NEW YORK--(BUSINESS WIRE)--Fitch Ratings has assigned a long-term Issuer Default Rating (IDR) of 'BBB' to Fortune Brands Home & Security, Inc. (NYSE: FBHS). The Rating Outlook is Stable.
KEY RATING DRIVERS
The company's 'BBB' rating reflects FBHS's leading market position with strong brand recognition in its 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. Fitch also expects the company's credit metrics will remain relatively stable in the intermediate term.
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.
The company seeks to pursue accretive and strategic acquisitions by expanding in current product categories or globally in adjacent categories. Since becoming a public, independent company in 2011, FBHS has spent approximately $470 million on acquisitions.
In March 2015, FBHS reached an agreement to acquire Norcraft Companies, Inc., a leading publicly owned manufacturer of kitchen and bathroom cabinetry. During 2014, Norcraft had sales of $376 million and operating income of $37.3 million (9.9% of sales). The acquisition will strengthen FBHS's overall product offering, round out its regional market penetration and enhance its frameless cabinet capabilities. The purchase price is $25.50 per share, resulting in an enterprise value of approximately $600 million, and will be initially financed with borrowings under the company's revolving credit facility (RCF). FBHS completed the tender offer to purchase all outstanding shares of Norcraft in mid-May, when about 78% of the Norcraft outstanding shares were tendered and accepted. Each remaining share of Norcraft common stock that was not validly tendered will be cancelled and converted into the right to receive $25.50 per share.
Fitch expects FBHS will continue to pursue acquisition opportunities to supplement its organic growth.
SOLID CREDIT METRICS
FBHS has solid credit metrics. Management 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-month (LTM) period ending March 31, 2015 was 1.4x compared with 1.2x at year-end 2014 and 0.7x at the end of 2013. FFO (funds from operations) adjusted leverage was 3.1x for the LTM period ending March 31, 2015 compared with 2.8x at year-end 2014 and 1.6x at the conclusion of 2013. Following its spin-off from Fortune Brands, Inc. in October, 2011, the company's debt-to-EBITDA was 2.0x and FFO adjusted leverage was 2.6x at the end of 2011.
FBHS's debt-to-EBITDA is projected to increase slightly to 1.9x at the end of 2015 due to the additional debt incurred from the Norcraft acquisition. Fitch expects leverage will remain under 2x during through 2016. Fitch would expect FBHS will manage its leverage at or below the low end of its 2.0x-2.5x leverage target as we approach the top of the residential construction cycle so as to allow the company to sustain leverage comfortably within its target when the cycle declines and EBITDA levels contract.
Interest coverage is strong at 45.8x for the March 31, 2015 LTM period compared with 51.8x during 2014 and 69.3x during 2013. The capital structure consists of bank debt (term loan and revolver) with a current interest rate of LIBOR + 125 bps. Fitch projects interest coverage will be in the 18x-20x range during the forecast period.
CONSISTENT FCF GENERATION
FBHS has consistently generated FCF (cash flow from operations less capital expenditures and dividends) since becoming a public, independent company in late 2011. The company reported $132.7 million of FCF (3.3% of revenues) for the March 31, 2015 LTM period. This compares to $48.8 million (1.2%) of FCF during 2014, $151.2 million (3.6%) during 2013 and $207.8 million (5.8%) during 2012. Fitch expects the company will generate 3%-4% FCF margins during the next few years.
Management seeks to use its cash flow and leverage its strong balance sheet for acquisitions, expansion into new markets and adjacent categories, and return cash to shareholders (in the form of dividends and share repurchases) when appropriate. During 2014, the company repurchased $439.8 million of its stock compared with $52.1 million during 2013. Fitch does not expect meaningful share repurchases in the near term as the company uses excess cash flow to pay down some of the debt incurred from the Norcraft acquisition. Fitch expects management will remain disciplined with the uses of its cash flow, balancing acquisition opportunities with shareholder-friendly activities.
FBHS has a solid liquidity position with cash of $179.4 million (of which $154.4 million is held by non-U.S. subsidiaries) as of March 31, 2015 and $740 million of borrowing availability under its $975 million RCF maturing in July 2018. FBHS has no debt maturities until 2018 and its term loan facility requires an annual amortization of $26.3 million in 2015 (starting in 3Q15) and $52.5 million in subsequent years.
Fitch expects the company will continue to have access to its credit facilities as FBHS has sufficient cushion under the required financial covenants of the credit agreements. Availability under the company's credit facilities will be reduced temporarily during 2Q15 as FBHS will use revolver borrowings to fund the $600 million acquisition of Norcraft. Fitch anticipates FBHS will issue long-term notes to term-out a portion of the borrowings under the credit facilities. Fitch expects the company will have liquidity (combination of cash plus revolver availability) of at least $400 million $500 million in the intermediate term.
CYCLICALITY OF END MARKETS
FBHS markets its products primarily to the residential construction sector. During 2014, management estimates that 47% of its overall sales were directed to the U.S. repair and remodel segment while new home construction accounted for about 23% of total sales. Sales to the U.S. security market represented 9% and commercial construction (new and repair and remodel) accounted for 4% of total company sales. International sales (primarily Canada and China) were 17% of overall sales during 2014.
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 have continued to recover, with FBHS reporting 2014 revenues of about $4 billion and operating profit margins (before corporate expenses) of roughly 11.8%.
Housing metrics increased in 2014 due to more robust economic growth during the last three quarters of the year (prompted by improved household net worth, industrial production and consumer spending), and, consequently, there was an acceleration in job growth (unemployment rates decreased to 6.2% for 2014 from an average of 7.4% in 2013), despite modestly higher interest rates as well as more measured home price inflation.
Single-family starts in 2014 improved 4.9% to 648,000 while multifamily volume grew 15.6% to 355,400; total starts in 2014 were 1.003 million. New-home sales increased 1.2% to 436,000, while existing home volume was off about 3% to 4.940 million largely due to fewer distressed homes for sale and limited inventory.
Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing economy throughout the year. Total housing starts are projected to expand 14% to 1.14 million as single-family starts advance 17% and multifamily volumes gain 7%. New-home sales should grow 18%, while existing home sales rise 4.3%.
Home improvement spending is expanding at a steady pace, despite irregular economic growth in 2014. Improving housing turnover during 2013 and gains in home prices in 2013 and 2014 are leading to increased optimism and spending for home remodeling. While housing turnover was volatile during much of 2014, growing strength in the economy and employment should positively influence remodeling spending in 2015. Fitch projects home improvement spending increased 4%-5% in 2014 and will grow approximately 6% during 2015.
Fitch projects spending for discretionary big ticket remodeling projects will continue to lag the overall growth in the home improvement sector somewhat, as credit availability remains relatively constrained and homeowners remain cautious in their spending.
Fitch's key 2015 assumptions within its rating case for the issuer include:
--Total industry housing starts improve 13.8%, while new and existing home sales grow 18% and 4.3%, respectively;
--Home improvement spending advances 6%;
--FBHS's revenues increase 11%-13%, including the operating results of Norcraft, and EBITDA margins increase 50-100 bps compared with 2014;
--Debt/EBITDA below 2x and interest coverage at or above 20x;
--FCF margins of between 3%-4%;
--No meaningful share repurchases in the near- to intermediate-term.
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, one 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 1x-2x, FFO adjusted leverage is consistently below 3.0x and FBHS maintains a solid liquidity position.
Negative rating actions may be considered if there is a severe and lengthy downturn in the U.S. residential construction market, leading to revenue declines in the mid-teens, debt-to-EBITDA consistently above 2.5x and FFO adjusted leverage sustaining above 3.5x for an extended period. Fitch would expect 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 remaining meaningfully above 3.5x.
FULL LIST OF RATING ACTIONS
Fortune Brands Home & Security, Inc.
--Issuer Default Rating assigned at 'BBB'.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)