Fitch Assigns 'BB+' Rating to KB Home's $300MM Debt Issue

Business Wire, Dec 8, 2004

NEW YORK -- Fitch Ratings has assigned a 'BB ' rating to KB Home's (NYSE: KBH) $300 million, 5.875% senior unsecured notes due Jan. 15, 2015. The Rating Outlook is Positive. Proceeds from the new debt issue will be largely used to pay down bank debt in the short term and for other corporate purposes.

The current ratings and Outlook reflect KB Home's solid, consistent profit performance in recent years and the expectation that the company's credit profile will continue to improve as it executes its business model and embarks on a new period of growth. The ratings also take into account the company's primary focus on entry-level and first-step trade-up housing (the deepest segments of the market), its conservative building practices, and effective utilization of return on invested capital criteria as a key element of its operating model. Over recent years the company has improved its capital structure and increased its geographic diversity and has better positioned itself to withstand a meaningful housing downturn. Fitch also has taken note of KB Home's role as an active consolidator within the industry. Risk factors also include the cyclical nature of the homebuilding industry. Fitch expects leverage (excluding financial services) to remain comfortably within KB Home's stated debt to capital target of 45%-55%.

The company has expanded EBITDA margins over the past several years on steady price increases, volume improvements and reductions in SG&A expenses. Also, KB Home has produced record levels of home closings, orders and backlog as the housing cycle extended its upward momentum. KB Home realizes a significant portion of its revenue from California, a region that has proved volatile in past cycles. But the company has reduced this exposure as it has implemented its growth strategy and currently sources approximately 17% of its deliveries from California, compared with 69% in fiscal 1995. Over recent years KB Home shifted toward a presale strategy, producing a higher backlog/delivery ratio and reducing the risk of excess inventory and debt accumulation in the event of a slowdown in new orders. The strategy has also served to enhance margins. The company maintains a five-year supply of lots (based on deliveries management has projected for 2004), approximately 49% of which are owned and the balance controlled through options. Inventory turnover has been consistently at or above 1.4 times (x) during the past nine years.

Balance sheet liquidity has continued to improve as a result of efforts to reduce long-dated inventories, quicken inventory turns and improve returns on capital. Progress in these areas has allowed the company to accelerate deliveries without excessively burdening the balance sheet.

As the housing cycle progresses, creditors should benefit from KB Home's solid financial flexibility supported by cash and equivalents of $1.9 million and $583.6 million available under its $1 billion domestic unsecured credit facility (net of $135.4 million of letters of credit) as of Aug. 31, 2004. In addition, liquid, primarily pre-sold work-in-process and finished inventory totaling $3.16 billion provides comfortable coverage for construction debt. Debt is well laddered and the current $1 billion revolving credit facility matures in four years.

Management's share repurchase strategy has been aggressive at times, but has not impaired the company's financial flexibility. KB Home repurchased $81.9 million of stock in fiscal 1999, $169.2 million in 2000, $190.8 million in 2002, $108.3 million (two million shares) in fiscal 2003 and $66 million (one million shares) through the first three quarters of fiscal 2004. At the end of August 2004, one million shares remained under the board of directors' repurchase authorization. Notwithstanding these repurchases, book equity has increased $1,148.5 million since the end of 1999, while construction debt grew $1,027.4 million. The company has had a moderate dividend. In early December 2004 the board of directors sharply raised the annual dividend from $1.00 per share to $1.50 per share - a pay out of 10.7%, based on forecast earnings for fiscal 2005. However, the cash expenditures on dividends represent only about $58 million, based on the current share count.

KB Home has lessened its dependence on the state of California, but it is still the company's largest market in terms of investment. Operations are dispersed within multiple markets in the north and in the south. During the 1990s the company entered various major Western metropolitan markets, including Phoenix, Las Vegas, Denver, Dallas, Austin and San Antonio, and has risen to a top five ranking in each market except Dallas (number 10 ranking). In an effort to further broaden and enhance its growth prospects it has established operations (greenfield and by acquisition) in the southeastern U.S., including various markets in Florida, Atlanta, Georgia, North and South Carolina. Recently, the company entered the Midwest (Chicago and Indianapolis) via acquisitions. Fitch recognizes the company as a consolidator in the industry, but expects future acquisitions will be moderate in size and largely funded through cash flow.