Fitch Ratings has affirmed the ratings of
The Rating Outlook is Stable.
MDC's 'BBB-' IDR reflects its steady capital structure through the housing cycle, relatively conservative land policy, build-to-order strategy, and strong market position in core markets. Risks include the company's less consistent cash flow generation and lower geographic diversification relative to higher-rated homebuilding peers. The company currently has solid financial flexibility and meaningful cushion relative to Fitch's negative sensitivities to withstand a potential correction in the single-family market.
The rating affirmation and Stable Outlook are based on the assumptions of a mid-single digit decline in housing activity in 2023 and a further decrease in 2024 as affordability continues to constrain demand, further exacerbated by meaningful margin compression (see Key Assumptions).
While Fitch's Rating Case does not assume a severe contraction, the likelihood of one has increased and negative rating actions could result should market fundamentals track closer to the Downgrade Case than the Ratings Case.
Fitch envisions negative rating actions could result in a more pronounced downturn, including housing activity falling 30% over a multi-year period and meaningful home price declines and/or the management team employing aggressive capital allocation strategies that diminish liquidity. Such actions by management would be a departure from Fitch's expectation and the strategy employed by MDC during the last housing downturn and the beginning of the pandemic.
Key Rating Drivers
Meaningful Rating Headroom: MDC has meaningful rating headroom relative to the negative rating sensitivities for the 'BBB-' IDR, principally net debt to capitalization below 40%. Fitch expects the company will remain disciplined with its capital allocation strategy during these uncertain times, resulting in net debt to capitalization remaining below 20% and total debt to operating EBITDA situating at or below 2.5x during the next few years, compared with 27.9% at
Historically Conservative Land Policies: The company has generally employed more conservative land and development strategies than homebuilding peers covered by Fitch. As of
Weaker CFFO than IG Peers: High land and development spending activity in 2018-2021 due to its strong growth caused the company to generate negative to modestly positive CFFO in recent years. All of MDC's investment-grade homebuilding peers have generated consistently positive CFFO during the same time period due to these peers' higher EBITDA margins and, in some cases, more muted inventory investment compared with MDC. However, given the recent pullback on land spend and Fitch's expectation that the company will continue to invest at lower levels, Fitch expects MDC to generate
Presale Strategy: The company's strategy has been to focus on the pre-sale of homes, with 91% of work-in-process unit inventory (excluding model homes) already sold as of
Geographic and Product Diversification: MDC benefits from geographic diversification, with operations across 15 states located in the
Shift to First-Time and Move-Down Buyer: MDC addressed ongoing home affordability concerns by expanding its product offerings designed for first-time or move-down buyers. About 60% of 2021 net orders were from what the company considers affordably priced homes. Strong demand from millennial buyers, particularly since the spring of 2020, has contributed to MDC's robust home order growth in recent years. Fitch expects that the company will continue to invest in this product segment during the intermediate-term.
Rating Incorporates Housing Cyclicality: The company's rating incorporates the cyclicality of the housing market. Fitch assumes housing activity will fall mid-single digits in 2023 and low-single digits in 2024, leading to revenue contraction in the mid- to high-single digits in 2023 and low- to mid-single digits in 2024 and EBITDA margins contracting roughly 600 bps during the two-year period.
Prospects for Downgrade Case Increasing: Fitch's Ratings Case forecast does not assume a meaningful contraction similar to the last housing downturn. Should that be the case, there could be negative momentum on the ratings and/or Outlook, particularly if management employs an aggressive capital allocation strategy.
Derivation Summary
MDC's 'BBB-' IDR reflects its steady capital structure through the housing cycle, its relatively conservative land policy and build strategy, and its strong market position in core markets. Fitch views MDC's 'to-be-built' build strategy as more conservative than peers such as
The company is smaller, less geographically diversified, and generates more volatile CFFO (as it grows its community count) than higher-rated peers, including
Key Assumptions
Homebuilding revenues increase 12.0%-12.5% in 2022 and fall 8% in 2023;
EBITDA margins of around 18.0% in 2022 and 14.0%-14.5% in 2023;
CFFO of
Net debt to capitalization below 20% and total debt to operating EBITDA peaking at about 2.5x during the forecast period.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Fitch's expectation that net debt-to-capitalization will sustain below 30%;
The company increases its size and further enhances its geographic diversification and local market leadership positions;
EBITDA margins sustain in the mid-teens.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Fitch's expectation that net debt-to-capitalization will sustain above 40%;
Fitch's expectation that total debt to operating EBITDA will sustain above 3.0x;
The company maintains an aggressive land and development spending program that leads to consistently negative CFFO, higher debt levels and a diminished liquidity position.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from '
Liquidity and Debt Structure
Strong Liquidity: MDC's homebuilding operation has strong liquidity with
Issuer Profile
Summary of Financial Adjustments
Historical and projected EBITDA is adjusted to add back non-cash stock-based compensation and interest expense included in cost of sales and also excludes impairment charges and land option abandonment costs.
Fitch excludes the EBITDA and debt of MDC's financial services operations as this subsidiary's only major debt, a mortgage repurchase facility, is non-recourse to MDC and the finance subsidiary generally sells the mortgage it originates and the related servicing rights to third-party purchases within 30 days.
Fitch's Corporate Criteria outlines adjusting consolidated profiles for group structures under which Fitch partially deconsolidates the mortgage origination operations from homebuilders' results as the agency believes there is weak linkage to the parent based on the debt being 364-day nonrecourse facilities, the assets securing it are typically held for short periods of time and limited strategic and operational links. When applying this adjustment, Fitch removes the associated debt and EBITDA from relevant ratios. Shareholders' equity is assumed to be unaffected. Fitch reviews historical cash flow from operations on a consolidated basis and also estimates CFFO excluding these operations.
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
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