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Homebuilding, Building Products Face Risk Despite Housing Strength, Fitch

August 13, 2020, 09:05 AM
Filed Under: Building Supply
Related: Fitch Ratings

The coronavirus’ effect on the US homebuilding and building products sector has not been as negative as anticipated, but better than expected second-quarter performance is not sustainable, says Fitch Ratings. We forecast housing activity and home improvement spending will weaken during second-half 2020 and into 2021, despite being stronger than expected during the second quarter. Unemployment remains elevated, consumer confidence is still below pre-coronavirus levels and infections are resurging with some states rolling back reopenings. Further government stimulus could partially offset some of the macroeconomic uncertainty.

Fitch remains cautious on the construction outlook for the remainder of 2020 and into 2021 but has upwardly revised revenue and EBITDA estimates for most rated homebuilders and building products issuers due to much stronger second quarter results than originally anticipated. Order backlogs provide some visibility for improving sales trends into the second-half of this year. Forecast 2020 and 2021 earnings and credit metrics for issuers with Negative Rating Outlooks are better than previously anticipated, supporting ratings at this time, but incorporate our subdued demand outlook.

Homebuilders are benefiting from record low mortgage rates, limited existing home inventory, limited government protection against foreclosure and forbearance on mortgage payments, and consumer reassessment of housing needs as consumers continue to work from home. Net orders for Fitch-rated homebuilders that have reported second-quarter results rose 14.8% on average. Net orders were particularly robust in June and remained strong in July. Nevertheless, we project total housing starts and new home sales will fall 8.6% and 5.7%, respectively, this year, compared with our April forecast of a 25% and 20% decline.

Rating Outlooks for Fitch-rated homebuilders are mostly Stable. Homebuilders took pro-active steps during the early part of the pandemic, slowing land spending, development activity and housing starts. Share repurchases were also temporarily suspended to preserve liquidity. Fitch-rated homebuilders have high rating headroom relative to Negative Rating sensitivities, providing cushion to absorb losses should the housing market weaken.

Land acquisition and development spending will increase modestly in second-half 2020, due to recent net order growth, but discipline around share buybacks is expected to continue due to economic uncertainty. High levels of impairment charges because of meaningfully lower absorption and declining home prices, combined with aggressive land and development spending and increased share buybacks, could pressure credit ratings.

Building products are benefiting from resilience in new home construction and residential repair and remodel activity, with do-it-yourself outperforming pro installation, exteriors performing better than interiors and low-ticket product categories well positioned for a recessionary environment. Government stimulus and a pulling forward of purchases is also supporting demand. Retail sales of building materials increased 13% in second-quarter 2020, per US Census Bureau data. Fitch views double-digit growth as unsustainable in the longer term and attributes much of the strong demand to the unique nature of the pandemic, which led to a renewed interest in home improvement.

We project retail sales of building materials will grow 3.5% in 2020 compared with our April forecast of a nearly 20% decline. Subdued non-residential construction and lingering supply chain disruptions may constrain future growth. Manufacturing is below full capacity due to social distancing and employee absenteeism, while component sourcing from Mexico is being challenged.

Stronger than expected sales and cost cutting resulted in meaningfully better than projected margins causing upward revisions to rating case assumptions. The majority of Fitch-rated building products companies’ Rating Outlooks remain Negative due to the uncertainty surrounding the shape of the demand and supply chain recovery later this year and through 2021, but capital allocation priorities and Fitch’s credit metrics forecasts support the current investment-grade credit profiles of Fitch-rated building products companies.

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