Fitch Rates Meritage Homes' Proposed Senior Notes 'BB-'; Outlook Stable

Fitch Ratings has assigned a 'BB-' rating to Meritage Homes Corporation's (NYSE: MTH) proposed offering of $200 million of senior notes due 2025. This issue will be ranked on a pari passu basis with all other senior unsecured debt. Net proceeds from the notes offering will be used for general corporate purposes, including repaying outstanding borrowings under MTH's unsecured revolving credit facility. A complete list of ratings follows at the end of this release.

KEY RATING DRIVERS

The 'BB-' rating and Stable Outlook for MTH are influenced by the company's execution of its business model, conservative land policies, geographic diversity and healthy liquidity position. The ratings and Outlook also take into account Fitch's expectation of further moderate improvement in the housing market in 2015 and 2016 and share gains by MTH and hence volume outperformance relative to industry trends as the market largely continues its focus on trade-up housing (MTH's strength).

MTH's sales are reasonably dispersed among its 17 metropolitan markets within nine states. During 2013, the company ranked among the top 10 builders in such markets as San Antonio and Austin, TX; Orlando, FL; Phoenix, AZ; Riverside/San Bernardino, CA; Denver, CO; San Francisco/Oakland/Fremont and Sacramento, CA; Greenville, SC and Nashville, TN. The company also builds in the Central Valley, CA; Houston, TX; Inland Empire, CA; Tucson, AZ; Tampa, FL; and Raleigh-Durham and Charlotte, NC. MTH entered the Nashville, Tennessee market with its August 2013 acquisition of Phillips Builders and entered Atlanta, GA and Greenville-Spartanburg, SC with the acquisition of Legendary Communities in 2014.

Fitch estimates that currently less than 20% of MTH's sales are to entry level buyers; less than 5% are to active adults (retirees); less than 5% are to luxury customers; and the balance of the total are generated from first and second time trade-up customers.

LAND STRATEGY

MTH employs conservative land and construction strategies. The company typically options or purchases land only after necessary entitlements have been obtained so that development or construction may begin as market conditions dictate.

Under normal circumstances MTH has used lot options, and that is expected to be the future strategy in markets where it is able to do so. The use of non-specific performance rolling options gives the company the ability to renegotiate price/terms or void the option, which limits downside risk in market downturns and provides the opportunity to hold land with minimal investment.

However, as of March 31, 2015, only 33.6% of MTH's lots were controlled through options. This is a lower than typical percentage as there are currently fewer opportunities to option lots and, in certain cases, the returns for purchasing lots outright are far better than optioning lots from third parties.

Total lots controlled, including those optioned, were 29,303 at March 31, 2015. This represents a 4.8-year supply of total lots controlled based on trailing 12-months deliveries. On the same basis, MTH's owned lots represent a supply of 3.2 years.

MTH began to increase its overall land position during the middle of 2010 following four years of declining lot supply. The company spent roughly $236 million on land purchases during 2010, compared with $182 million during 2009. In 2011, MTH invested $200 million in land and $50 million in development. The company spent $480 million on land and development in 2012. In 2013 MTH expended $565 million on real estate including $165-175 million on development activities. In 2014, the company committed $705 million to land and development. This year the company may invest approximately $700 million in real estate activities, excluding about $200 million in land banking.

Debt/Leverage/Cash Flow/Liquidity

MTH successfully managed its balance sheet during the severe housing downturn, allowing the company to accumulate cash and pay down its debt as it pared down inventory. The company had unrestricted cash and equivalents of $89.2 million at March 31, 2015. The company's debt totaled $931.3 million at the end of the first quarter 2015.

MTH's debt maturities are well-laddered, with the next debt maturity in March 2018, when its 4.50% $175 million senior notes become due.

MTH has been willing to occasionally issue equity. It issued $90 million of common equity during the 3Q 2012. More recently, in January 2014 the company issued approximately 2.53 million shares of common stock for net proceeds of approximately $110 million to use for working capital, potential expansion into new markets and/or expansion of existing markets, including the possible acquisition of other homebuilders or assets, and general corporate purposes.

In July 2012, the company entered into a $125 million unsecured revolving credit facility maturing in 2015. In 2014, MTH amended and restated the credit facility, increasing the capacity as of Dec. 31, 2014 to $400.0 million, raising the amount available for letters of credit to $200 million and extending the maturity date to June 2018. In the first quarter of 2015, MTH further increased the capacity to $500 million. Current availability is $453.3 million.

Leverage has been steadily improving in recent years, in particular during 2013 and 2014. The ratio decreased to 3.4x at the end of 2014 from 3.8x at year-end 2013 and 7.9x at the conclusion of 2012. Leverage was 3.6x at March 31, 2015. Interest coverage, which was 4.7x as of Dec. 31, 2013 and 4.6x at the end of 2014. Coverage was 4.3x as of March 31, 2015.

As is the case with most builders in our coverage, Fitch expects MTH will be cash flow negative in 2015. The company was cash flow from operations (CFFO) negative $38.2 million in the March 2015 quarter and on an LTM basis was CFFO negative by $117.7 million. In 2014, 2013, 2012 and 2011, the company was negative CFFO by $211.2 million, $86.3 million, $220.5 million and $74.1 million, respectively. Fitch currently expects MTH will be CFFO negative by about $35 million in 2015. The company is expected to spend a similar amount on land and development this year as in 2014 influencing cash flow. As the cycle matures, real estate spending is leveling out in as profits continue to rise and consequently cash flow likely will turn positive in 2016.

Fitch is comfortable with this real estate strategy given the company's liquidity position and debt maturity schedule. Fitch expects MTH over the next few years will maintain liquidity (consisting of cash and investments and the revolving credit facility) of at least $350 million, a level that Fitch believes is appropriate given the challenges/risks still facing the industry.

KEY ASSUMPTIONS

Fitch's key assumptions within its rating case for the issuer include:

--Industry single-family housing starts improve about 17%, while new and existing home sales grow 18% and almost 4.5%, respectively, in 2015;

--MTH's revenues increase at a mid-twenties pace, but homebuilding EBITDA margins erode in excess of 100 bps this year, due to higher expenses (especially land costs) and lesser home price inflation;

--The company's debt/EBITDA approximates 3.7x and interest coverage reaches about 5.0x by year-end 2015;

--MTH spends approximately $900 million on land acquisitions and development activities this year;

--The company maintains an adequate liquidity position (above $350 million) with a combination of unrestricted cash and revolver availability.

RATING SENSITIVITIES

Future ratings and Outlooks will be influenced by broad housing-market trends as well as company specific activity, such as trends in land and development spending, general inventory levels, speculative inventory activity (including the impact of high cancellation rates on such activity), gross and net new order activity, debt levels and especially free cash flow trends and uses, and the company's cash position.

Positive rating actions may be considered if the recovery in housing is better than Fitch's current outlook and shows durability; MTH shows sustained improvement in credit metrics (such as homebuilding debt to EBITDA consistently below 3.5x); and the company continues to maintain a healthy total liquidity position consisting of cash, short term investments and credit facility availability (above $350 million).

A negative rating action could be triggered if the industry recovery dissipates; 2015 and 2016 revenues each drop at a mid-teens pace while pretax profitability approaches 2012/2011 levels; and MTH's liquidity position falls sharply, perhaps below $300 million as the company maintains an overly aggressive land and development spending program.

FULL LIST OF RATINGS

Fitch currently rates Meritage as follows:

--Long term Issuer Default Rating 'BB-';

--Senior unsecured debt 'BB-'.

The Rating Outlook is Stable.

Additional information is available on www.fitchratings.com

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

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