Fitch Cites Success of Spec Building Strategy in Upgrade of DR Horton

Fitch Ratings upgraded its outlook for DR Horton (DHI), reflecting the Fort Worth, Texas-based homebuilder’s strong liquidity position, improved operating results and moderately stronger prospects for the housing sector this year. Fitch Ratings upgraded its outlook for DR Horton to stable from negative, and affirmed the builder’s issuer default rating, senior unsecured debt and senior unsecured convertible notes all at double-B. DR Horton is consistently one of the country’s largest homebuilders in terms of total new home closings. In a Fitch US homebuilding/construction report published in April, Fitch cited the most recently available market data that showed Horton closed 23,915 homes in 2008. While down 37% from the company’s previous peak, it was enough to keep Horton the largest in the country for the second straight year. In Thursday’s rating action, Fitch analysts wrote that DR Horton’s business model has consistently relied on holding a large supply of speculative homes built before buyers were in place. As of March 31, 2010, 7,300, or 53%, of the builder’s total inventory of 13,900 houses were spec properties. Of those spec properties, 2,900 were complete. That strategy was effective during the availability of the homebuyer tax credit, which required sales contracts in place by April 30 and a recently extended closing deadline of Sept. 30. Many builders utilized the spec building strategy, but according to the April housing report, Fitch said Horton and Columbus, Ohio-based M/I Homes (MHO) were the only builders to increase spec building in 2010 compared to 2008 levels. In the January edition of its monthly magazine, HousingWire published a feature analyzing the impact of the $6,500 homebuyer tax credit for existing homeowners. In that report, John Burns, CEO of John Burns Real Estate Consulting (JBREC), said builders learned their lesson when they ran out of inventory leading up to the tax credit’s originally scheduled expiration in November. The builders with inventory of spec homes to sell in September and October profited, while builders who ran out of homes were left on the outside looking in. Horton’s strategy of building spec homes leading up to April was critical to existing homeowners who likely put their homes on the market at the end of 2009, but didn’t sell until spring. After their existing home sold, those buyers needed to close on a new home deal quickly. Burns said passage of the tax credit extension into April was a boon to confidence for builders to step up their spec construction, which has dragged since the onset of the housing downturn, adding the impact of an increased spec market is widespread, as builders hire workers, buy supplies and step up sales efforts. Large builders like Horton — which benefited from a temporary change in tax law that extended the time that companies can claim tax refunds from previous profitable years to cover current losses — were able to use their influx of cash to build spec properties. But smaller builders that rely on construction loans to finance construction projects faced challenges benefiting from the homebuyer tax credit because available credit was low. “The big builders are going to gain a lot of market share in the coming months,” Burns said in the January feature. Fitch said that Horton ended the March 2010 quarter with $1.6bn of unrestricted cash and $198.7m of marketable securities. Since December 1, 2009, Horton’s embarked on a $500m debt security repurchase plan, with only $154m outstanding at the end of March 2010. In addition, Fitch said, Horton’s remaining debt maturities are well-laddered, with no more than 10% of its total debt maturing in any one year during the next three fiscal years. Horton returned to profitability in its fiscal year Q110, which ended on December 31, 2009 and generated cash flow from operations of $207.8m during its fiscal year Q210 that ended in March, when it posted a $11.4m profit. For all of fiscal 2010, Fitch said it expects Horton to be cash flow positive, excluding tax refunds. Commenting on the overall housing sector, Fitch said an anemic recovery has begun, but warned the recovery may appear jaw-toothed as substantial foreclosures now in the pipeline present as distressed sales and as meaningful new foreclosures arise from Alt-A and option ARM resets. In addition, the tax credit pulled demand forward and unemployment are “headwinds” in the face of housing recovery. Going forward, Fitch said Horton’s future ratings and outlook will be influenced by the broader housing market and company specific activity, such as trends in land and development spending, general inventory levels, speculative inventory activity (including the impact of high cancellation rates), new order activity, debt levels and the company’s cash position. Write to Austin Kilgore. The author held no relevant investments.

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