TEXT-S&P revises Hovnanian outlook to positive, affirms ratings
Overview -- Hovnanian Enterprises Inc. is among the largest homebuilders in the U.S. but the company has struggled under a heavy debt load. -- Through the first half of fiscal 2012 (ending Oct. 30), the company has reported improving trends that have exceeded our expectations. -- We revised our outlook on Hovnanian to positive from negative and affirmed our ratings on the company. -- The positive outlook reflects an improved liquidity position that we believe will be sufficient to meet near-term capital needs. We would raise our ratings if recently improved operating trends appear sustainable and the company maintains adequate liquidity. Rating Action On July 27, 2012, Standard & Poor's Ratings Services revised its outlook on Hovnanian Enterprises Inc. to positive from negative. At the same time, we affirmed our ratings on the company, including the 'CCC-' corporate credit rating (see list). Rationale The outlook revision reflects the company's improved liquidity position. We also revised our liquidity assessment to "adequate" from "less than adequate." Hovnanian has taken steps to improve its near-term liquidity, which consists of cash that modestly exceeds our prior expectations. Importantly, the company faces negligible maturities over the next 18 months. However, we note that aggressive land spend or debt repurchases would reduce what is a moderate absolute level of cash. Our rating on Hovnanian reflects the company's "highly leveraged" financial risk profile and very weak credit metrics. We view the company's business risk profile as "vulnerable." The company has significant overhead and interest burden due to a heavy debt load. Although operating performance has been improving, we consider the company's potential to return to profitability unlikely until at least 2013. We further note that if the operating environment modestly recovers (as we expect) and Hovnanian cannot return to consistent profitability, the company will need to raise additional capital or pursue another round of debt exchanges/restructurings to contend with its future debt maturities. However, Hovnanian's pretax loss has narrowed in the first half of fiscal 2012 to $60 million (excluding noncash gains/charges) from more than $100 million. The second-quarter loss was more moderate at $22 million on stronger deliveries (up 25%), average sales price (up 13%), and gross margins (up 260 basis points). New orders were up 52.2% and the average price of new orders increased 7.8%. Higher unit orders and a lower cancellation rate (17%) helped drive unit backlog up 48.2% to 2,298 units, which will be delivered over the next two to three quarters. Overhead reductions have helped contain selling, general, and administrative (SG&A) expenses (including corporate overhead). Additionally, as the company's deliveries increase, SG&A as a percent of revenues will improve. SG&A-to-homebuilding revenues improved to 15% in the second quarter compared with 21% in the prior year period. Despite these stronger recent trends, we do not expect the company to attain profitability until 2013 at the earliest. Our base case assumes a 20%-25% improvement in 2012 deliveries, resulting in about 4,600-4,700 deliveries. We also assume a $300,000 average home price, an average margin around 14.5% (18.5% excluding interest in cost of sales), and SG&A-to-revenues around 14%-15% for the full year. Under these assumptions, Hovnanian's gross profits would still not be sufficient to cover overhead and interest. As a result, we expect key credit metrics to remain weak. Most notably, we expect debt-to-EBITDA to improve but remain very high in the 17x-20x range. Liquidity Hovnanian's liquidity position, in our view, has improved and is now adequate to meet the company's needs over the next 12 months. Relevant liquidity profile considerations include: -- We expect Hovnanian's sources of liquidity over the next 12 months to be well above 1.2x, however we take our expectation that the company is likely to invest current cash holdings into new land investments and the large maturity the company faces in 2016 into consideration. -- The company faces negligible debt maturities until 2014. -- The company is unlikely to absorb a high-impact, low-probability event. -- The company, in our view, has poor standing in the credit markets based on trading levels of its debt and equity. Hovnanian's liquidity consists of $195.2 million of unrestricted homebuilding cash ($243.5 million including restricted cash) as of April 30, 2012. We estimate that land sales, primarily through the sale of existing inventory to a land banking arrangement the company entered with GSO Capital Partners L.P. (GSO), added roughly $30 million to Hovnanian's cash in the second quarter. We estimate cash flow from operations will be relatively flat over the next 12 months, including land acquisitions and development that we estimate at $350 million over the next four quarters. However, land spend may be greater than what we have assumed based on the company's intent to maintain total cash between $170 million and $245 million (roughly $125 million-$200 million excluding restricted cash) and its publicly stated goal of potentially managing cash at the lower end of the range. We believe the company could pull back on its land expenditures if recent sales momentum recedes in order to preserve cash. In addition, the recent $125 million land banking arrangement with GSO provides the company with the flexibility to retain cash by using third party capital to acquire land, grow and utilize rolling options, and acquire lots. The ability to grow or replicate this structure could help Hovnanian expand its platform and return to profitability while retaining its current liquidity. The company's next debt maturity is not until 2014 when $42 million matures, followed by $84 million in 2015. However, the debt maturity burden is considerably higher in 2016 when $1 billion matures (67% of total debt). Recovery analysis The rating on the company's 10.625% senior secured first-lien notes due 2016 is 'CCC-' (the same as the corporate credit rating), with a recovery rating of '3', indicating our expectation for a meaningful (50%-70%) recovery in the event of a payment default. The rating on the 5% and 2% first-lien senior secured notes due 2021 is 'CC', with a recovery rating of '5', indicating our expectations for a modest (10%-30%) recovery in the event of a payment default. We assigned a 'CC' rating on the senior unsecured notes, with a recovery rating of '6', indicating our expectation for a negligible (0%-10%) recovery in the event of a payment default. For the latest recovery analysis, please see "Recovery Report: Hovnanian Enterprises Inc.'s Recovery Rating Profile," published Oct. 27, 2011, on RatingsDirect on the Global Credit Portal, at www.globalcreditportal.com. Outlook The positive outlook reflects an improved liquidity position that appears sufficient to meet near-term capital needs. We would raise our ratings if recently improved operating trends appear sustainable and adequate liquidity is maintained. Alternatively, we would lower our ratings if housing operations deteriorate and the company aggressively invests in land resulting in a cash position below the low end of the company's cash target or we believe another distressed debt exchange or debt restructuring is likely. Related Criteria And Research -- Issuer Ranking: U.S. Homebuilders, Strongest To Weakest, July 23, 2012 -- Industry Economic And Ratings Outlook: U.S. Home Buyers Return, But Can Builders Deliver?, July 20, 2012 -- The Credit Overhang: The Differing Recovery Trajectories Of U.S. Auto Companies And Homebuilders, May 21, 2012 -- Capital Markets Update: Homebuilder Bond Spreads May Foretell U.S. Housing Price Trends, April 20, 2012 -- Key Credit Factors: Global Criteria For Single-Family Homebuilders, Sept. 27, 2011 Ratings List Ratings Affirmed; CreditWatch/Outlook Action To From Hovnanian Enterprises Inc. Corporate credit rating CCC-/Positive/-- CCC-/Negative/-- Ratings Affirmed Hovnanian Enterprises Inc. Senior unsecured CC due 2021 Recovery Rating 6 Preferred Stock C K. Hovnanian Enterprises Inc. Senior Secured CCC- due 2016 Recovery Rating 3 Senior Secured CC due 2021 Recovery Rating 5 Senior Unsecured CC Recovery Rating 6 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.