top 15 (and often among the top 10) largest homebuilders. The company has particularly heavy exposure in Colorado, Arizona and California. MDC designs, builds and sells single-family homes, especially for the first-time and first-time move-up buyers (the deepest part of the market). The company also builds a limited number of homes for the second-time move-up and luxury homebuyers. The average price for its homes during 2013 was $345,373. MDC also has design centers (Home Galleries and Design Centers) in most of its homebuilding markets. Through the design centers, homebuyers are able to customize certain features of their homes by selecting from a variety of options and upgrades.
MDC has rarely used acquisitions of companies to grow. Occasionally, the company has purchased assets (i.e. real estate lots) of a company to establish itself in a new market or supplement its position in an existing market. More often MDC has started greenfield operations, hiring a manager with experience in the new market. This is generally the least risky way of geographic expansion. The company does not participate in joint ventures.
MDC FIRST HALF FINANCIAL RESULTS
MDC's corporate revenues grew 1.3% to $770.51 million during the first six months of 2014. Home sales revenues expanded 2.3% to $749.28 million as home deliveries declined 7.7% to 2,031 and the average selling price increased 10.9% to $368,920. Deliveries improved in the East (+2.6%) but fell in the West (-8.3%) and Mountain regions (-12.8%). Softer demands and a conscious metering of sales to maximize price was reflected in the 2014 delivery statistics
The homebuilding gross profit margin edged up 5 bps to 17.82% for the first two quarters of 2014. Cost increases, including direct construction and land costs, combined with additional incentives offered in certain markets to spur demand in a slower homebuilding environment partly offset the impact of home price increases captured in prior periods.
SG&A expenses fell 2.0% ytd in 2014. SG&A expenses as a percentage of homebuilding revenues declined from 13.64% in the first half of 2013 to 13.09% in 2014.
Homebuilding EBITDA totaled $68.1 million for the first half of 2014, up from $60.8 million in the same period of 2013. Excluding an early extinguishment of debt charge of $9.41 million, 2014 ytd homebuilding pretax profits expanded 12.9% to $62.08 million.
YTD financial services revenues declined 21.5% to $20.71 million, while segment pretax income dropped 26.9% to $11.66 million. The decrease was primarily driven by lesser pretax income from MDC's mortgage operations segment due to reduced volumes, origination income per unit and gains on loans locked and sold compared to a year ago resulting primarily from a more competitive mortgage market.
Corporate pretax income, before the debt extinguishment charge, increased 2.4% to $62.08 million in the first half 2014.
Net income was $33.05 million during the first two quarters of 2014. Reported net income was $247.42 million for the same period in 2013 including the $187.6 million deferred tax asset reversal.
Net unit orders and the value of orders expanded 0.2% and 9.8%, respectively, for the first six months of 2014. However, second quarter 2014 unit orders and value of orders improved 5.0% and 12.2%, respectively. As of June 30, 2014 unit backlog is down 10.0%, while value of backlog ($761.47 million) is off 2.9%. The ASP in backlog was $403,746, up 7.9%.
MDC's average community count for the first half of 2014 was 153, up 7.0% yoy. The actual community count at 6/30/14 was 159, up 11.3% as compared to a year ago.
The company ended the second quarter of 2014 with $100.15 million in unrestricted cash and equivalents and $492.50 million in marketable securities and $2.19 million in restricted cash compared to total debt of $1,106.11 million. The company's debt maturities are well-laddered, with about $250 million maturing in mid-2015. The next debt maturity is not until 2020.
MDC currently has a $450 million unsecured revolving credit facility. The maturity date of the facility is December 13, 2018. As of 6/30/14 there was a modest $10 million of borrowings outstanding and $16.0 million of letters of credit issued under the revolving credit facility. The facility has an uncommitted accordion feature that could increase the size of the facility to $1.0 billion, subject to certain conditions and availability of additional bank commitments.
Like most other builders in our coverage, Fitch expects MDC will be cash flow negative in 2014. The company was CFFO positive $18.0 million in the June 2014 quarter and on an LTM basis was CFFO negative by $219.5 million. In 2013 and 2012, the company was negative CFFO by $269.5 million and $108.8 million, respectively. MDC was negative cash flow from operations $80.3 million in 2011. Fitch currently expects the company will be CFFO negative approximately $200 million - $250 million in 2014. MDC will again spend substantially on land and development activities for the full year 2014. As the cycle matures, real estate spending will level-out or trend down in 2015, profits will continue to rise and negative cash flow could significantly moderate or turn positive.
DEBT AND CREDIT METRICS
MDC had $1,106.11 million of debt outstanding, net of applicable discounts, as of June 30, 2014. Debt-to-LTM EBITDA at the end of the second quarter was 7.3x compared with 7.6x at the end of 2013 and 11.8x at the conclusion of 2012. Net debt-to-LTM EBITDA was 3.4x at June 30, 2014. FFO adjusted leverage was 5.1x at the end of the 2014 second quarter which compares to 5.1x and 8.3x at the conclusion of 2013 and 2012, respectively. Debt-to-capitalization was 47.5% and debt (net of cash and equivalents and marketable securities)-to-net capitalization was 29.6% as of the end of the second quarter 2014. EBITDA-to-interest coverage was 2.3x for the LTM period ending June 30, 2014 compared with 2.4x and 1.5x at year end 2013 and 2012, respectively. Fitch expects these credit metrics will improve by the conclusion of 2014, with leverage declining to 6.5x and interest coverage of about 2.8x. These credit metrics should be meaningfully better in 2015.
MDC has $249.96 million of 5.375% senior notes, net, scheduled to mature July 2015. It is likely that the company will pay off this debt at that time. The next debt maturity is not until February 2020 ($246.16 million, net).
Also, during the first quarter 2014, MDC redeemed its 5.375% senior notes due December 2014.
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. 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 2014 quarter, MDC controlled 16,706 lots, a 13.5% increase from the year-ago period. 80.2% of lots are owned. Based on LTM closings, the company controlled 3.7 years of land and had 3.0 years of owned land. The community count was 159 at quarter end 2014 as compared to 140 at second quarter end 2013.
MDC chooses to be relatively short on land as many of its peers control 6-8 years of lots (much of that owned). That strategy can be a disadvantage when land prices are rapidly rising (not currently). On the other hand, being short on land is clearly advantageous following a market peak when excess land compromises the balance sheet and margins.
Based on Fitch estimates of closings for 2014, the company has 3.7 years of land under control. Similar to the other builders Fitch follows, the company is expected to aggressively purchase sizable land this year to replenish its supply. MDC is expected to spend approximately $825 million - $875 million on real estate acquisitions with about two thirds of that targeted for land spend and the balance for land development. This projection is considerably higher than was anticipated early in the year. Land spend could be possibly 10% less in 2015.
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. MDC spent $280 million on land and development in 2011 and $370 million in 2012. The company invested $740 million in real estate in 2013.
Fitch is comfortable with MDC's growth strategy given its liquidity position, existing land supply, and proven access to the capital markets. Fitch expects management to pull back on its land spending if market conditions deteriorate from current levels.
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 significantly stronger than the agency's current outlook, if the company's operating and credit metrics are well above Fitch's expectations for 2014 and 2015, and liquidity is largely maintained. In particular, debt leverage would need to approach 2x and Funds from operations (FFO) interest coverage would need to exceed 7x in order to take positive rating actions.
A negative rating action could be triggered if the industry recovery dissipates; MDC's 2014/2015 revenues drop sharply while pretax income approaches break-even levels; and MDC's 2014/2015 liquidity position (cash, investments and availability from the revolving credit facility) falls sharply, perhaps below $500 million. Negative rating actions could also occur if the company's credit metrics do not improve much from current levels in a sustained housing recovery, including debt-to-EBITDA consistently remaining above 5x over the next 18-24 months.
Fitch affirms the following ratings for MDC:
--Long -term IDR at 'BBB-';
--Senior unsecured debt at 'BBB-'.
The Rating Outlook is Stable.
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