Fitch Affirms Beazer's IDR at 'B-'; Outlook Stable
Fitch Ratings has affirmed the ratings of Beazer Homes USA, Inc. (NYSE: BZH), including the company's Issuer Default Rating (IDR), at 'B-'. The Rating Outlook is Stable. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
Beazer's 'B-' IDR reflects the company's execution of its business model in the current moderately recovering housing environment, land policies, and geographic diversity. Risk factors include the cyclical nature of the homebuilding industry, BZH's tight liquidity position, the company's high debt load and weak credit metrics (particularly its high leverage), BZH's underperformance relative to its peers in certain operational and financial categories, and its current over-exposure to the credit-challenged entry level market (approximately 60% of BZH's customers are first-time home buyers).
The Stable Outlook takes into account the improving housing outlook for 2015 and 2016, and the expected modest improvement in operating results and credit metrics during the next 12-18 months.
SLOW START TO FISCAL YEAR 2015
BZH's homebuilding revenues for the first nine months of its 2015 fiscal year (ending June 30, 2015) increased 5.5% to $959 million as closings fell 4.4% while the average sales price advanced 10.2% to $307,900 during the period. Land sales totalled $35.6 million during the 2015 year-to-date (YTD) period compared with $8.6 million last year. Homebuilding gross profit margins (excluding inventory impairments and lot option abandonments) contracted so far this year, falling 260 basis points (bps) to 16.9% during the first nine months of 2015 compared with 19.5% during the same period last year. The decline in gross margin was due to community and geographic mix, higher indirect costs, as well as warranty charges related to Florida stucco issues. SG&A as a percentage of sales declined slightly to 14.3% during the nine-month period in 2015 from 14.6% last year. BZH reported a pre-tax loss of $8.7 million during the period, which included $13.6 million of charges related to the Florida stucco issues. Fitch expects BZH will be slightly profitable during all of FY15.
The company has been expanding its community count over the past year, which has translated into increased new order activity and higher backlog during the past two quarters. BZH's average active community count grew 17.1% year-over-year to 164 communities during the third quarter of 2015 (3Q'15) from 140 communities during 3Q'14. Net orders during 3Q'15 increased 18.1% and BZH's ending unit backlog was 25% higher year-over-year (up 35.6% in value). These positive trends should be reflected in the company's financial results during 4Q'15 and into FY2016.
TIGHT LIQUIDITY POSITION
BZH ended 3Q'15 with $128.8 million of unrestricted cash and $101.7 million of borrowing availability under its $150 million revolving credit facility. BZH's liquidity position has lessened over the past few years as the company has stepped up land and development spending. Nevertheless, Fitch expects BZH will maintain cash and revolver availability of at least $200 million - $300 million in the near to intermediate term, which should allow the company to fund seasonal working capital needs.
There is some refinancing risk as BZH has $172.9 million of 8.125% senior notes coming due in June 2016. While the company currently has sufficient cash and revolver availability to fund this debt maturity, BZH's liquidity will be meaningfully diminished if the company is unable to refinance these maturing notes. The company has in the past demonstrated its ability to access the capital markets. In April 2014, BZH issued $325 million of 5.75% five-year senior unsecured notes. Fitch expects the company will refinance its 2016 notes ahead of the scheduled maturity. BZH is also in the process of renewing its $150 million secured revolving credit facility that matures in September 2016 ($130 million matures in September 2016 and $20 million matures in September 2015), although the size and structure of the facility has not been finalized.
HIGH DEBT LOAD AND LEVERAGE
BZH had total debt of $1.55 billion at June 30, 2015. Leverage for the latest 12 months (LTM) ending June 30, 2015 was 12.5x compared with 12.7x at FYE14 and 17.4x at the conclusion of FY13. EBITDA to interest coverage is also low at 1.0x for the latest 12 months (LTM) period ending June 30, 2015 compared with 1.0x in FY14 and 0.8x in FY13. Fitch expects these credit metrics will improve in the next 12-15 months, although leverage is expected to remain weak at around 9x-10x and interest coverage is projected to increase to approximately 1.25x-1.50x at the end of FY16.
BZH is geographically diversified with active operations in 16 states across the country. The company ranks among the top 10 builders in such metro markets as Phoenix, Arizona, Dallas, TX, Washington DC / Arlington, VA / Alexandria, WV markets, Tampa / St. Petersburg / Clearwater, FL, Orlando, FL, Las Vegas, NV, Philadelphia, PA / Camden, NJ / Wilmington, DE markets, Indianapolis / Carmel, IN, Nashville / Davidson / Murfreesboro / Franklin, TN, Baltimore / Towson, MD, and Charleston / North Charleston, Summerville, SC.
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. 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, as measured by the Census Bureau, 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 (average 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. Through the first seven months of the year, total housing starts increased 11.3% versus the same period last year, while new home and existing home sales rose 21.2% and 8.2%, respectively.
Single-family starts are forecast to rise about 12.5% to 729,000 as multifamily volume expands 7.3% to 381,000. Total starts would be in excess of 1.1 million (up 10.7%). New home sales are projected to increase 20% to 523,000. 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%-3.5%.
Fitch expects further improvement in 2016, with total housing starts projected to rise 12.2%, new home sales advances 18%, and existing home sales grows 5% for the year.
SOME EROSION IN HOME AFFORDABILITY
The most recent Freddie Mac 30 year average mortgage rate (Aug. 27, 2015) was 3.84%, down 9 bps sequentially from the previous week and 43 bps higher than the average rate during the month of January 2013 (3.41%), a low point for mortgage rates. Current rates are still well 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 to moderate. 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 1Q'12, averaged 176.9 in 2013, 164.3 in 2014 and was 153.1 in June 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 30-40 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%-3.5% this year, further pressuring affordability.
LAND POSITION AND SPENDING
BZH maintains a 5.7-year supply of lots (based on last 12 months deliveries), 77.6% of which are owned, and the balance controlled through options. Total lots controlled declined 8.7% year-over-year and fell 2.2% compared with the previous quarter. The company has been selling excess land ($53 million during FY14 and $35.6 million YTD) and has also decided to stop reinvesting in its New Jersey homebuilding operations.
The company has been aggressive in its land and development spending following the successful execution of its capital markets transactions in 2012. BZH spent roughly $475.2 million on land purchases and development activities during fiscal 2013 compared with $185.6 million expended during fiscal 2012. During fiscal 2014, the company spent $551.2 million during FY14, of which 60% was directed to new land purchases and 40% for development activities.
Through the first nine months of fiscal 2015 (ended June 30, 2015), BZH spent $353.4 million for land and development activities (50% for new land acquisitions and 50% for development activities). For all of 2015, the company expects total spending will be $475 million, with roughly 50% directed to new land acquisitions and the other half for development expenditures. Fitch is comfortable with BZH's land strategy given the company's liquidity position and management's demonstrated discipline in managing spending and pulling back on its land and development activities during periods of distress.
Fitch's key assumptions within the rating case for BZH include:
--Industry single-family housing starts improve 12.5%, while new and existing home sales grow 20% and 4.3%, respectively, in 2015;
--BZH's homebuilding revenues rise 11%-14% during FY15;
--The company generates EBITDA margins of 7.5% - 8.5% during FY15;
--BZH spends approximately $475 million on land and development activities this year;
--BZH reports negative cash flow from operations of $125 million - $175 million during FY15;
--The company refinances $172.9 million of debt maturing in June 2016 and maintains an adequate liquidity position (above $200 million) with a combination of unrestricted cash and revolver availability in the intermediate term.
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.
BZH's ratings are constrained in the intermediate term due to weak credit metrics and high leverage. However, positive rating actions may be considered if the recovery in housing is maintained and is meaningfully better than Fitch's current outlook, BZH shows continuous improvement in credit metrics (particularly debt to EBITDA consistently below 8x and interest coverage above 2x), and preserves a healthy liquidity position.
Negative rating actions could occur if the recovery in housing dissipates, resulting in revenues and operating losses approaching 2011 levels, and the company maintains an overly aggressive land and development spending program. This could lead to consistent and significant negative quarterly cash flow from operations and diminished liquidity position. In particular, Fitch will review BZH's ratings if the company's liquidity position (unrestricted cash plus revolver availability) falls below $200 million.
Negative rating actions could also occur if the company's credit metrics do not improve much from current levels in a sustained housing recovery, including debt to EBITDA consistently remaining above 10x and interest coverage below 1x in the next 12-18 months. Fitch will also review the company's rating if BZH is unable to refinance $172.9 million of debt maturing in June 2016 and uses cash on hand and/or revolver availability to fund the debt repayment, leading to a diminished liquidity position.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings for Beazer Homes USA, Inc.:
--Long-term IDR at 'B-';
--Secured Revolver at 'BB-/RR1';
--Second lien secured notes at 'BB-/RR1';
--Senior unsecured notes at 'CCC+/RR5';
--Junior subordinated debt at 'CCC/RR6'.
The Rating Outlook is Stable.
The Recovery Rating (RR) of 'RR1' on BZH's secured credit revolving credit facility and second-lien secured notes indicates outstanding recovery prospects for holders of these debt issues. The 'RR5' on BZH's senior unsecured notes indicates below-average recovery prospects for holders of these debt issues. BZH'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. The 'RR6' on the company's junior subordinated notes indicates poor recovery prospects for holders of these debt issues in a default scenario. Fitch applied a liquidation value analysis for these recovery ratings.
Additional information is available on www.fitchratings.com.
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