TEXT-S&P: Lennar Corp outlook revised to positive
Overview -- Miami-based Lennar Corp. is one of the largest U.S. homebuilders and has been more profitable than most of its peers over the past few years. -- We revised our outlook on Lennar to positive from stable and affirmed our ratings on the company, including the 'B+' corporate credit rating. -- At the same time, we assigned a 'B+' issue-level rating and '4' recovery rating to Lennar's proposed offering of senior notes due 2017. -- The outlook revision reflects our expectation that higher revenues and improved profitability over next 12 to 18 months could materially improve EBITDA-based credit metrics. Rating Action On July 17, 2012, Standard & Poor's Ratings Services revised its outlook on Lennar Corp. to positive from stable. At the same time, we affirmed our ratings on the company, including the 'B+' corporate credit and issue-level ratings on the company's debt. Our recovery rating on the company's unsecured senior notes is '4', indicating an average (30%-50%) recovery in the event of a payment default. We also assigned a 'B+' issue rating and '4' recovery rating to Lennar Corp.'s proposed $300 million of senior notes due 2017. Our '4' recovery rating indicates our expectations for an average (30% to 50%) recovery in the event of default. Rationale The outlook revision reflects our expectation that higher sustained revenue growth and improved profitability over the next 12 to 18 months could result in substantial improvement in Lennar's EBITDA-based credit measures. Additionally, the company's liquidity has been bolstered by the addition of a $410 million committed unsecured revolving credit facility, which should enable Lennar to fund investment in land and inventory sufficient to achieve meaningful revenue growth over the next two years. The recent partial reversal of Lennar's deferred tax asset allowance (DTA) improves balance sheet metrics such as debt to total book capitalization, but perhaps more importantly, provides additional support for our expectation that Lennar is likely to post consistent net operating profits over the next two years. Lennar plans to use proceeds from the proposed senior note offering to fund its recently announced tender for $268 million of 5.95% senior notes due 2013. The tender offer is conditioned on the completion of the new senior note offering. The company will use the remainder of the net proceeds for working capital and general corporate purposes, which may include acquisitions or additional debt repurchases. The new notes will rank equally with Lennar's other senior unsecured obligations and will be guaranteed by substantially all of Lennar's homebuilding subsidiaries for as long as these subsidiaries guarantee other Lennar obligations. The guarantees can be released under certain circumstances. Standard & Poor's ratings on Lennar reflect the company's position as one of the largest U.S. homebuilders, having delivered 11,944 homes during the 12 months ended May 31, 2012. Lennar has been more profitable than most of its homebuilding peers over the past few years, due, in part, to its better-than-average homebuilding gross margins, as well as contributions from opportunistic investments in distressed financial and real estate assets through its Rialto Investments subsidiary. However, the impact of the protracted downturn in the housing market has caused Lennar's revenues and EBITDA to decline significantly from 2006 peak levels, and Lennar's profitability measures are still low relative to similarly rated industrial peers. As a result, we view Lennar's business risk profile as "weak." We view Lennar's financial profile as "aggressive," given the company's weak EBITDA-derived credit measures. After an extremely weak selling season in 2011, demand for new homes strengthened in the first half of 2012, albeit off very low levels. Standard & Poor's 2012 base-line U.S. economic scenario assumes that single-family housing starts increase approximately 14% in 2012, followed by more significant (low 20% range) growth in 2013. Given Lennar's improving absorption trends through the first half of 2012, we believe the homebuilder has sufficient liquidity to grow its community count 8% to 10% in 2012 and 2013. Given our expectations for community count growth and recent absorption trends (3.5 homes per month during the second quarter of 2012), we believe Lennar could potentially increase home deliveries by 20% annually in both 2012 and 2013. We also believe Lennar's operating margin, which was at 9.2% for the second quarter of 2012 (among the highest of its peers), will strengthen modestly over our forecast period as Lennar continues to drive more sales from newer, more profitable communities and leverage its operating platform. Under this scenario, we expect adjusted debt-to-EBITDA to approach the high-6x area by the end of fiscal 2013, down substantially from 14x at Nov. 30, 2011. This scenario also assumes that funded debt (including recourse debt at Rialto and Lennar Financial Services) does not change materially from the $3.7 billion at May 31, 2012. Early indications of traffic count, order levels, and backlog through the first half of 2012 appear to support our expectation for improving homes sales in 2012 compared with 2011, but we remain cautious regarding the impact that the weak economic environment may have on the still-fragile housing recovery. Job growth and consumer confidence remain weak, and the overhang of shadow inventory still weighs on many markets. Despite our cautiously stable view for the overall homebuilding sector, however, we think our near-term expectation of 20% improvement in 2012 home deliveries for Lennar is achievable, particularly given that second-quarter 2012 order levels totaled 4,481 homes, up 40% from the prior year period. Debt to total book capitalization at May 31, 2012, totaled 50.1%, down from 53.4% at the end of the prior quarter primarily because of Lennar's partial reversal of its DTA during the quarter. While improvement in this metric is not a primary driver of credit quality, reversal of the DTA, which is contingent on a number of factors including the likelihood that the tax asset will be utilized, provides additional support for our expectation for sustained profitability over our forecast period. Liquidity We estimate that the company's cash balance and revolver availability, along with an estimated $200 million to $300 million of funds from operations annually, is sufficient to meet anticipated capital needs over the next two years. -- Capital needs include $268 million of senior notes that mature in 2013, and estimated seasonal working capital outflows of $250 million to $350 million annually to fund potential growth deliveries of 15% to 20%. -- As of May 31, 2012, Lennar had a consolidated unrestricted cash balance of about $829.4 million ($667 million of which was attributable to Lennar's homebuilding operations) that has benefitted from the liquidation of legacy land holdings earlier in the housing cycle and a large tax refund in 2010. -- In May 2012, Lennar entered into a $410 million unsecured revolving credit facility that matures in May 2015. Borrowings under the facility accrue interest at LIBOR plus 350 basis points. The credit facility also contains an accordion feature that enables Lennar to seek commitments to increase the size of the facility up to $525 million. -- The facility contains financial maintenance covenants, including a maximum leverage ratio (currently 67%) and a minimum interest coverage test of 1.5x. If interest coverage falls below 1.5x, Lennar must maintain a minimum unrestricted cash balance equal to interest incurred for the prior 12 months. Interest coverage exceeded this level at the end of the second quarter. -- Lennar also has letter of credit facilities with various financial institutions that in aggregate total $400 million. Lennar was in compliance with covenants contained in these facilities at May 31, 2012. Recovery analysis For our most recent recovery analysis, please "Lennar Corp.'s Recovery Rating Profile," to be published shortly on the Global Credit Portal. Outlook Our positive outlook acknowledges our expectation that Lennar's EBITDA-based credit metrics will improve materially over the next 12 to 18 months. We could raise our corporate credit rating to 'BB-' if we think Lennar will continue to post revenue gains in the low 20% area through 2013, while modestly expanding adjusted EBITDA margins to about 10%. Under this scenario, we would expect debt-to-EBITDA to decline to the high-6x area by year-end 2013. However, we could revise the outlook back to stable if sales growth is more moderate than we currently expect and adjusted EBITDA margins decline to the high 7% area. Under this scenario, we would not expect adjusted debt-to-EBITDA to improve materially from the current 11x area, and an upgrade would be unlikely. Related Criteria And Research -- Industry Report Card: Operating Performance for U.S. Homebuilders Is On The Mend, But Risks Remain, April 10, 2012 -- Issuer Ranking: U.S. Homebuilders, Strongest To Weakest, April 10, 2012 -- Key Credit Factors: Global Criteria For Single-Family Homebuilders, Sept. 27, 2011 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 8, 2011 -- Use Of CreditWatch And Outlooks, Sept. 14, 2009 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From Lennar Corp. Corporate Credit Rating B+/Positive/-- B+/Stable/-- Ratings Affirmed Lennar Corp. Senior Unsecured B+ Recovery Rating 4 New Rating Lennar Corp. Senior Unsecured US$300 mil sr nts due 12/15/2017 B+ Recovery Rating 4 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.
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