-- 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.
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).
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
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).
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.
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 Affirmed; CreditWatch/Outlook Action
Hovnanian Enterprises Inc.
Corporate credit rating CCC-/Positive/-- CCC-/Negative/--
Hovnanian Enterprises Inc.
Senior unsecured CC
Recovery Rating 6
Preferred Stock C
K. Hovnanian Enterprises Inc.
Senior Secured CCC-
Recovery Rating 3
Senior Secured CC
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