Fitch Upgrades Masco's IDR to 'BB+'; Outlook Stable
KEY RATING DRIVERS
The rating for Masco reflects the company's leading market position with strong brand recognition in its various business segments, the breadth of its product offerings, and solid liquidity position. Risk factors include sensitivity to general economic trends, as well as the cyclicality of the residential construction market.
The ratings upgrade reflects Masco's improving financial and credit metrics and Fitch's expectation of further improvement in financial results during the next 12-18 months. Fitch noted last year, following the revision of Masco's Outlook to Positive from Stable, that the company's IDR may be upgraded to 'BB+' as housing and home improvement markets continue to rebound and the company shows sustained improvement in financial results and credit metrics, including debt to EBITDA levels in the 3.0x-3.5x range, interest coverage that is consistently above 4.5x, and FCF margins above 2.5%.
The new home construction market grew last year, although the industry underperformed relative to Fitch's expectations going into 2014. Total housing starts grew 8.8% while new home sales advanced 1.2% during 2014. Existing home volume was off more than 3% due to fewer distressed homes for sale and somewhat limited inventory. Nevertheless, Masco's sales improved 4.3% and EBITDA margins increased almost 90 bps during 2014 compared with 2013. Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing economy throughout the year.
Masco ended the year with debt to EBITDA of 3.2x and interest coverage was 4.7x during 2014. The company also reported strong free cash flow (FCF: Operating Cash Flow less Capital Expenditures, Common Dividends and Dividends Paid to Non-controlling Interest), generating \$323 million (3.8% of sales) during 2014. Fitch expects these credit metrics will be relatively stable this year.
The Stable Outlook reflects Fitch's expectation that demand for Masco's products will continue to grow during 2015 as the housing market maintains its moderate recovery and home improvement spending increases at a steady pace. The Stable Outlook also incorporates Masco's solid liquidity position.
SPIN-OFF OF INSTALLATION AND OTHER SERVICES BUSINESS
In September 2014, Masco announced the spin-off of 100% of its Installation and Other Services businesses into an independent, publicly traded company through a tax-free stock distribution to Masco shareholders. This transaction is expected to be completed by mid-2015. This business had \$1.5 billion of revenues in 2014 (17.8% of total company sales) and \$86 million of adjusted EBITDA. Masco estimates that approximately 82% of this segment's sales are directed to the new home construction market, while repair and remodel accounts for about 18%.
While the spin-off will result in some loss of EBITDA, Masco's credit profile will benefit from lower exposure to the more volatile new home construction market. Masco estimates that its sales to the new home construction market will be reduced from 28% to 17% once the spin-off is completed. Between 2006 and 2010, during the major economic and construction downturns, sales from the installation business fell 67% from \$3.16 billion to \$1.04 billion. By comparison, sales from the company's other business segments declined 29.0% from \$9.23 billion to \$6.55 billion during the same period.
The company's EBITDA margin post-spin will also improve, as the EBITDA margin of the installation business was about 620 bps below the total company EBITDA margin during 2014.
Excluding the financial results from the Installation and Other Services business, Fitch expects leverage will settle around 3.3x at year-end 2015. Similarly, interest coverage is projected to be roughly 4.5x during 2015.
CAPITAL ALLOCATION
In September 2014, Masco also announced the implementation of a share repurchase program for an aggregate of 50 million shares of its common stock, representing about \$1.2 billion at the share price upon the announcement. The program will be funded with FCF and cash on the balance sheet. The company also expects to receive about \$200 million from the spin-off of the installation business.
Masco expects to execute the share repurchase program over a multi-year period, starting in the 4Q'14. The company repurchased 5 million shares or about \$124 million during 4Q'14 and expects to buy back between \$400 million and \$500 million in 2015.
Fitch is comfortable with this strategy given Masco's strong cash and equivalents position, which totaled \$1.69 billion at year-end 2014. Additionally, management has demonstrated in the past its commitment to preserving the company's liquidity position during difficult market conditions. Masco was an aggressive purchaser of its stock from 2003-2007, spending roughly \$1.2 billion annually, on average, on share repurchases and dividends during this period. The company did not repurchase stock between July 2008 and September 2014, except for share repurchases to offset the dilutive effect of stock grants. In 2009, Masco also reduced its quarterly dividend from \$.235 per common share (\$.94 annually) to \$0.075 per share (\$0.30 annually), saving approximately \$225 million per year. Last year, the company increased its quarterly dividend by 20% to \$0.09 per share. The company remains committed to reducing debt by about \$300 - \$500 million by 2016.
EXPECTED CONTINUED IMPROVEMENT IN MASCO'S U.S. END-MARKETS
Masco markets its products primarily to the residential construction sector. Management estimates that 72% of its 2014 sales were directed to the repair and remodel segment, with the remaining 28% to the new construction market. Revenues in North America accounted for about 81% of 2014 worldwide sales.
Housing metrics increased in 2014 due to more robust economic growth during the last three quarters of the year (prompted by improved household net worth, industrial production and consumer spending), and consequently acceleration in job growth (as unemployment rates decreased to 6.2% for 2014 from an average of 7.4% in 2013), despite modestly higher interest rates, as well as more measured home price inflation. Single-family starts in 2014 improved 4.9% to 648,000 while multifamily volume grew 16.4% to 357,800. Thus, total starts in 2014 were 1.006 million. New home sales increased 1.2% to 435,000, while existing home volume was off more than 3% to 4.927 million largely due to fewer distressed homes for sale and limited inventory.
Housing activity is likely to ratchet up more sharply in 2015 with the support of a steadily growing economy throughout the year. The unemployment rate should continue to move lower (averaging 5.8% in 2015). Credit standards should moderately but steadily ease throughout next year. Demographics should be more of a positive catalyst. Total housing starts are projected to expand 14% to 1.14 million as single-family starts advance 17.6% and multifamily volumes gain 7%. New home sales should grow 18%, while existing home sales rise 4.3%.
Fitch projects home improvement spending increased 6% in 2014 and will grow at a similar pace this year. Spending for discretionary big-ticket remodeling projects should continue to lag the overall growth in the home improvement sector somewhat, as credit availability remains relatively constrained and homeowners remain cautious in their spending. However, there are signs that homeowners are a bit more willing to undertake larger discretionary projects.
EUROPEAN EXPOSURE
Management estimates that approximately 19% of the company's sales are directed to international markets, primarily Europe. Management estimates that the UK accounts for about 28% of its international operations, while Central Europe and Eastern Europe make up 25% and 9%, respectively. Southern Europe is about 10% of its international operations. Sales from international operations grew 5.8% during 2014 after a 6.2% increase during 2013 and a 5.5% decline during 2012. Fitch expects weak growth in the European markets, as Eurozone GDP is only projected to improve 1.1% during 2015.
BROAD PRODUCT PORTFOLIO
Masco is one of the world's leading manufacturers of home improvement and building products, which include brand names such as Delta and Hansgrohe, Kraftmaid and Merillat cabinets, Behr and Kilz paint, and Milgard windows.
SOLID LIQUIDITY POSITION
The company continues to have solid liquidity, with cash and equivalents and short-term bank deposits of \$1.69 billion (of which \$672 million are held in foreign subsidiaries) and no borrowings under its \$1.25 billion revolving credit facility that matures in 2018. Fitch expects Masco will have cash in excess of \$1 billion during 2015 and will continue to have access to its revolver as the company has sufficient room under the facility's financial covenants. Based on the revolver's leverage ratio, as of Dec. 31, 2014, the company had additional borrowing capacity (subject to availability) of up to \$1.2 billion. Additionally, Masco could absorb a reduction to shareholder's equity of approximately \$747 million and remain in compliance with the facility's leverage ratio.
The company reduced debt by \$200 million during 2013 and has no major debt maturities until 2015 and 2016, when \$500 million and \$1 billion of senior notes mature, respectively. Fitch expects the company will refinance \$1-\$1.2 billion of these debt maturities, reducing overall debt by \$300 million to \$500 million by 2016.
FREE CASH FLOW GENERATION
Masco reported strong FCF during 2013 and 2014, generating \$378 million (4.6%) and \$323 million (3.8% of sales), respectively. By comparison, the company had FCF of \$15 million (0.2%) during 2012 and negative \$37 million during 2011. Masco has historically reported strong FCF, generating about \$5.7 billion during the 2000-2010 periods (approximately 5.2% of total revenues during the time period). Fitch expects Masco will generate FCF of approximately 3.5% - 4.5% of revenues during the next few years.
KEY ASSUMPTIONS
Fitch's key assumptions within its rating case for the issuer include:
--Total industry housing starts improve 13.8%, while new and existing home sales grow 18% and 4.3%, respectively, in 2015;
--Home improvement spending advances 6% during 2015;
--The company's installation and other services business is spun-off in mid-2015;
--Masco's revenues (excluding the results of the installation business) grow mid single-digits and the company reports slight improvement in pro forma operating profit margins in 2015;
--Debt/EBITDA between 3.0x-3.5x and interest coverage at or above 4.5x during 2015;
--Share repurchases of \$400 million to \$500 million in 2015;
--Debt reduction of \$300 million-\$500 million by year-end 2016.
RATING SENSITIVITIES
Future ratings and Outlooks will be influenced by broad end-market trends, as well as company specific activity, particularly FCF trends and uses, and liquidity position.
Additional positive rating actions may be considered in the next 12-18 months if the housing and home improvement markets continue to rebound and the company shows sustained improvement in financial results and credit metrics, including debt to EBITDA levels approaching 2.5x (and the expectation that leverage is sustained at or below this level), interest coverage consistently above 6x, and FCF margin in excess of 3.5%.
On the other hand, a negative rating action may be considered if the recovery in the U.S. housing and home improvement markets dissipate, leading to weaker than expected credit metrics, including EBITDA margins at or below 10%, debt to EBITDA levels consistently above 4.0x and interest coverage falls below 4.0x.
Fitch has upgraded Masco's ratings as follows:
--IDR to 'BB+' from 'BB';
--Senior unsecured debt to 'BB+/RR4' from 'BB';
--Unsecured revolving credit facility to 'BB+/RR4' from 'BB'.
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 (RR) of '4' for Masco's senior unsecured debt supports a rating of 'BB+', the same as Masco's IDR, and reflects average recovery prospects in a distressed scenario.
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