Fitch Affirms NVR's IDR at 'BBB+'; Outlook Stable
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 rating 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 a sometimes challenging housing environment. The cyclical nature of homebuilding is reflected in the ratings as is 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 rating also considers 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 0.9x and LTM EBITDA-to-interest incurred of 26.7x and solid liquidity (cash and equivalents) are supportive of the 'BBB+' rating level. Fitch expects these credit metrics will further improve by the end of 2016.
IMPROVING HOUSING MARKET
Housing activity ratcheted up more sharply in 2015 as compared with 2014 with the support of a generally robust economy throughout the year. Considerably lower oil prices restrained inflation and left American consumers with more money to spend. The unemployment rate moved lower (5.0% in 2015). Credit standards steadily, moderately eased throughout 2015.
Demographics were somewhat more of a positive catalyst. Single-family starts rose 10.3% to 715,000 as multifamily volume grew 11.8% to 397,000. Total starts were just in excess of 1.1 million. New home sales increased 14.6% to 501,000. Existing home volume approximated 5.250 million, up 6.3%.
New home price inflation slimmed with higher interest rates and the mix of sales shifting more to first-time homebuyer product. Average home prices increased 3.7%, while median prices rose 4.7%.
Sparked by a similarly growing economy the housing recovery is expected to continue in 2016. Although interest rates are likely to be higher, a robust economy, healthy job creation, demographics, pent-up demand, steep rent increases, and further moderation in lending standards should stimulate housing activity. More of those younger adults who have been living at home should find jobs and these 25- to 35-year-olds should provide some incremental elevation to the rental and starter home markets. First-time buyers should be able to take advantage of less expensive mortgage insurance and lenders offering low downpayment programs.
Housing starts should approximate 1.21 million with single-family volume of 0.797 million and multifamily starts of 0.413 million. New home sales should reach 574,000, up 14.6%. Existing home volume growth should be in the low single digits (+3.0%).
Average and median home prices should rise 3.0%-3.5%, higher than earlier forecasts because of still tight inventories.
Next year (2017) could prove to be almost a mirror image of 2016. Real economic growth should be similar to this year, although overall inflation should be more pronounced. Interest rates will rise further but demographics and employment growth should be at least as positive in 2017. First-time buyers will continue to gradually represent a higher portion of housing purchases as qualification standards loosen further. We believe land and labor costs will inflate more rapidly than materials costs.
Housing starts should total 1.311 million. Single-family volume should expand 10% to 877,000, while multifamily starts grow 5% to 434,000. New home sales should reach 640,000, up 11.5%. Existing home sales should gain 4% to 5.625 million.
Average and median home prices should expand 2.0%-2.5% in 2017.
SOME EROSION IN HOME AFFORDABILITY
The most recent Freddie Mac 30-year average mortgage rate (June 16, 2016) was 3.54%, down 6 bps sequentially from the previous week and 13 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. 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 (1Q12), averaged 176.9 in 2013, 165.8 in 2014, 163.9 in 2015, and was 162.4 in April 2016.
Erosion in affordability is likely to continue as interest rates likely head higher in 2016 (as the economy strengthens). Fitch projects that mortgage rates will average up to 20 bps higher in 2016. Home price inflation should moderate a bit 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 may occasionally 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 reflects some unique strategic opportunities.
Over 70% 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 currently 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 pay current market value for the land in its delivery pipeline.
NVR's short-dated inventory position turns over rapidly (about 3.5-to-5 times), 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 eight years. By establishing a significant presence in its markets, NVR positions itself as the preferred land purchaser and forges relationships with key local developers.
As of March 31, 2016, the company controlled 75,400 lots, of which 91.6% were optioned and the remaining were owned (2.3%) and controlled through joint ventures (JVs) (6.1%). Based on LTM closings, NVR controlled 5.5-years of land and owned roughly 0.12-years of land. As is the case with other public homebuilders, the company is accelerating its land activity and trying to opportunistically acquire land at attractive prices. Total lots controlled increased 8.3% year over year.
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 ending March 31, 2016, cash flow from operations totaled $158.7 million. This compares with $203.4 million of cash flow from operations during 2015. Fitch currently projects cash flow from operations will be in the $375 million-$400 million range during 2016.
NVR has historically been an aggressive purchaser of its stock, buying back approximately $3.1 billion of its stock from 2001 through 2007. From 4Q07 through 1Q10, NVR refrained from buying its stock.
The company resumed share repurchase activity later in 2010 buying back $417.1 million. The company repurchased $689.3 million of stock in 2011, $227.3 million during 2012, $554.5 million during 2013, $567.5 million in 2014 and $431.4 million in 2015. NVR repurchased $87.1 million of stock during 1Q16. As of March 31, 2016, the company had $252.1 million remaining under its share repurchase authorization program. Fitch currently projects share repurchases during 2016 will be within $50 million of 2015 levels. Fitch expects NVR will remain disciplined in its share repurchase activity in the period ahead, especially while the housing recovery remains relatively fragile.
NVR ended 1Q16 with $302.9 million of unrestricted cash and cash equivalents and $600 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, possibly in 2016 or 2017 at a size approaching that of its former facility. 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 2016 within its rating case for NVR include:
-Industry single-family housing starts improve 11.5%, while new and existing home sales grow 14.6% and 3.0%, respectively, in 2016;
--NVR's total revenues increase high single digits and homebuilding EBITDA margins rise 50bps this year, largely due to higher volume;
--Debt/EBITDA is approximately 0.8x and interest coverage of about 30.8x by year-end 2016;
--Cash flow from operations should approximate $375 million-$400 million this year;
--The company maintains a healthy liquidity position (roughly $400 million in readily available cash) despite a relatively aggressive share repurchase program.
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 significantly better than Fitch's current industry outlook and shows durability and the company's credit metrics are sustained at or above current levels. NVR would be expected to maintain a robust liquidity position, consisting of cash and eventually credit facility availability, through the cycle with a bias toward the cash component into the next downturn.
A negative rating action could be triggered if the industry recovery dissipates; 2017 revenues decline markedly, while pretax profitability drops below 2011 levels; and NVR's liquidity position falls sharply, perhaps below $200 million as it 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 at 'www.fitchratings.com'.
Summary of Financial Statement Adjustments - Financial statement adjustments that depart materially from those contained in the published financial statements of the relevant rated entity or obligor are disclosed below:
--Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and interest expense included in cost of sales and also excludes impairment charges and land option abandonment costs or recoveries.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Dodd-Frank Rating Information Disclosure Form
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