Fitch, the debt ratings agency, on Monday left the debt ratings on Beazer Homes USA as they were but dropped the company's rating outlook to negative. The company has more than $850 million in notes due in 2018 and 2019, and, as recently reported by BIG BUILDER, the credit markets have frozen up for companies with less-than-stellar ratings.
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 has been revised to Negative from Stable. A complete list of rating actions follows at the end of this release.
KEY RATING DRIVERS
The revision of the Outlook to Negative from Stable reflects Fitch's concern regarding the company's meaningful debt maturities in 2018 and 2019. While Fitch expects further moderate growth in housing activity through 2017 and the company has executed its deleveraging strategy and improved its credit metrics, there is refinancing risk associated with its upcoming debt maturities. BZH has $300 million of senior secured notes coming due in April 2018 and about $549.6 million of senior unsecured notes maturing in mid-2019. The company's $140 million term loan also requires quarterly amortization of $17.5 million until its maturity in March 2018.
The rating for BZH is based on the company's execution of its business model in the current moderately recovering housing environment, land policies, and geographic diversity. BZH's rating is also supported by the company's improving credit metrics. Risk factors include the cyclical nature of the homebuilding industry, the company's high debt load and, although improving, still 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).
BZH had total debt of $1.46 billion at March 31, 2016 compared with $1.53 billion at Sept. 30, 2015. BZH has improved its credit metrics during the past few years, although leverage remains high and interest coverage is still low. Debt/EBITDA declined from 12.9x at the end of FY14 (ending Sept. 30, 2014) to 11.7x at the conclusion of FY15 and 9.1x for the latest-12-month (LTM) period ending March 31, 2016. EBITDA to interest coverage improved to 1.3x for the LTM period ending March 31, 2016 compared with 1.1x in FY15, 0.9x in FY14 and 0.8x in FY13.
Last year, the company had planned to partly refinance $170.9 million of 8.125% senior notes maturing in June 2016 and originally anticipated reducing overall debt by $50 million during FY16. However, the capital markets were somewhat challenging last year and thus far during 2016. As a result, BZH has accelerated its deleveraging strategy and now intends to reduce debt by at least $100 million during FY16 and by at least $70 million during FY17. Fitch projects leverage will settle around 9.1x at the end of FY16 and at or below 8.0x at the conclusion of FY17. Fitch expects interest coverage will be 1.3x - 1.8x during the next 12 - 18 months.
MEANINGFUL DEBT MATURITIES IN 2018 AND 2019
BZH has $300 million of senior secured notes coming due in April 2018 and about $549.6 million of senior unsecured notes maturing in mid-2019. The company's $140 million term loan also requires quarterly amortization of $17.5 million until its maturity in March 2018.
The company has in the past demonstrated its ability to tap the capital markets to refinance debt and/or finance growth initiatives. However, BZH was unable to access the unsecured debt market (at reasonable terms) in late 2015/early 2016 to refinance $170.9 million of senior unsecured notes that were scheduled to mature in June 2016. Instead, BZH chose to access the term loan (T/L) market in March 2016 and issued a $140 million T/L to retire the 2016 unsecured notes. The new term loan (priced at LIBOR plus 550 basis points) provided the company with greater flexibility to manage its deleveraging strategy as it requires quarterly amortization of $17.5 million starting in June 2016 until its maturity in March 2018.
Fitch believes that BZH has several options to address the $300 million of senior secured notes coming due in April 2018:
--Access the secured term loan market (similar to the $140 million T/L issued in March 2016);
--Issue senior secured notes (similar to the notes maturing in April 2018);
--Issue unsecured notes (if at reasonable terms).
BZH's bond indentures/credit agreements allow for a secured debt basket of the greater of $700 million or 40% of Consolidated Tangible Assets (CTA). Fitch estimates that the secured debt basket under the company's bond indentures was roughly $900 million as of March 31, 2016. Taking into account the company's $145 million first-lien revolver, the $300 million of senior secured (2nd lien) notes coming due in 2018 and the $140 million senior secured (2nd lien) term loan, BZH can incur up to an additional $320 million of secured debt. Potentially, when excluding the maturing secured notes and the amortization of the T/L, BZH can issue up to $650 million of secured debt by the end of FY16. Fitch believes that the ability to issue secured debt and the company's improving credit profile somewhat lessen the refinancing risk associated with the company's $300 million senior secured notes maturing in April 2018.
Fitch is more concerned with the 2019 maturities due to the larger amount of these unsecured notes. BZH has been repurchasing some of these notes in open market transactions this year (about $10.4 million). Fitch will monitor BZH's ability to access the capital markets and company's plan to address these maturities in the next 12 - 18 months.
FOCUS ON DEBT REDUCTION WILL PRESSURE MARGINS
BZH has employed a capital efficiency program that includes the increased use of land banking arrangements and activating mothballed lots as it plans to pay down debt. The focus on expanding its land banking activities allows the company to generate cash flow (from home deliveries built on existing land holdings) while limiting the upfront capital typically required to purchase and/or develop raw land for future home deliveries.
However, margins are likely to be negatively impacted as gross margins on home sales from land banking transactions are typically 400 bps lower compared with homes delivered from lots developed internally. For FY16, management estimates that homes delivered from land banking transactions will approximate 10% of revenues, which will have about a 40 bps negative impact on gross margins. Additionally, the company also expects to activate mothballed lots and monetize these assets through home deliveries and land sales. Management estimates this initiative could have a 60 bps negative margin impact during FY16.
In addition, the company's focus on debt reduction will likely result in slower growth for the company beyond 2017 as cash used to pay down debt will not be available to invest in new land opportunities. These are somewhat offset by improved asset turnover as well as well as lower interest expense payments from reduced debt levels.
BZH ended March 31, 2016 with $134.9 million of unrestricted cash and $116.1 million of borrowing availability under its $145 million revolving credit facility maturing in January 2018. Fitch expects BZH will maintain unrestricted cash and revolver availability of at least $200 million - $250 million in the near to intermediate term, which should allow the company to fund seasonal working capital needs.
LAND POSITION AND SPENDING
During FY15, BZH spent $453 million on land and development activities. This compares to $551.2 million of land and development spending in FY14 and $475 million spent in FY13. Through the first six months of its 2016 fiscal year, BZH spent $195.3 million on land and development compared with $247.5 million spent during the same period in FY15. For all of FY16, Fitch expects BZH's total land and development spending will be below FY15 levels. As a result, Fitch expects BZH will report cash flow from operations (CFFO) of approximately $75 million - $125 million in FY16. The company generated $62 million of CFFO for the LTM period end March 31, 2016 compared with negative CFFO of $81.1 million during FY15 and negative $160.4 million during FY14.
BZH maintains a 4.7-year supply of lots (based on last 12 months deliveries), 76.1% of which are owned, and the balance controlled through options. Total lots controlled declined 9.6% year-over-year and fell 0.8% compared with the previous quarter. Owned lots fell 12.5% YOY while lots controlled through options increased 1.2% compared with the same period last year. At the end of March 2016, BZH had 19,958 active lots, 4,469 lots held for future development and 705 lots held for sale.
The company has been selling excess land ($53 million during FY14, $56.8 million during FY15 and $16.2 million through the first six months of FY16) and has also decided to stop reinvesting in its New Jersey homebuilding operations during FY15. As of March 31, 2016, the company had $49.5 million of land held for sale.
At this point in the housing cycle and given the company's upcoming debt maturities, Fitch expects BZH will be more cautious on its land and development spending. In the past, management has demonstrated discipline in pulling back on its land and development activities during periods of distress.
BZH is geographically diversified with active operations in 13 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, SC. While BZH is not one of the top builders in Houston, this market represents roughly 10% of the company's FY15 closings. BZH was cautious on its Houston land investments during the last 12 months, but remains committed to this market over the long term.
MODERATE HOUSING RECOVERY CONTINUES
Housing activity ratcheted up more sharply in 2015 than in 2014 with the support of a steadily growing, relatively robust economy. Total housing starts grew 10.9% versus 2014, while existing and new home sales were up 6.3% and 14.6%, respectively. After four years of a moderate recovery and with land and labor constraints, it is unlikely that housing will accelerate into a V-shaped recovery. But a continuation of a multi-year growth is in the offing, and is supported by demographics, pent-up demand and attractive affordability as well as steady, albeit modest, easing in credit standards.
Fitch is projecting single-family starts to expand 11.5% in 2016 and multifamily volume to gain about 4%. Total starts would be roughly 1.2 million (up 8.8%). New home sales should improve about 14.6%, while existing home sales rise 3%. Fitch expects the housing upcycle to continue in 2017, with single-family starts forecast to improve 10% and multifamily volume to grow 5.1%. Total starts would be in excess of 1.3 million (up 8.3%). Fitch also expects new and existing home sales will increase about 11.5% and 4%, respectively.
Fitch's key assumptions within the rating case for Beazer include:
--Industry single-family housing starts improve 11.5%, while new and existing home sales grow 14.6% and 3%, respectively, in 2016; Fitch expects the housing upcycle to continue in 2017, with single-family starts forecast to improve 10% and new and existing home sales increase 11.5% and 4%, respectively.
--BZH's homebuilding revenues advance in the low to mid-teens during FY16;
--EBITDA margins expand 25 bps - 50 bps during FY16 compared with FY15;
--Land and development spending this year will be lower compared with FY15;
--The company generates cash flow from operations of $75 million - $125 million during FY16;
--Debt to EBITDA settles at around 9.0x and interest coverage is roughly 1.4x by the end of FY16;
--BZH refinances its 2018/2019 debt maturities.
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.
The company's IDR could be downgraded to 'CCC' if the company is unable to favorably refinance its upcoming debt maturities well ahead of their due dates, leading to a meaningfully diminished liquidity position. Negative rating actions could also occur if the company's credit metrics deteriorate from current levels, including debt to EBITDA consistently above 10x and interest coverage below 1x.
The Outlook could be revised to Stable if the company successfully completes a favorable refinancing of its upcoming debt maturities.
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 BZH successfully refinances its upcoming debt maturities, 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 the company preserves a healthy liquidity position.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Beazer Homes USA, Inc.
--Long-Term IDR at 'B-';
--Secured revolver at 'BB-/RR1';
--Second lien secured notes at 'BB-/RR1';
--Second lien secured term loan at 'BB-/RR1';
--Senior unsecured notes at 'CCC+/RR5';
--Junior subordinated debt at 'CCC/RR6'.
The Rating Outlook has been revised to Negative from Stable.
The Recovery Rating (RR) of 'RR1' on BZH's secured credit revolving credit facility, second-lien secured notes and secured term loan 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