Fitch Rates Lennar's Proposed $350MM Sr. Notes Offering 'BB+/RR4'; Outlook Positive
KEY RATING DRIVERS
The ratings for Lennar are based on the company's strong track record over the past 36 plus years, geographic diversity, customer and product focus, generally conservative building practices and effective utilization of return on invested capital criteria as a key element of its operating model. Additionally, there has been continuity in Lennar's management during this housing cycle and Fitch considers this management team to be the deepest among the public builders within its coverage.
The Positive Outlook reflects Lennar's operating performance in 2014 and year-to-date (YTD) in 2015, current and year end projected 2015 and 2016 financial ratios (especially leverage and coverage), solid liquidity position and favorable prospects for the housing sector during the balance of 2015 and 2016 and probably 2017. Fitch believes that the housing recovery is firmly in place (although the rate of recovery remains well below historical levels and the recovery will likely continue to occur in fits and starts).
The company did a good job in reducing its inventory exposure (especially early in the correction) and generating positive operating cash flow during the recent, severe industry downturn. Additionally, Lennar steadily, substantially reduced its number of JVs over the last few years and, as a consequence, has very sharply lowered its JV recourse debt exposure (from $1.76 billion to $22.4 million as of Aug. 31, 2015).
In contrast to almost all the other public homebuilders Lennar was profitable in fiscal 2010 and 2011 and the company was solidly profitable in fiscal 2012, 2013 and 2014. The company's gross margins are consistently above its peers and contributions from its Rialto Investment segment have added to profits in 2010, 2011, 2012, 2013 and 2014.
There are still some challenges facing the housing market that are likely to moderate the intermediate stages of this recovery. Nevertheless, Fitch believes Lennar has the financial flexibility to navigate through the sometimes challenging market conditions and continue to broaden its franchise and invest in land and other opportunities.
Housing activity has ratcheted up more sharply in 2015 with the support of a steadily growing, relatively robust economy throughout the year. Considerably lower oil prices should restrain inflation and leave American consumers with more money to spend. The unemployment rate should continue to move lower (5.0% in 2015). Credit standards should steadily, moderately ease throughout 2015. Demographics should be more of a positive catalyst. More of those younger adults who have been living at home should find jobs and these 25-35-year-olds should provide some incremental elevation to the rental and starter home markets. Single-family starts are now forecast to rise about 11.4% to 722,000 as multifamily volume expands about 11% to 394,000. Total starts would be just in excess of 1.1 million. New home sales are projected to increase 20% to 523,000. Existing home volume is expected to approximate 5.280 million, up 6.9%.
New home price inflation should further taper off with higher interest rates and the mix of sales shifting more to first time homebuyer product. Average and median home prices should increase 3.0% - 3.5%.
Sparked by a slightly faster growing economy the housing recovery is expected to continue in 2016. Although interest rates are likely to be higher, a more robust economy, healthy job creation and further moderation in lending standards should stimulate housing activity. Housing starts should approximate 1.24 million with single-family volume of 0.82 million and multifamily starts of 0.42 million. New home sales should reach 617,000, up 18.0%. Existing home volume growth should again be mid-single digit (+4.0%).
Average and median home prices should rise 2.0% - 2.5%.
Challenges remain, including the potential for higher interest rates, and continued restrictive credit qualification standards.
As Fitch noted in the past, the housing recovery will likely continue in fits and starts.
The company's homebuilding operations ended the third quarter of 2015 with $595.72 million in unrestricted cash and equivalents. Homebuilder debt totaled $5.26 billion as of August 31, 2015, up from $4.69 billion at fiscal year-end 2014.
At Aug. 31, 2015, Lennar had a $1.6 billion unsecured revolving credit facility with certain financial institutions that matures in June 2019. The proceeds available under the credit facility, which are subject to specified conditions for borrowing, may be used for working capital and general corporate purposes. The credit facility agreement also provides that up to $500 million in commitments may be used for letters of credit. As of Aug. 31, 2015, there were $575 million of outstanding borrowings under the credit facility. Lennar believes that it was in compliance with its debt covenants at Aug. 31, 2015. Also, the company had $315 million of letter of credit facilities with different financial institutions.
Lennar's debt maturities are well-laddered, with 23.7% of its senior notes (as of Aug. 31, 2015) maturing through 2017.
Lennar's performance letters of credit outstanding were $243.3 million at Aug. 31, 2015. The company's financial letters of credit outstanding were $185.6 million at Aug. 31, 2015. Performance letters of credit are generally posted with regulatory bodies to guarantee the performance of certain development and construction activities. Financial letters of credit are generally posted in lieu of cash deposits on option contracts, for insurance risks, credit enhancements and as other collateral.
Debt leverage (debt/EBITDA) increased to 4.1x for the latest-twelve-months (LTM) August 31, 2015 from 4.0x at the conclusion of 2014, but is down from 4.9x at the end of 2013. EBITDA-to-interest expense rose from 3.2x at Nov. 30 2013 to 4.3x at the conclusion of 2014 and 4.6x for the August 31, 2015 LTM period.
The company was the second largest homebuilder in 2014 and primarily focuses on entry-level and first-time move-up homebuyers. In 2013 and 2014, approximately one third of sales were to the first-time buyer, half to first-time move-up customers and the balance is a mix of second-time move-up, luxury and active adult. So far in 2015 approximately 25% of sales are to the first time buyer, half to first time move up customers and the balance is a mix of second time move up, luxury and active adult. The company builds in 17 states with particular focus on markets in Florida, Texas and California. Lennar's significant ranking (within the top five or top 10) in many of its markets, its largely presale operating strategy, and a return on capital focus provide the framework to soften the impact on margins from declining market conditions. Fitch notes that in the past, acquisitions (in particular, strategic acquisitions) have played a significant role in Lennar's operating strategy.
As the cycle matures, Lennar is pivoting to a lighter land position and plans to reduce the number of years of land owned. It will shorten the tail of new land buys to 3 - 4 years. The company will endeavor to utilize rolling options and deferred take downs with sellers and land developers. Lennar will sell non-core holdings of land.
Compared to its peers, Lennar has had above-average exposure to JVs during this past housing cycle. Longer-dated land positions are controlled off balance sheet. The company's equity interests in its partnerships generally ranged from 10% to 50%. These JVs have a substantial business purpose and are governed by Lennar's conservative operating principles. They allow Lennar to strategically acquire land while mitigating land risks and reduce the supply of land owned by the company. They help Lennar to match financing to asset life. JVs facilitate just-in-time inventory management.
Nonetheless, Lennar has substantially reduced its number of JVs over the last eight years (from 270 at the peak in 2006 to 33 as of August 31, 2015, of which 4 had recourse debt, 5 had non-recourse debt and 24 had no debt). As a consequence, the company has very sharply lowered its JV recourse debt exposure from $1.76 billion to $22.4 million as of Aug. 31, 2015. In the future, management will still be involved with partnerships and JVs, but there will be fewer of them and they will be larger, on average, than in the past.
The company did a good job in reducing its inventory exposure (especially early in the correction) and generating positive operating cash flow. In 2010, the company started to rebuild its lot position and increased land and development spending. Lennar spent about $600 million on new land purchases during 2011 and expended about $225 million on land development during the year. This compares to roughly $475 million of combined land and development spending during 2009 and about $704 million in 2010. During 2012, Lennar purchased approximately $1 billion of new land and spent roughly $302 million on development expenditures. Land spend totaled almost $1.9 billion in 2013, and development expenditures reached about $600 million, double the level of 2012. Approximately, $1.5 billion was expended on land and $1.1 billion on development in 2014. Fitch expects that total real estate spending in 2015 could be up slightly (perhaps $100 million) with about 55% expended on land and 45% on development activities.
The company was slightly less cash flow negative in 2014 ($788.49 million) than in 2013 ($807.71 million). Lennar is likely to be less cash flow negative in 2015. The company could be cash flow positive in 2016.
Fitch is comfortable with this real estate strategy given the company's cash position, debt maturity schedule, proven access to the capital markets and willingness to quickly put the brake on spending as conditions warrant.
Homebuilding realized $5.79 billion in revenues (88.7% of total revenues) and $834.14 million in operating profits 85.8% of the total) YTD in FY 2015.
Fitch's key assumptions within the rating case for Lennar include:
--Industry single-family housing starts improve 11.4%, while new and existing home sales grow 20% and 6.9%, respectively, in 2015;
--Lennar's homebuilding revenues increase at about a 21% pace. Although homebuilding EBITDA margins erode 140 bps this year due to higher expenses (especially land costs) and lesser home price inflation, homebuilding EBITDA increases about 9.0%;
--The company's Debt/EBITDA approximates 3.8x and interest coverage reaches about 5.4x by year end 2015;
--Lennar spends approximately $2.5-2.7 billion on land acquisition and development activities this year;
--The company maintains an adequate liquidity position (well above $500 million) with a combination of unrestricted cash and revolver availability.
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.
Fitch would consider taking further positive rating action if the recovery in housing accelerates and Lennar shows steady improvement in credit metrics (such as debt-to-EBITDA leverage consistently less than 3x), while maintaining a healthy liquidity position (in excess of $1 billion in a combination of cash and revolver availability) and begins generating positive cash flow from operations starting in 2016 as it moderates its land and development spending.
Conversely, negative rating actions could occur if the recovery in housing dissipates and Lennar maintains an overly aggressive land and development spending program. This could lead to sharp declines in profitability, consistent and significant negative quarterly cash flow from operations, higher leverage and meaningfully diminished liquidity position (below $500 million).
FULL LIST OF RATINGS
Fitch currently has the following ratings for Lennar Corp.:
--Long-term IDR 'BB+';
--Senior unsecured debt 'BB+/RR4';
--Unsecured revolving credit facility 'BB+/RR4'.
The Rating Outlook is Positive.
In accordance with Fitch's updated Recovery Rating (RR) methodology, Fitch is now providing RRs to issuers with IDRs in the 'BB' category. The Recovery Rating of '4' for Lennar's unsecured debt supports a rating of 'BB+', and reflects average recovery prospects in a distressed scenario.