CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of Masco Corporation (NYSE: MAS), including the company's Issuer Default Rating (IDR), at 'BB+'. The Rating Outlook has been revised to Positive from Stable. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
Masco's rating reflects the company's leading market position with strong brand recognition in its various business segments, the breadth of its product offerings, improving financial results and credit metrics, and solid liquidity position. Risk factors include sensitivity to general economic trends, heightened customer concentration, and the cyclicality of the residential construction market.
The Positive Outlook reflects Fitch's expectation that demand for Masco's products will continue to grow as the housing market maintains its moderate recovery and home improvement spending increases at a steady pace. Fitch also expects Masco's credit metrics will continue to improve, including debt/EBITDA approaching 2.5x, as the company reports modestly better financial results and reduces overall debt by $300 million - $500 million this year.
The Positive Outlook also reflects Fitch's view that operational improvements, healthy liquidity, and solid free cash flow (FCF) generation, combined with lessened exposure to the more volatile new home construction market (from the spin-off of its installation business), is likely to allow Masco to achieve a low investment-grade rating in the next 12 months.
SUSTAINED IMPROVEMENT IN CREDIT METRICS
Masco's operating and credit metrics have shown sustained improvement over the past four years as the company continues to benefit from the recovering housing and home improvement markets as well as business rationalization and cost reduction initiatives put in place over the past few years. EBITDA margins have increased from a low of 7.8% during 2011 to 15.6% during 2015. The company has also focused on strengthening its balance sheet, lowering debt by about $675 million since the end of 2010. Masco intends to reduce debt by an additional $300 million - $500 million in the next 12 months.
Debt/EBITDA declined from 6.9x at year-end (YE) 2011 to 5.1x at YE 2012, 3.6x at YE 2013, 3.2x at YE 2014 and 3.1x at YE 2015. Similarly, interest coverage increased from 2.3x during 2011 to 2.8x during 2012, 4.0x during 2013, 4.8x during 2014 and 5.2x during 2015. (Note: Credit metrics for 2011-2014 include the installation services business, which was spun-off in June 2015.) The improvement in credit metrics was achieved from a combination of debt reduction as well as EBITDA and EBITDA margin growth. Fitch expects further improvement in these metrics this year, with debt/EBITDA approaching 2.5x by YE 2016 and interest coverage remaining above 5.0x this year. Management is committed to an investment-grade rating and indicated that it will continue to focus on strengthening the company's balance sheet.
HOUSING RECOVERY CONTINUES
Masco markets its products primarily to the residential construction sector. During 2015, management estimates that 83% of Masco's sales were directed to the repair and remodel segment, with the remaining 17% to the new-construction market. Revenues in North America accounted for about 79% of its 2015 worldwide sales.
Housing activity ratcheted up more sharply in 2015 with the support of a steadily growing, relatively robust economy. Total housing starts grew 10.8% versus 2014, while existing home sales and new home sales were up 6.5% and 14.6%, respectively. Fitch expects further improvement in 2016, with total housing starts projected to rise 9.6%, new home sales advancing 14.6%, and existing home sales growing 4% for the year. Unlike previous housing recoveries, which tended to be V-shaped, this recovery has been more subdued and will perhaps extend longer than the typical 3-5-year upturn.
Home improvement spending is expected to sustain its steady increase during 2016, driven by an expanding U.S. economy, a continued recovery in housing, and higher home values realized over the past few years. National home price indices have been broadly increasing over the past few years and more modest but steady home price inflation ahead should further encourage remodeling spending, particularly for discretionary projects. Fitch projects home improvement spending will grow 4.5% in 2016 after improving an estimated 4.5% in 2015.
SOLID LIQUIDITY SUPPORTS CAPITAL ALLOCATION STRATEGY
The company continues to have solid liquidity, with cash and equivalents and short-term bank deposits of $1.72 billion and no borrowings under its $750 million revolving credit facility that matures in 2020. The company has $1 billion of senior notes coming due in October 2016 and $300 million of senior notes maturing in March 2017. Fitch expects the company will refinance $800 million - $1 billion of these debt maturities, reducing overall debt by $300 million - $500 million in the next 12 months.
Masco reported strong free cash flow (FCF) during the past few years, generating $379 million (5.3% of sales) during 2015, $323 million (3.8%) during 2014, and $378 million (4.6%) during 2013. By comparison, the company had FCF of $15 million (0.2%) during 2012 and negative $37 million during 2011. Masco has historically reported strong FCF, generating in excess of $5.7 billion during 2000-2010 (about 5.2% of total revenues during the time period). Fitch expects Masco will generate FCF margins of 3% - 4% during 2016.
In May 2014, Masco's board approved a 20% increase in its quarterly common stock dividend, from $0.075 per common share to $0.09 per share. The increased dividend was paid in July 2014. In May 2015, the board approved a 5.6% increase in its quarterly dividend to $0.095 per share payable in July 2015. Dividend payments totalled $126 million during 2015.
In September 2014, Masco announced a share repurchase program for an aggregate of 50 million shares of its common stock, representing about $1.2 billion based on the share price at the time of the announcement. The program will be funded with FCF and cash on the balance sheet. Masco expects to execute the share repurchase program over several years. The company repurchased $158 million of its stock during 2014 and $456 million during 2015 and expects to repurchase between $400 million - $500 million in 2016.
Fitch is comfortable with Masco's capital allocation strategy given the company's strong liquidity position. In the past, management has also demonstrated its commitment to preserving the company's liquidity position during difficult market conditions. Masco refrained from share repurchases between July 2008 and September 2014, except to offset the dilutive effect of stock grants. In 2009, Masco also reduced its quarterly dividend from $0.235 per common share ($0.94 annually) to $0.075 per share ($0.30 annually), saving about $225 million annually.
BROAD PRODUCT PORTFOLIO
Masco is one of the world's leading manufacturers of home improvement and building products, which include brand names such as Delta and Hansgrohe, Kraftmaid and Merillat cabinets, Behr and Kilz paint, and Milgard windows.
SPIN-OFF OF INSTALLATION BUSINESS
In June 2015, Masco completed the previously announced spin-off of its Installation and Other Services businesses into an independent, publicly traded company named TopBuild Corp. through a tax-free stock distribution to Masco shareholders. This business had $1.5 billion of revenues in 2014 (18% of total company sales) and $86 million of adjusted EBITDA. Masco estimates approximately 80% of this segment's sales were directed to the new home construction market, while repair and remodel accounted for about 20%.
While the spin-off resulted in some loss of EBITDA, Masco's credit profile benefits from lower exposure to the more volatile new home construction market. Masco estimates that its sales to the new home construction market were reduced from 28% to 17% following the spin-off. Between 2006 and 2010, during the major economic and construction downturns, sales from the installation business fell 67% from $3.16 billion to $1.04 billion. By comparison, sales from the company's other business segments declined 31.9% from $9.62 billion to $6.55 billion during the same period. The company's EBITDA margin post-spin also improved, as the EBITDA margin of the installation business was about 620 bps below the total company EBITDA margin during 2014.
HEIGHTENED CUSTOMER CONCENTRATION
Following the spin-off of its installation business in 2015, the concentration of Masco's sales to its two largest customers increased modestly. During 2015, net sales to The Home Depot (Masco's largest customer) totalled $2.4 billion or about 33% of net sales. This compares to about $2.3 billion or 27% of net sales during 2014. Masco's Behr paint is sold exclusively at The Home Depot. Sales to Lowe's, the company's second largest customer, accounted for less than 10% of Masco's net sales for the past two years.
Fitch believes that Masco benefits from the large retail network of The Home Depot and Lowe's, including these retailers' strength in the DIY channel and their push to play a bigger role in the professional segment. However, these retailers also have significant bargaining power, which could limit Masco's ability to raise prices. Additionally, these large home improvement stores also sometimes request product exclusivity, which may limit Masco's ability to offer certain of its products to other distribution channels/customers.
Approximately 21% of the company's sales are directed to international markets, primarily Europe. Management estimates that the UK accounts for about 29% of its international operations, while Central Europe and Eastern Europe make up 26% and 5%, respectively. Southern Europe is about 8% of its international operations. Emerging market sales accounted for about 17% of international sales.
Sales from international operations fell 8% during 2015 due primarily to the impact of foreign currency translation. In local currency, international sales increased 5% during the year. By comparison, sales advanced 5.8% during 2014 after a 6.2% increase during 2013 and a 5.5% decline during 2012. Fitch expects slight growth in the European markets, as Eurozone GDP is projected to improve by only 1.7% during 2016. GDP growth for emerging markets is forecast to grow 3.6% this year.
Fitch's key assumptions within the rating case for Masco include:
--Total industry housing starts improve 9.6%, while new and existing home sales grow 14.6% and 4%, respectively, in 2016;
--Home improvement spending advances 4.5% during 2016;
--Masco's revenues grow mid-single-digits and the company reports slight improvement in EBITDA margins this year;
--Debt/EBITDA settles between 2.5x-2.75x and interest coverage remains above 5x during 2016;
--FCF margins of 3%-4% this year;
--Share repurchases of $400 million-$500 million in 2016;
--Debt reduction of $300 million-$500 million by year-end 2016.
Future ratings and Outlooks will be influenced by broad housing and home improvement market trends, as well as company-specific activity, including free cash flow trends and uses.
Masco's IDR may be upgraded to 'BBB-' in the next 6-12 months if the company reduces its total debt and shows further improvement in financial results and credit metrics, including debt/EBITDA approaching 2.5x, interest coverage above 6x, and FCF margins above 3.5%.
On the other hand, the Outlook could be revised to Stable if Masco's credit metrics do not improve much from current levels, including debt/EBITDA consistently above 3.0x and interest coverage sustained around 5.0x.
A negative rating action may be considered if there is a sustained erosion of profits and cash flows due either to weak residential construction activity, meaningful and continued loss of market share, and/or continuous materials and energy cost pressures resulting in margin contraction, including EBITDA margins of less than 10%, debt/EBITDA consistently above 4x and interest coverage below 4x.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
--Long-term Issuer Default Rating at 'BB+';
--Senior unsecured debt at 'BB+/RR4';
--Unsecured revolving credit facility at 'BB+/RR4'.
The Rating Outlook is Positive.
The Recovery Rating (RR) of '4' for Masco's senior unsecured debt supports a rating of 'BB+', the same as Masco's IDR, and reflects average recovery prospects in a distressed scenario.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
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