CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings of Fortune Brands Home & Security, Inc. (NYSE: FBHS), 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
The company's rating reflects its leading market position with strong brand recognition in each of its product offerings, solid credit metrics, strong liquidity position, and consistent free cash flow (FCF) generation. Risk factors include sensitivity to general economic trends, as well as the cyclicality of the residential construction market and the company's growth strategy.
The Stable Outlook reflects Fitch's expectation that demand for FBHS's products will continue to grow in the near to intermediate term as the housing market maintains its moderate recovery and home improvement spending increases at a steady pace.
The company's leverage at the end of the first quarter of 2016 (1Q16) was 2.3x, which is at the mid-point of its leverage target of 2.0x-2.5x. FBHS has been active with share repurchases during the 1Q16, buying back 7.6 million shares of its common stock for $362.7 million. Fitch expects the company's leverage will be at or below 2.0x by the end of 2016 as FBHS uses FCF for the remainder of the year to pay down borrowings under its revolving credit facility (which was used to fund working capital as well as share repurchases during 1Q16).
The company seeks to pursue accretive and strategic acquisitions by expanding in current product categories or adjacent categories globally. The company is focused on attractive consumer-facing categories that value product quality and innovation. In May 2015, the company completed the acquisition of Norcraft Companies, Inc. (Norcraft) for $648.6 million. This acquisition strengthened FBHS's overall product offering, rounded out its regional market penetration and enhanced its frameless cabinet capabilities. Since becoming a publicly independent company in 2011, FBHS has spent more than $1 billion on acquisitions. Fitch expects FBHS will continue to pursue acquisition opportunities to supplement its organic growth.
FBHS also seeks to refine its portfolio to position the company for meaningful long-term growth. In addition to its acquisition activities, the company also evaluates its existing portfolio of businesses. In 2014, the company sold its Simonton window business for $130 million and instead is focusing on driving higher sales and profitability within its fiberglass door entry door business. In September 2015, FBHS also sold its tool storage business. The windows and tool storage businesses do not have as attractive operating profit profiles as its other product offerings.
STRONG CREDIT METRICS
FBHS's credit metrics are strong and remain appropriate for the rating. The company has increased its debt levels over the past few years to fund acquisitions and return cash to shareholders. Total debt grew from $356 million at the end of 2013 to $1.17 billion at year-end 2015 and $1.6 billion as of March 31, 2016. Management indicated that it is committed to a strong investment grade rating and will manage its leverage between 2.0x-2.5x through the housing cycle.
Debt to EBITDA for the latest 12 months (LTM) period ending March 31, 2016 was 2.3x compared with 1.8x at the end of 2015 and 1.4x at year-end 2014. FBHS's leverage for the LTM period was higher compared with year-end 2015 as the company increased debt to fund working capital as well as $362.7 million in share repurchases during 1Q16. Fitch expects leverage will be at or below 2x by year-end 2016 as FBHS uses FCF for the remainder of the year to pay down borrowings under its revolving credit facility.
Interest coverage is strong at 20.1x for the March 31, 2016 LTM period compared with 25.2x during 2015 and 56.1x during 2014. Fitch expects interest coverage will be above 13x by the end of 2016.
SOLID LIQUIDITY AND CONSISTENT FCF GENERATION
FBHS has solid liquidity with cash of $253.6 million (of which $202.5 million is held by non-U.S. subsidiaries) and about $525 million of borrowing availability under its $975 million revolving credit facility maturing in July 2018. FBHS has no debt maturities until 2018, when its $280 million term loan matures. Fitch expects the company will continue to have access to its credit facility as FBHS has sufficient cushion under the required financial covenants of the credit agreement.
Following the acquisition of Norcraft in 2015, the company issued $900 million of senior notes consisting of two tranches ($400 million 3% senior unsecured notes due 2020 and $500 million of 4% senior unsecured notes due 2025). This was the company's first senior notes issuance since becoming a public company in 2011. Prior to the notes issuance, the company's capital structure has been mainly bank debt.
FBHS has consistently generated FCF since becoming a public independent company in late 2011. The company reported $218.4 million of FCF (4.6% of revenues) for the LTM period ending March 31, 2016. This compares to $193.1 million (4.2%) of FCF during 2015, $48.8 million (1.2%) during 2014, $151.2 million (3.6%) during 2013 and $207.8 million (5.8%) during 2012. Fitch expects the company will generate 4%-5% FCF margins during 2016.
DISCIPLINED CAPITAL ALLOCATION APPROACH
Management strives to use its cash flow and leverage its strong balance sheet for acquisitions, expansion into new markets and adjacent product categories, and return cash to shareholders when appropriate. Since the beginning of 2013, the company has deployed about $1.1 billion for acquisitions, $906.3 million for share repurchases, and $241.2 million for dividends.
FBHS increased its quarterly dividend by 14% to $0.16 per share in December 2015. The board also increased quarterly dividends by 17% in December 2014 and by 20% in December 2013. Over the long term, the company seeks to manage a payout ratio of less than 30%. The 2015 payout ratio was about 30% of 2015 earnings per share.
Management seeks to repurchase shares when accretive acquisitions are not available and returns are high. During 2015, FBHS reduced its share repurchases to $51.7 million from $439.8 million during 2014 as the company completed the Norcraft acquisition. At the end of 2015, the company had $247.8 million remaining under its repurchase authorization. In February 2016, the board approved a new repurchase authorization of up to $400 million of the company's stock over a two year period. During the 1Q16, FBHS repurchased $362.7 million of its stock. As of March 31, 2016, FBHS had $285 million remaining under its repurchase authorization. Fitch expects the company will continue to repurchase its stock opportunistically, funded primarily with FCF.
Fitch is comfortable with FBHS's capital allocation approach given the company's strong liquidity, consistent FCF generation, and management's demonstrated commitment to stay within or below its stated leverage target.
FBHS has a leadership position in each of its business segments. Management believes that it is a leading manufacturer of residential kitchen and bath cabinets and faucets in North America as well as the No.1 residential fiberglass entry-door brand in the U.S. among homebuilders and remodelers. Management also believes that it has the leading brand in padlock and personal safes in North America. Fitch believes that a leading market position and meaningful market share often command some pricing power and perhaps provide advantages in shelf-space allocation from distribution channels.
CYCLICALITY OF THE U.S. RESIDENTIAL CONSTRUCTION MARKET
FBHS markets its products primarily to the residential construction sector. During 2015, management estimates that 49% of its overall sales were directed to the U.S repair and remodel segment while U.S. new home construction accounted for about 23% of total sales. Sales to the U.S. security market represented 9% and U.S. commercial construction (new and repair and remodel) accounted for 4% of total company sales. International sales (primarily Canada and China) were 15% of overall sales during 2015. Fitch expects continued modest revenue growth through at least 2017.
FBHS's businesses are sensitive to general economic conditions as well as the cyclicality of the residential construction markets. During the last housing cycle, revenues from Fortune Brands, Inc.'s home and security segment (that was spun-off as FBHS) peaked at roughly $4.7 billion during 2006 and troughed at $3 billion in 2009, a 36% decline. Operating profit margins (before corporate expenses) declined from roughly 15% in 2006 to 5% in 2009. Revenues and operating profits then steadily recovered, with FBHS reporting 2015 revenues of about $4.6 billion and operating profit margins (before corporate expenses) of roughly 12.6%.
Housing activity ratcheted up more sharply in 2015 than in 2014 with the support of a steadily growing, relatively robust economy. Total housing starts grew 10.9% versus 2014, while existing and new home sales were up 6.3% and 14.6%, respectively. After four years of a moderate recovery and with land and labor constraints, it is unlikely that housing will accelerate into a V-shaped recovery. But a continuation of a multi-year growth is in the offing, and is supported by demographics, pent-up demand and attractive affordability as well as steady, albeit modest, easing in credit standards.
Fitch is projecting single-family starts to expand 11.5% in 2016 and multifamily volume to gain about 4%. Total starts would be roughly 1.2 million (up 8.8%). New home sales should improve about 14.6%, while existing home sales rise 3%. Fitch expects the housing upcycle to continue in 2017, with single-family starts forecast to improve 10% and multifamily volume to grow 5.1%. Total starts would be in excess of 1.3 million (up 8.3%). Fitch also expects new and existing home sales will increase about 11.5% and 4%, respectively.
Home improvement spending is expected to sustain its steady increase during 2016 and into 2017, driven by a modestly growing U.S. economy (Fitch estimated GDP growth of 1.8% in 2016 and 2.1% in 2017), 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 and 4% in 2017 after increasing an estimated 4.5% in 2015.
Fitch's key assumptions within our rating case for FBHS include:
--Total Industry housing starts improve 8.8%, while new and existing home sales grow 14.6% and 3%, respectively, in 2016; Fitch expects the housing upcycle to continue in 2017, with total housing starts forecast to improve 8.3% and new and existing home sales increase 11.5% and 4%, respectively;
--Home improvement spending advances 4.5% during 2016 and 4% in 2017;
--FBHS's revenues grow 9%-11% and EBITDA margins expand 50 basis points (bps)-100 bps this year;
--Debt/EBITDA settles at or below 2x and interest coverage is above 13x by the end of 2016;
--FBHS reports FCF margin of 4%-5% in 2016.
Future ratings and Outlooks will be influenced by broad residential construction market trends and how the company manages its capital structure through the cycle, including FCF trends and uses.
Fitch does not anticipate positive rating actions in the near to intermediate term. However, a positive rating action may be considered if management commits to lowering its leverage target to below 2.0x through the housing cycle from the current target of 2.0x-2.5x and the company's debt to EBITDA is consistently between 1.0x-2.0x, funds from operations (FFO) adjusted leverage is sustained below 3.0x and FBHS maintains a solid liquidity position.
A negative rating action may be considered if there is a sustained erosion of profits and cash flows either due to weak residential construction activity, meaningful and continued loss of market share, and/or continuous materials and energy cost pressures resulting in margin contraction, leading to debt to EBITDA consistently above 2.5x and FFO adjusted leverage sustaining above 3.5x for an extended period. Fitch expects FBHS will manage its leverage at or below the low-end of its 2.0x-2.5x leverage (debt to EBITDA) target as we approach the top of the construction cycle so as to allow the company to sustain its leverage comfortably within its target when the cycle declines and EBITDA levels contract.
Negative rating actions may also be considered if there is a change in the company's financial strategy, including debt financed share repurchases and leveraged acquisitions that result in debt to EBITDA sustaining above 2.5x and FFO adjusted leverage consistently and meaningfully above 3.5x.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Fortune Brands Home & Security, Inc.
--IDR at 'BBB';
--Senior unsecured notes at 'BBB'.
The Rating Outlook is Stable.
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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