U.S.

Homebuilders And Building

Materials Companies Maintain A
Stable Outlook Amid A Slow Housing
Recovery
Primary Credit Analysts:
Maurice S Austin, New York (1) 212-438-2077; maurice.austin@standardandpoors.com
Matthew Lynam, CFA, New York (1) 212-438-8002; matthew.lynam@standardandpoors.com
Secondary Contacts:
Thomas J Nadramia, New York (1) 212-438-3944; thomas.nadramia@standardandpoors.com
Lisa R Sarajian, New York (1) 212-438-2597; lisa.sarajian@standardandpoors.com
Table Of Contents
Our 2014 Economic Outlook: A Slight Dip From January
Homebuilders' Recovery Will Be Slow, Uneven, And Regional
Our Outlook For The Building Materials Sector Is Stable
A Slightly Brighter Outlook For Builders Than Building Materials
Companies
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U.S. Homebuilders And Building Materials
Companies Maintain A Stable Outlook Amid A
Slow Housing Recovery
Standard & Poor's Ratings Services' ratings outlook for the U.S. homebuilding sector remains broadly stable with a
positive ratings bias, supported by our expectations for a continued favorable, but uneven, national housing recovery.
We believe the builders we rate are well positioned to continue to gain market share relative to smaller, private
competitors given their current healthy land inventory and capital positions. Our economists expect that the economy
will get back on track and continue to recover for the balance of this year, with help from gains in private demand and
hiring.
The slower-than-expected recovery in housing starts has not resulted in a change in our stable outlook for building
materials companies given that new residential construction accounts for less than a half of their revenues. Weakness
in their other markets, including residential remodeling and repair and commercial and government construction, will
dampen prospects for rating upgrades and significant improvement in credit quality for the remainder of 2014.
Overview
We expect U.S. homebuilders and building materials companies to maintain a broadly stable outlook,
supported by our expectations for a continued favorable, but uneven, national housing recovery.
For homebuilders, as in 2013, upgrades have outweighed downgrades year-to-date in 2014.
For building materials companies, barring a major negative event, we see little downside risk to the sector's
current rating profile at this point in the cycle.
For homebuilders, as in 2013, upgrades have outweighed downgrades year-to-date in 2014. We raised our ratings on
PulteGroup Inc. and Meritage Homes Corp., for instance, to reflect our expectation that both companies will maintain
their recently strengthened financial risk profiles. However, the majority of our homebuilder rating outlooks are stable
because the degree that healthier sector revenues and profits could help bolster their ratings will depend on the size of
periodic company debt issuances. We note that builders have regularly and opportunistically tapped receptive debt
markets for expansion capital since the start of the recovery. Debt issuance in anticipation of growth will slow potential
improvement in key credit measures, in our view.
For building materials companies, barring a major negative event, we see little downside risk to the sector's current
rating profile at this point in the cycle: 80% of companies have stable ratings outlooks. However, we rate close to 65%
of building material credits in the 'B' category and below, and almost all of these companies have what we consider to
be "highly leveraged" financial risk profiles and thus are very susceptible to cyclical downturns. Most of these
companies are owned by private equity firms, and we don't expect any upward ratings movement for them until
private ownership falls below 40% or leverage improves significantly. About 15% of the building materials companies
we rate currently have positive outlooks with almost all of these outlook revisions occurring in the second quarter.
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Our 2014 Economic Outlook: A Slight Dip From January
We've revised our forecast for U.S. real GPD growth in 2014 to 2.5%, down from 2.8% at the start of the year, due to
weakness in the first quarter of 2014 arising from harsh weather and a softer housing market. We expect modestly
growing private demand and consumer confidence to support economic growth this year.
The harsh winter was one of the reasons for the slow start for homebuilders this year, reducing buyer traffic and
slowing the land development required to open new communities in some Midwest and Northeast housing markets.
Bad winter conditions were also a primary cause of the 1% drop in real U.S. GDP in the first quarter of 2014.
We believe that tougher year-over-year comparisons with respect to higher home prices, mortgage rates, and
inventory have also contributed to the weaker housing reports to date. Nonetheless, we expect to see better gains in
the back half of 2014 assuming interest rates are less volatile. Median new home price increases of 9.7% in 2013
following a 7.9% rise in 2012 have caused some potential buyers to pause, and the spike in mortgage rates last summer
has also created more difficult comparisons with respect to affordability. It's important to consider that mortgages
rates were 4.34% in April 2014 versus 3.45% in April 2013. In addition, while still low, inventory levels have drifted up
over the past year. As of April 2014, there was 5.3 months' supply of new homes (5.9 for existing), up from 4.3 months
(5.2 for existing) in the prior year. Although we expect inventory will continue to trend up, it remains below 2012
levels, when prices began to increase.
Our economists expect single-family housing starts to rise approximately 10% in 2014, to about 688,000 units. While
the 2014 projection is a significant improvement from 2013, it is only about two-thirds of the 50-year historical average
of about 1.04 million units per year.
Homebuilders' Recovery Will Be Slow, Uneven, And Regional
We rate 25 of the largest public and private homebuilders in the U.S. and estimate that they currently represent a little
over 25% of overall new home sales production. Despite recent broader housing weakness, we believe they remain on
track for sustained, multiyear growth. However, their recovery trajectory will continue to be more measured, uneven,
and dependent upon their respective regional exposures. For the largest public builders we rate, our baseline forecast
calls for:
A sales volume increase of 9% in 2014, following increases of more than 20% in 2012 and 2013.
A moderation in average selling price increases to the mid- to high-single-digit range.
Limited growth or even some compression in gross margins. While gross margins have widened over the past two
years, we project that most builders have relatively little room for further expansion given our expectations for
lower price appreciation. In some instances, we project very modest margin compression as a result of higher land,
labor, and material cost appreciation, which so far builders have been able to pass through in the form of price
increases.
We revised our sales volume forecasts downward from a year ago, but we believe builders will still meet our projected
credit measures given better-than-expected selling prices and gross margins. Many builders have shifted to
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higher-priced products to meet higher demand from move-up and luxury buyers, who typically have fewer issues with
mortgage financing and less sensitivity to changes in rates. Most builders are also aggressively opening new
communities and expanding their platforms, which will act as a de facto hedge against a weaker sales pace.
Our projection for 130,000 combined unit sales from our 13 largest rated builders is still one-half of peak production.
Furthermore, new home sales remain less than 10% of overall home sales (which are also 50% below their peak in
2006).
Homebuilder debt issuance and maturities
Year-to-date, 10 builders have raised $3.3 billion in debt, the bulk of which we believe was for growth. In comparison,
19 companies raised $7.1 billion in 2013 and 16 companies raised $8 billion in 2012. Debt issuance for refinancing
activity has been more modest, given the group's relatively well-laddered debt maturity profile. We estimate rated debt
maturities of about $1 billion and $2.3 billion in 2014 and 2015, respectively, which together represents about 11% of
the $30 billion in total rated debt outstanding. We note that year-to-date issuance activity has included debut debt
deals for several smaller, private companies (including recently rated Century Communities). Given a currently robust
high-yield investor appetite, we believe several more private builders could tap the markets over the next few months.
Our Outlook For The Building Materials Sector Is Stable
Until total housing starts reach 1.5 million or more, most building materials companies will still derive less than 50% of
their revenues from new home construction. Residential repair and remodeling, commercial construction, and, to a
lesser extent, institutional and government spending all constitute significant sources of demand for building materials
and products suppliers. Unfortunately, all of the those markets have been, and are expected to remain, weak in 2014,
relative to historical averages, with Standard & Poor's economists forecasting about 4.5% growth in U.S. nonresidential
construction, 2.5% growth for residential improvement spending, and flat growth in publics works spending. Absolute
spending levels declined significantly during the downturn and still have not reached historical levels.
Repair and remodeling
In general, repair and remodeling is less cyclical than new-construction markets. Uneven repair and remodeling
markets in the U.S., however, have held ratings back for some companies. In the first quarter of 2014, a particularly
harsh winter and continued labor shortages strained much of the housing market, including repair and remodeling.
Smaller renovation jobs, though, continued to show strength as the home maintenance and repair component of the
Remodeling Market Index (RMI) increased two points to 59 in the first quarter, a historically high reading, according to
the National Assn. of Home Builders. An RMI above 50 indicates that more remodelers report that market activity is
higher (compared with the prior quarter) than report it is lower.
The gradual rise in home equity levels is helping homeowners better afford to remodel their homes. If a housing
recovery picks up steam as the year progresses, more existing homeowners are likely to put their homes up for sale.
Experience tells us that homeowners often engage in repairs to prepare a home for sale, and buyers often make repairs
and remodeling changes shortly after taking possession of a resale property. Also, a jobs recovery and improved
consumer confidence could prompt homeowners who have deferred repairs, maintenance, and remodeling across a
broad range of products to reconsider.
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Average sales for roofing products, heating and air conditioning units, carpet and kitchen replacements, and other
products have been below levels prior to the downturn, despite a continual aging of the housing stock (the average age
is now greater than 37 years). As such, we believe there is still some pent-up demand for these items from the housing
downturn. This bodes well for companies like Lennox International Inc., roofing products makers Building Materials
Corp. of America and Owens Corning, and carpet maker Mohawk Industries Inc. over the long term, but sales growth
for these companies over the next year is likely to be slow and steady as consumers regain their willingness to spend
on home repairs and refurbishment.
Commercial construction
Office and retail construction, the commercial sector's largest user of building materials, has been weak for several
years now. We know that demand for new retail and office space (as well as institutional, educational, and hotel space)
generally lags residential development by 18 to 24 months. So while we don't expect a big uptick in office and retail
construction in 2014, we might see the first signs of such a recovery midyear as new projects finally come off the
drawing board and into development. Standard & Poor's economists project 4.4% growth in nonresidential
construction in 2014. We expect the construction growth rates for commercial building and mining and petroleum
segments to improve, while the power (mostly wind) and communications construction segments will remain weak.
Still, within the nonresidential areas of growth, some of the companies we rate are likely to see sales growth as a result,
including metal buildings and components maker NCI Building Systems Inc., modular carpet manufacturer Interface
Inc., and metal pole and utility structures company Valmont Industries Inc.
Public works/infrastructure
While we expect to see some improvement for aggregates producers as more homes are built, public works
construction such as highway and bridge work is much more aggregates-intensive. Cement producers also have
significant exposure to this segment. While the renewed U.S. Federal Highway Bill (Moving Ahead for Progress in the
21st Century; MAP-21), which expires in September 2014, should provide certainty and stability for some more
longer-term projects, overall spending levels are flat, which leaves cement and aggregates producers such as Martin
Marietta Materials Inc. and Vulcan Materials Co. little prospect for anything other than mediocre growth. However,
there is some upside for producers depending upon the particular states where they operate, as certain states, such as
Texas and North Carolina, are in a stronger position to increase spending on roads.
Other risks/impediments to improvement in building materials
The surprising challenge of finding skilled labor may also constrain building materials companies' growth if demand
picks up too rapidly. Homebuilders are already grappling with the task of finding sufficient construction labor in certain
markets, and this will delay orders to building materials companies if a lack of skilled workers stalls housing
construction. We estimate these labor inefficiencies have lengthened the cycle times of new housing build rates. Some
window and cabinet makers have also found it difficult to find and train skilled and semi-skilled factory workers as they
gear up for higher demand in certain markets, leading to inefficiencies in ramping up production.
In addition, while many companies in the space are operating at 50% to 60% of capacity, turning on additional
capacity may take some time. Certain types of idled plants (e.g., cement, glass, and wallboard facilities) can take
months, or longer, to reach operating efficiency. It is probably not too difficult for these companies to increase
capacity utilization to 70% or 75% from 60% by running extra shifts. But getting idled plants above 80% may require
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hiring new workers in a short period of time.
Despite these obstacles, however, we think building materials companies will be able to supply materials to
homebuilders without any material impact on home build rates. But it may take a bit longer to turn starts into
deliveries, and for building materials companies to realize their sales increases. In the short term, they may not be able
to optimize profitability as they incur expenses to ramp up production.
A Slightly Brighter Outlook For Builders Than Building Materials Companies
We expect the slowly recovering new home construction market to have a greater benefit for homebuilders' credit
metrics and outlooks, as residential market revenues currently account for less than 50% of many building materials
companies' revenues. However, we expect the outlook for the majority of ratings in both sectors to remain stable for
the balance of the year.
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