NEW YORK--(BUSINESS WIRE)--Fitch Ratings has affirmed the ratings for NVR, Inc. (NYSE: NVR), 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 ratings and Outlook for NVR reflect the strong credit protection measures, solid free cash flow generation and balance sheet liquidity that results from its unique operating model. The ratings also reflect NVR's capacity to withstand a meaningful housing downturn and manage effectively in an often challenging housing environment. The cyclical nature of homebuilding is reflected in the ratings as are NVR's relatively heavy exposure to Washington D.C. and Baltimore markets. Fitch also takes into account NVR's track record through the past few recessions, and its, at times, active share repurchase program.
The ratings also consider NVR's capital structure, solid liquidity position and Fitch's level of confidence with regard to its operating model under various economic conditions. Current debt to latest 12 months (LTM) EBITDA of 1.1x and LTM EBITDA to interest incurred of 21.8x and solid liquidity (cash and equivalents) are supportive of the 'BBB+' rating level. Fitch expects these credit metrics will further slightly improve by the end of 2015.
IMPROVING HOUSING MARKET
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 acceleration in job growth (as 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. A combination of tax increases and spending cuts in 2013 shaved about 1.5pp off annual economic growth, according to the Congressional Budget Office. Many forecasters estimate the fiscal drag in 2014 was only about 0.25%.
Single-family starts in 2014 improved 4.8% to 648,000 as multifamily volume grew 15.6% to 355,000. Thus, total starts in 2014 were 1.003 million. New home sales were up a modest 1.6% to 436,000, while existing home volume was off 2.9% to 4.940 million largely due to fewer distressed homes for sale and limited inventory.
New home price inflation moderated in 2014, at least partially because of higher interest rates and buyer resistance. Average new home prices rose 6.4% in 2014, while median home prices advanced approximately 5.4%.
Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing, relatively robust economy throughout the balance of the year. Considerably lower oil prices should restrain inflation and leave American consumers with more money to spend. The unemployment rate should continue to move lower (5.3% in 2015). Credit standards should steadily, moderately ease throughout 2015. 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 about 17.3% to 760,000 in 2015 as multifamily volume expands about 7% to 381,000. Total starts would be in excess of 1.1 million. New home sales are projected to increase 18% to 515,000. Existing home volume is expected to approximate 5.152 million, up 4.3%.
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 3.0%-3.5%.
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 (March 28, 2015) was 3.87%, up 3 basis points (bps) sequentially from the previous week and 46 bps higher than the average rate during the month of January 2013 (3.41%), a low point for mortgage rates. Current rates are still below historical averages and help moderate the effect of much higher home prices during the past few years. Income growth has been (and may continue to be) relatively modest.
Nevertheless, there has been some lessening of affordability as the upcycle in housing has matured. The Realtor Association's composite affordability index peaked at 207.3 in the first quarter of 2012, averaged 176.9 in 2013, 164.4 in 2014 and was 170.3 in March 2015.
Erosion in affordability is likely to continue as interest rates likely head higher in 2015 (as the economy strengthens). Fitch projects that mortgage rates will average 20-30 bps higher in 2015. Home price inflation should moderate this year reflecting the higher interest rates and the mix of sales shifting more to first time homebuyer product. However, average and median home prices should still rise within a range of 3.0%-3.5% this year, pressuring affordability.
NVR utilizes an operating model in which land is primarily controlled through rolling options with fixed deposits sourced from independent land developers. Land is not purchased until construction is set to begin. As a consequence, NVR occasionally may be able to participate in land appreciation, while minimizing capital outlays. This enables NVR to significantly reduce the risk of downside volatility.
On a limited basis NVR has acquired several raw parcels of land to be developed into finished lots. Additionally, the company has also obtained finished lots using joint ventures. This does not represent a change in NVR's disciplined approach in controlling finished lots through options, but is representative of several unique strategic opportunities.
Consistently, over 75% of NVR's inventory is represented by relatively liquid pre-sold work in process that is less vulnerable to significant declines in value in periods of economic stress. In a downturn, write-downs would primarily be limited to forfeiture of option deposits, a fraction of total finished lot value (typically 5%-10%). Alternatively, NVR seeks to renegotiate option contracts to realign the proposed land purchase price with prevailing market conditions, thereby averting severe gross margin compression.
NVR's gross margins are lagging some of its peers during this housing recovery as most of the large public builders started to rebuild their land positions during 2010 and have been/are delivering homes that have favorable land cost basis, including some land that was impaired during the downturn. NVR's just in time operating model necessitates that the company pays current market value for the land in its delivery pipeline.
NVR's short-dated inventory position turns over rapidly (about 3.5x to 5x), enhancing operating cash flow. NVR's inventory turnover ratios are consistently and considerably higher than those of its peers.
Because of its operating model, NVR is reliant on third party land developers to prepare finished lots and sell them under option to NVR. This strategy may restrict growth only to markets where such a strategy is viable. However, NVR has expanded its strategy to six new markets over the past seven years. By establishing a significant presence in its markets, NVR positions itself as the preferred land purchaser and forges relationships with key local developers.
Fitch believes that, if options were to become unattainable in NVR's markets, bondholders would be well protected due to the strong cash flow dynamics of NVR's model. Without land reinvestment requirements, NVR produces significant cash with which to retire its debt. For the LTM period ending March 31, 2015, cash flow from operations totaled $198.7 million. This compares with $184.5 million of cash flow from operations at year-end 2014. Fitch currently projects cash flow from operations will be in the $300 million-$325 million range at the conclusion of 2015.
NVR has historically been an aggressive purchaser of its stock, buying back approximately $3.1 billion of its stock from 2001 through 2007. From fourth quarter-2007 (4Q'07) through 1Q'10, the company refrained from buying its stock.
NVR resumed share repurchase activity later in 2010 buying $417.1 million. The company repurchased $689.3 million of stock in 2011, $227.3 million during 2012, $554.5 million during 2013 and $567.5 million in 2014. NVR repurchased $63.1 million of stock during the 1Q'15. As of March 31, 2015, the company had $407.5 million remaining under its share repurchase authorization program. Fitch currently estimates share repurchases during 2015 will be similar to 2014 levels. Fitch expects NVR will remain disciplined in its share repurchase activity in the period ahead, especially should the housing recovery stall.
NVR ended 1Q'15 with $520.5 million of unrestricted cash and cash equivalents and $599.2 million of recourse debt.
Effective Oct. 27, 2010, NVR voluntarily terminated its $300 million unsecured revolving credit facility, which was scheduled to mature on Dec. 6, 2010. Fitch expects NVR will re-establish a credit facility at some point, although probably not in 2015. In any case, Fitch anticipates that the company will keep more cash on the balance sheet than in the past.
Fitch's key assumptions for 2015 within the rating case for NVR include:
--Industry single-family housing starts improve about 17%, while new and existing home sales grow 18% and almost 4.5%, respectively;
--NVR's revenues increase at a mid-teens pace, but homebuilding EBITDA margins erode about a percentage point this year, due to higher expenses (especially land costs) and lesser home price inflation;
--Pretax and net profits continue to expand at a low double digit pace;
--The company's debt/EBITDA approximates 1.1x and interest coverage remains over 20x at year-end 2015;
--The company maintains an adequate liquidity position (between $275 million-$300 million).
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, debt levels, free cash flow trends and uses, and the company's cash position.
Fitch currently does not expect the company's ratings and/or Outlook to change in the next 12-18 months. However, a Positive Outlook may be considered if the recovery in housing is better than Fitch's current outlook and shows durability and the company's credit metrics are sustained at or above current levels. The company would be expected to maintain a robust liquidity position, consisting of cash and eventually credit facility availability, through the cycle with a bias towards the cash component into the next downturn.
A negative rating action could be triggered if the industry recovery dissipates; 2015 and 2016 revenues decline markedly (in excess of 20% from 2014 volume), while pretax profitability drops below 2011 levels; and NVR's liquidity position falls sharply, perhaps below $200 million as the company maintains an overly aggressive share repurchase program and/or diverges meaningfully from its land operating model.
FULL LIST OF RATING ACTIONS
Fitch has affirmed NVR's ratings as follows:
--Issuer Default Rating at 'BBB+';
--Senior unsecured debt 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. 28 May 2014)