NEW YORK--(BUSINESS WIRE)--Fitch Ratings has upgraded the Issuer Default Rating (IDR) of D.R. Horton, Inc. (NYSE: DHI) to 'BB+' from 'BB'. The Rating Outlook is revised to Stable from Positive. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The ratings for DHI reflect the company's successful execution of its business model, steady capital structure, and geographic and product line diversity. The company was an active consolidator in the homebuilding industry in the past, but has been much less acquisitive over the past 10 years and it appears that the company will continue to be focused principally on harvesting the opportunities within its current and adjacent markets.
The ratings also reflect the company's relatively heavy speculative building activity (at times averaging 50%-60% of total inventory and 49% at March 31, 2014). Historically, the company built a significant number of its homes on a speculative basis (i.e. begun construction before an order was in hand). DHI successfully executed this strategy in the past, including during the severe housing downturn. Nevertheless, Fitch is somewhat more comfortable with the more moderate spec targets of 2004 and 2005, when spec inventory accounted for roughly 35%-40% of homes under construction.
The Stable Outlook takes into account further moderate improvement in the housing market in 2014 and 2015 and the potential for share gains by DHI and hence volume outperformance relative to industry trends. The Outlook also considers the company's above-average performance from credit and operating perspectives during much of the past housing downturn and so far in the recovery. DHI was one of the few public builders profitable in 2010 and 2011, reporting solid profits in 2012 and 2013, and should report much stronger pretax income this fiscal year. DHI was the second builder to reverse its substantial federal deferred tax asset allowance (during FY 2012).
D.R. Horton was established in 1978 and completed its initial public offering in 1992. DHI has grown quite rapidly since its beginnings. From 1978 to 1987 its activities were exclusively in the Dallas/Ft. Worth area. The company has entered 77 markets since then through a combination of 'greenfield' entries and acquisitions. Since 1978, DHI has made 20 acquisitions, almost all of these during the 1994-2002 period.
DHI acquired the homebuilding operations of Breland Homes in August 2012 for $105.9 million in cash. Breland Homes operated in Huntsville and Mobile in Alabama and along the gulf coast of Mississippi. In October 2013, the company acquired the homebuilding operations of Regent Homes, Inc. for $34.5 million cash. Regent operated in Charlotte, Greensboro and Winston-Salem, N.C. DHI acquired Crown Communities, the largest builder in Atlanta, on May 9, 2014.
In calendar 2013, DHI was ranked the largest homebuilder in the U.S. based on closings and revenues, holding the #1 position based on home closings since 2002. The company has made only two acquisitions since 2003 and it appears that DHI may remain less acquisitive in the future as it focuses on harvesting the opportunities within its current and adjacent markets. The company operates in 27 states and 79 markets in the U.S. and has 36 homebuilding operating divisions.
GENERALLY IMPROVING HOUSING MARKET
Comparisons are challenging through first-half 2014, and so far this year most housing metrics seem to have been short of expectations and fallen somewhat from a year ago. Though the severe winter throughout much of North America restrained some housing activity, there was an absence of underlying consumer momentum so far this year, perhaps due to buyer sensitivity to higher home prices and finance rates and the slowing of job growth at year end.
Housing metrics should improve for all of 2014 due to faster economic growth, and some acceleration in job growth, despite somewhat higher interest rates, as well as more measured home price inflation. Single-family starts are projected to improve 15% to 710,000 as multifamily volume grows about 9% to 335,000. Thus, total starts this year should top 1 million. New home sales are forecast to advance about 16% to 500,000, while existing home volume is flat at 5.10 million, largely due to fewer distressed homes for sale.
As Fitch noted in the past, the housing recovery will likely occur in fits and starts.
SOME EROSION IN HOME AFFORDABILITY
The most recent Freddie Mac 30-year average mortgage rate was 4.17%, down 3 basis points (bps) sequentially from the previous week and about 76 bps higher than the average rate during the month of January 2013, a recent low point for mortgage rates. While current rates are still well below historical averages, the sharp increase in rates and considerably higher home prices in 2013/2014 have moderated affordability.
Fitch projects that mortgage rates could average as much as 60 bps higher in 2014 (relative to 2013) as the Fed continues to taper and the economy strengthens. New home price inflation should moderate in 2014, at least partially because of higher interest rates. Average and median new home prices should increase about 3.5% in 2014. However, Fitch's expectations of a more dynamic economic expansion in the second half of this year with stronger job growth should more than offset this lessening in affordability. This will particularly be the case for the move-up and active adult markets.
DHI successfully managed its balance sheet during the housing downturn and generated significant operating cash flow. DHI had been aggressively reducing its debt during the downturn and early in the recovery. Homebuilding debt declined from roughly $5.5 billion at June 30, 2006 to $1.58 billion as of Dec. 31, 2011, a 71% reduction.
More recently, DHI has been responding to the stronger housing market, expanding inventories and increasing leverage. Homebuilding debt at the end of the fiscal 2014 second quarter was $3.64 billion.
As of March 31, 2014, debt/capitalization was 45.6%. Net debt/capitalization was 38.4% at the end of fiscal 2014 second quarter. Debt-to-EBITDA has improved from 5.7x at Sept. 30, 2012 to 4.0x at Sept. 30, 2013 and 3.7x at March 31, 2014. Funds from operations (FFO) adjusted leverage was 6.6x at the end of fiscal 2012 and is currently 3.6x. Interest coverage rose from 3.35x at the end of fiscal 2012 to 4.75x in 2013 and 5.2x at the end of the fiscal 2014 second quarter. Fitch projects that debt-to-EBITDA should draw near to 3x by the end of 2014 and be below 3x by the conclusion of 2015. Fitch also projects that at the end of 2015 interest coverage should come close to 6.5x.
DHI's earlier debt reduction was accomplished through debt repurchases, maturities and early redemptions. DHI repaid the remaining $145.9 million principal amount of its 6.125% senior notes on Jan. 15, 2014, its due date; $500 million principal amount of 2% convertible senior notes matured May 15, 2014 and converted into common stock; $137.9 million of 5.625% senior notes are due later in 2014. The company also has $157.7 million of senior notes coming due in February 2015.
DHI has solid liquidity with unrestricted homebuilding cash and equivalents of $930.8 million as of March 31, 2014.
On Sept. 7, 2012, DHI entered into a new $125 million five-year unsecured revolving credit facility. In early November 2012, the company announced that it had received additional lending commitments, increasing the capacity of the facility to $600 million. Currently, the facility size is $725 million with an uncommitted accordion feature that could increase the size of the facility to $1 billion, subject to certain conditions and availability of additional bank commitments.
The facility also provides for the issuance of letters of credit (LOCs). LOCs issued under the facility reduce available borrowing capacity and may total no more than $362.5 million in the aggregate. The maturity date of the facility is Sept. 7, 2018. At March 31, 2014, there were no borrowings outstanding and $70.5 million of LOCs issued under the revolving credit facility.
DHI continues to have access to capital markets. In February 2014, the company priced an offering of $500 million aggregate principal amount of 3.750% senior notes due March 1, 2019.
In early December 2012, DHI declared a cash dividend of $0.15 per share. This dividend was in lieu of and accelerated the payment of all quarterly dividends that the company would have otherwise paid in calendar 2013. DHI resumed its normal quarterly cash dividends in calendar 2014.
The company expended $2 billion on land/lots in 2013 and spent about $640 million on development activities. DHI purchased $1.1 billion of land and lots in 2012 and spent approximately $300 million on land development. The company spent $790 million on land and development activities in 2011, and about $830 million during 2010, compared with $380 million paid in 2009. During the peak of the housing cycle, DHI spent $5.2 billion annually.
Through the first half of fiscal 2014, the company committed roughly $1 billion on real estate activities (57% on land and 43% on development). Fitch expects that land and development spending will approximate $2.5 billion for full-year fiscal 2014 - about two-thirds for land and lots and one-third for development activities.
DHI maintains a 6.8-year supply of lots (based on LTM deliveries), 72.7% of which are owned and the balance controlled through options. The options share of total lots controlled is down sharply over the past six years as the company has written off substantial numbers of options and land owners are less inclined to use options. Fitch expects DHI to continue rebuilding its land position and increase its community count. The primary focus will be optioning (or in some cases, purchasing for cash) or developing finished lots in relatively small phases, wherein DHI can get a faster return of its capital.
DHI's cash flow from operations during fiscal 2013 (ending Sept. 30, 2013) was a negative $1.23 billion. In fiscal 2014, Fitch expects DHI to be cash flow negative by $750 million-$825 million as the company continues to spend substantial amounts on land and development activities.
The ratings also reflect DHI's relatively heavy speculative building activity (at times averaging 50%-60% of total inventory and 48.8% at March 31, 2014). DHI has historically built a significant number of its homes on a speculative basis (i.e. begun construction before an order was in hand).
A key focus is on selling these homes either before construction is completed or certainly before a completed spec has aged more than a few months. This has resulted in consistently attractive margins. DHI successfully executed this strategy in the past, including during the severe housing downturn. Nevertheless, Fitch is generally more comfortable with the more moderate spec targets of 2004 and 2005, when spec inventory accounted for roughly 35%-40% of homes under construction.
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;
--Free cash flow trends and uses;
--DHI's cash position.
Fitch would consider taking further positive rating actions if the recovery in housing persists or accelerates and DHI shows steady improvement in credit metrics (such as debt-to-EBITDA leverage approaching 2x and sustaining at that level), while maintaining a healthy liquidity position (in excess of $1 billion in a combination of cash and revolver availability).
Conversely, negative rating actions could occur if the recovery in housing dissipates and DHI maintains an overly aggressive land and development spending program. This could lead to sharp declines in profitability, consistent and significant negative quarterly cash flow from operations, and meaningfully diminished liquidity position (below $500 million).
Fitch has upgraded the following ratings of DHI:
--Long-term IDR to 'BB+' from 'BB';
--Senior unsecured debt to 'BB+' from 'BB'.
The Rating Outlook is revised to Stable from Positive.
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