Fitch Rates KB Home's Proposed $150MM Convertible Sr. Notes Offering 'B+/RR4'; Outlook Stable
Fitch Ratings has assigned a 'B+/RR4' rating to KB Home's (NYSE: KBH) proposed offering of $150 million convertible senior unsecured notes due 2019. The new issue will be equal in right of payment with all other senior unsecured debt. Concurrent with the notes offering, KBH also announced the public offering of $100 million of its common stock. The company intends to use the proceeds of the notes issuance and the common stock offering for general corporate purposes, including land acquisitions and development.
The Rating Outlook is Stable. A complete list of ratings follows at the end of this release.
The ratings for KBH are based on the company's geographic diversity, customer and product focus, conservative building practices and effective utilization of return on invested capital criteria as a key element of its operating model. The company did a good job in reducing its inventory exposure and generating positive operating cash flow during the severe industry downturn. Since its peak in the third quarter of 2006, homebuilding debt has been reduced from $7.89 billion to $1.87 billion currently (pro forma).
The Stable Outlook reflects the continuing growth prospects for the U.S. housing sector. Fitch raised its housing forecast for 2012 a number of times during the course of the year. Nevertheless, the current estimates for the year still reflect a below-trend line cyclical rise off a very low bottom. In a slowly growing economy with somewhat diminished distressed home sales competition, less competitive rental cost alternatives, and new and existing home inventories at historically low levels, 2013 single-family housing starts should improve about 18%, while new home sales increase approximately 22% and existing home sales grow 7%. However, as Fitch has noted in the past, recovery will likely occur in fits and starts.
The ratings also reflect KBH's business model and marketing prowess. The ratings take into account the company's current primary exposure to entry-level and to a lesser degree first-step trade-up housing (the deepest segments of the market), its leadership role in constructing energy efficient homes, its reemphasis of the value-engineered Open Series of home designs, its conservative building practices, utilization of return on invested capital criteria as a key element of its operating model and its capital structure.
The company maintains a 7.1-year supply of lots (based on last 12 months deliveries), 72.9% 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.)
KBH's most recent credit metrics, while improving in certain cases, remain stressed. Debt to capitalization was 82.1% as of year-end 2012, up from 78.2% at year-end 2011. Net debt (debt less unrestricted homebuilding cash) to capitalization was 76.1%, up from 72.5% as of Nov. 30, 2011. Debt to LTM EBITDA, excluding real estate impairments, was 17.5 times (x) at year-end 2012 and was 37.0x at the end of 2011. Interest coverage was 0.8x for fiscal 2012 and 0.4x for fiscal 2011.
KBH currently has solid liquidity with unrestricted homebuilding cash of $524.8 million as of Nov. 30, 2012. The company has also negotiated a commitment letter with four financial institutions for a proposed $200 million unsecured revolving credit agreement. This facility has an uncommitted accordion feature that could increase the facility up to $300 million, subject to additional bank commitments. The credit agreement is expected to close during the first quarter of 2013.
The company generated $34.6 million of cash flow from operations (CFFO) during 2012 after investing roughly $565 million in land and development during the year. For all of fiscal 2013, Fitch expects KBH will significantly increase its land and development spending as it executes its 'going on offense' initiative. CFFO could range from negative $350 million to $450 million should the company increase its land and development spending by 75% to 100% during 2013 compared with 2012 levels.
Fitch is comfortable with this strategy given the company's improved liquidity position from the proposed equity and notes issuance as well as its newly established $200 million revolving credit facility. Fitch expects KBH to end fiscal 2013 with homebuilding unrestricted cash in excess of $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.
KBH's ratings are constrained in the intermediate term because of relatively high leverage metrics. However, a positive rating action may be considered if the recovery in housing is meaningfully better than Fitch's current outlook, KBH shows continuous improvement in credit metrics, and maintains a healthy liquidity position. In particular, debt leverage would need to approach 4x and interest coverage would need to exceed 4x in order to take a positive rating action.
Negative rating actions could be triggered if the industry recovery dissipates; KBH's 2013 revenues drop by the mid-teens while the pre-tax loss approaches 2011 levels; and the company's liquidity position (a combination of cash and revolver availability) falls sharply, perhaps below $350 million.
Fitch currently rates KB Home with a Stable Outlook as follows:
--IDR at 'B+';
--Senior unsecured debt at 'B+/RR4'.
The Recovery Rating (RR) of 'RR4' on KBH's senior unsecured notes indicates average recovery prospects for holders of these debt issues. KBH's exposure to claims made pursuant to performance bonds and joint venture debt and the possibility that part of these contingent liabilities would have a claim against the company's assets were considered in determining the recovery for the unsecured debtholders. Fitch applied a liquidation value analysis for these RRs.
Additional information is available at 'www.fitchratings.com'. The ratings above were solicited by, or on behalf of, the issuer, and therefore, Fitch has been compensated for the provision of the ratings.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Recovery Rating and Notching Criteria for Non-Financial Corporate Issuers' (Aug. 14, 2012);
--'Liquidity Considerations for Corporate Issuers' (June 12, 2007).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers
Liquidity Considerations for Corporate Issuers
Robert Curran, +1-212-908-0515
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Jason Paraschac, +1-212-908-0746
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