March 10 (The following statement was released by the rating agency)
Fitch Ratings has upgraded the Issuer Default Rating (IDR) of PulteGroup, Inc. (NYSE: PHM) to 'BB+' from 'BB'. The Rating Outlook is Stable. A complete list of rating actions follows this release.
KEY RATING DRIVERS
The upgrade of the IDR reflects PHM's solid operating performance in 2013 and current financial ratios which compare well with those of its peers, substantial liquidity position and favorable prospects for the housing sector in 2014 and 2015. Fitch believes that the housing recovery is firmly in place (although the rate of recovery remains well below historical levels and the upturn will likely continue to occur in fits and starts).
The rating for PHM also reflects the company's broad geographic and product diversity, a long track record of adhering to a disciplined financial strategy and, somewhat more recently, an at times, aggressive growth strategy. The merger with Centex in August 2009 further enhanced the company's broad geographic and product line diversity. Centex's significant presence in the first move-up and especially in the entry-level categories complements PHM's strength in both the move-up and active adult segment. PHM's Del Webb (active adult) segment is perhaps the best recognized brand name in the homebuilding business. The company also did a good job in reducing its inventory and generating positive operating cash flow during the severe housing downturn from 2007 through 2011 and since then. The Stable Outlook takes into account the solid housing outlook for 2014 and 2015.
PHM's future ratings and Outlook will be influenced by broad housing market trends as well as company-specific activity such as 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 and free cash flow trends and uses.
DEBT AND LIQUIDITY
The ratings upgrade also takes into account the company's successful execution of its debt repayment strategy following the merger with Centex in August 2009 and more recently. Subsequent to the merger the company repurchased $1.5 billion of senior notes through a tender offer. PHM also retired $898.5 million in debt in 2010, $323.9 million in 2011, $592.4 million in 2012 and $461.4 million in 2013. On Feb. 21, 2014, the company announced the redemption of the $95.6 million outstanding 5.20% unsecured senior notes due February 2015 and the redemption of $150 million outstanding 7.375% unsecured senior notes due June 2046. The redemptions will occur on March 26, 2014. The company's remaining debt maturities are well laddered with $238 million scheduled to mature in 2015 and $465.2 million due in 2016.
The reduced debt and growing profitability have enabled the company to improve its debt/EBITDA ratio from 14.3x at the end of 2010 to 2.3x at the conclusion of 2013. During that same period, interest coverage improved to 5.7x from 0.9x. PHM ended the December 2013 quarter with $1.58 billion of unrestricted cash and equivalents and $2.06 billion of senior notes.
As a cost saving measure and to provide increased operational flexibility, PHM voluntarily terminated its $250 million unsecured revolving credit facility effective March 30, 2011. Fitch anticipates that PHM will re-establish a credit facility over the next 12-18 months.
As is the case with other public homebuilders, PHM is using the liquidity accumulated over the past few years to expand its land position and trying to opportunistically acquire land at attractive prices.
In late July 2013 the board of directors reinstituted a quarterly dividend ($0.05 per share). The board had eliminated the $0.04 per share quarterly dividend in November 2008 to conserve cash. During 2013, PHM repurchased $127.66 million of its common stock; $234.3 million remains under the current share repurchase authorization.
Even with substantial land and development spending in 2014 as well as some moderate share repurchase activity and about $51 million paid out in dividends, Fitch expects PHM will end the year with a cash position between $900 million and $1.4 billion.
MARGIN ENHANCEMENT AND COST-REDUCTION EFFORT
PHM has realized considerable improvement in gross profit margins, before real estate charges, from 8.7% in 2009 to 20.4% in 2013 and on-going operational initiatives which are expected to at least maintain and potentially generate further margin expansion. Those initiatives include a rising share of closings from the implementation of common plans to help drive construction efficiency, favorable product mix benefiting from move-up and active adult closings, pushing design, engineering and purchasing activities out to field operations to drive local costs lower, and working to ensure proper balance of dirt vs. lower margin speculative sales (currently 76.4% pre-sold, 23.6% spec).
As of Dec. 31, 2013, PHM controlled 123,478 lots, of which 77.1% are owned and the remaining 22.9% are controlled through options. Total lots controlled represent an approximately seven-year supply of total lots based on LTM closings and the company owns 5.4 years of lots. The company's land position has historically been longer compared to other public homebuilders due to its Del Webb operations. PHM's active adult and certain master-planned communities can extend from five to seven years or longer during their build-out.
During the past few years, the company has been relatively subdued in committing to incremental land purchases because of its already sizeable land position. Of course, the acquisition of Centex in 2009 allowed the company to sharply increase its land position.
PHM spent $750 million on land and development in 2009, while Centex spent roughly $200 million. PHM spent $980 million on land and development in 2010 and $1.04 billion in 2011. The company paid out $924 million for land and development in 2012 - roughly 1/3 for land and 2/3 for development activities. PHM expended approximately $1.3 billion on real estate in 2013 with roughly 40% for land and 60% for development. The preliminary management projection for spending in 2014 is $2 billion with 45% targeted for land and 55% for development activities. (For perspective, PHM alone spent $4.6 billion on land and development in 2006.)
PHM continues to have meaningful development expenditures, partially due to its Del Webb active adult (retiree) operations, but largely related to its Pulte brand. Currently, fewer developed lots are available to buy; thus, more raw land, which will require development spending, is being acquired for its Pulte and Centex brands. This is also the case for other homebuilders.
Fitch is comfortable with PHM's land strategy given the company's cash position, debt maturity schedule, proven access to the capital markets, and management's demonstrated discipline in pulling back on its land and development activities during periods of distress. Additionally, Fitch expects management to be disciplined with the uses of its cash, refraining from significant share repurchases or one-time dividends to its stockholders that would meaningfully deplete its liquidity position.
Housing metrics showed improvement in 2013. Single-family housing starts grew 15.5%, while new-home sales increased 16.3%. Existing home sales advanced 9.2% in 2013. The most recent Freddie Mac 30-year interest rate was 4.28%, 97 bps above the all-time low of 3.31% set the week of Nov. 21, 2012. The NAR's latest monthly existing home affordability index was 168.1, well below the all-time high of 213.6, but still meaningfully above the 20-year average. Housing metrics should increase in 2014 due to faster economic growth (prompted by improved household net worth, industrial production and consumer spending), and consequently, some acceleration in job growth (as unemployment rates decrease to 6.9% for 2014 from an average of 7.5% in 2013), despite somewhat higher interest rates as well as more measured home price inflation. A combination of tax increases and spending cuts in 2013 shaved about 1.5pp off annual economic growth, according to the Congressional Budget Office. Many forecasters expect the fiscal drag in 2014 to be one-third that amount or less.
Fitch's housing estimates for 2014 are as follows: Single-family starts are forecast to grow almost 20% to 741,000, while multifamily starts expand about 9% to 333,000; single-family new-home sales should grow approximately 20% to 513,000 as existing home sales advance 2.0% to 5.19 million. Average single-family new-home prices (as measured by the Census Bureau), which dropped 1.8% in 2011, increased 8.7% in 2012. Median new-home prices expanded 2.4% in 2011 and grew 7.9% in 2012. Average and median new-home prices improved 9.8% and 8.4%, respectively, in 2013. New-home price inflation should moderate in 2014, at least partially because of higher interest rates. Average and median new-home prices should rise about 3.5% this year.
Additional positive rating actions leading to a low investment-grade rating, although unlikely in the near term, may be considered if the recovery in housing is maintained and is better than Fitch's current outlook; PHM shows continuous improvement in credit metrics (particularly debt-to-EBITDA of 2x or lower and interest coverage in excess of 8.5x and then maintains those metrics); and the company maintains a substantial liquidity position.
A negative rating action could be triggered if the industry recovery dissipates; PHM's 2014 revenues drop sharply while the EBITDA margins decline below 10%; and PHM's liquidity position falls sharply, perhaps below $500 million.
Fitch has upgraded the following ratings for PHM:
--Long-term IDR to 'BB+' from 'BB';
--Senior unsecured notes to 'BB+' from 'BB'.
--Long-term IDR to 'BB+' from 'BB';
--Senior unsecured debt to 'BB+' from 'BB'.