Alpha Challenge Long EVEN Construtora e Incorporadora S.A. (EVEN3.BZ) Short KB Homes (NYSE: KBH)
Steve Schembri, Bradley Murray, Gustav Karlsson 18th November, 2011 Recommendation
Long EVEN Construtora Short KB Homes • Current Price: R$ 6.38 • Current Price: $7.51 • Target Price: R$ 12.29 • Target Price: $4.97 • Target Return: +93% • Target Return: +34% • Position Size: R$ 50 million • Position Size: $25 million
• Thesis (Fundamentals) • Thesis (Event Driven) 1. Secular tailwinds 1. Serious liquidity concerns 2. Mid-income segment focus 2. Inventory in hardest hit areas 3. Best-in-class capital allocation 3. Exposure to first-time buyers 4. Incentivized leadership 4. Structural problems in market 5. Supportive valuation 5. Low inventory vis-à-vis peers
• Catalysts • Catalysts 1. Q4 inflation inflection point 1. Potential S&P downgrade 2. Prudent monetary policy 2. Dividend cut 3. Analyst upward revision 3. Failed bond auction in 2012 4. Q411E CF underperformance Agenda
Long EVEN Construtora • Macro Outlook: Brazil • Buy Recommendation
Short KB Homes • Macro Outlook: US • Sell Recommendation
Macro Outlook BRAZIL Favorable Macroeconomic Tailwinds
Population, Unemployment, Real GDP • Young and growing population Millions growth • 100mm people (50% of country) 210 15% between 20 and 59 years old 200 10% • Average GDP growth of 3.6% 190 5% over the past 10 years 180 0% • Unemployment rate at 6% 170 -5% 1 • Low leverage among consumer 2004 05 06 07 08 09 10 11F 12F 13F base Population (LHS) Unemployment (RHS) Real GDP (RHS)
Mortgage Debt / GDP (2009) 100% 80% • Increased consumer purchasing 60% power 40%
• Ability to “lever up” 20%
0%
UK
USA
Chile
Spain
Brazil
China
Korea
France
Turkey
Poland
Mexico
Canada
Portugal
Thailand
Australia
Germany
Argentina
Hong KongHong New Zealand New Source: Bloomberg; Broker research: DB (19 Aug 2010) 1. Interpreted as mortgage debt / GDP Driving Robust Real Estate Market
Funding supply to real estate (2004-10) • Banks required to direct 65% of R$ bn reserves to real estate loans 80 • Employees required to deposit 8% 60 of monthly paycheck into FTGS • Currently receiving c. 3% APR 40 • Withdrawals upon (I) retirement (II) 20 layoffs (III) real estate investment • 0 Housing deficit of 6.3 million units 2004 05 06 07 08 09 10E (target build of one million/yr) FTGS (Employee Savings Accounts • Streamlined application process guarantee fund) making home ownership easier Delinquency rates on mortgages (2000-10) 15% • Ease of credit access for average consumer 10% • Greater affordability has led to lower delinquency rates 5%
0%
Source: Broker research: DB (19 Aug 2010); ABECIP Prudent Monetary Policy Effective
SELIC rate vs BOVESPA Inflation (CPI) Expectations Homebuilder Index*
Index: Jan 07 = 1 SELIC rate cut in 8.0% Actual Forecast 1.4 August 2010 from 16% 12.5% to 12% 7.0% 1.2 14% 12% 6.0% 1.0 10% 5.0% 0.8 8% 4.0% Critical inflection 0.6 point for inflation 6% 3.0% 0.4 4% 2.0%
0.2 2% 1.0%
0.0 0% 0.0% 2007 2008 2009 2010 2011 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 10 10 11 11 11 11 12 12 12 BOVESPA Homebuilder SELIC Rate (RHS) Index (LHS) JPMorgan HSBC Banco Votorantim Quest Investimentos Note: * Includes Gafisa, MVR, Brookfield, PDG, and Rossi Barclays Capital Source: Capital IQ; Bloomberg Recommendation (Long – Fundamental) EVEN CONSTRUTORA Company Overview Equity Price R$ 6.38 Market Capitalization R$ 1,488.41 Enterprise Value R$ 2,455.18 • Major Brazilian homebuilder LTM Revenue R$ 1,925.72 14 LTM EBITDA R$ 303.17 exclusively focused on middle- Cash on Hand R$ 381.94 12 income segment Inventory R$ 757.04 10 • Operations in Sao Paulo (60%) and Southwest Brazil (40%) 8 6 • In 2009, launched Open, which provides EVEN with greater 4 access to lower mid-income 2 market 0 5/29/2008 5/29/2009 5/29/2010 5/29/2011
Financial Overview 2011YTD Sales Breakdown R$ m Unit Value (R$ ‘000s) 2,500 20% 5% 150-200 18% 11% OPEN 2,000 15% 2% 200-350 1,500 350-500 10% 9% 1,000 500-1,100 500 5% 16% 39% 1,100-1,600 EVEN 0 0% Above 1,600 2007 08 09 10 LTM Commercial Revenue (LHS) Operating Margin (RHS)
Source: Bloomberg; Company accounts; Company annual reports Comparable Analysis
Brazilian Homebuilder Group Comparables Table Mkt Cap Net Debt to 2011E YoY 2011E LTM LTM P/TBV Company Name Ticker PRICE ($ MM) LTM EBITDA Rev Growth EBITDA Margin ROIC ROE CY10 CY11E CY12E
Homebuilder Peer Group
Gafisa S.A. GFSA3 R$ 5.60 R$ 2,429.73 5.4x 15.4% 16.2% 5.5% 5.2% 0.7x 0.6x 0.6x
Brookfield Incorporacoes SA BISA3 R$ 6.00 R$ 2,661.22 3.6x 8.0% 21.1% 8.5% 9.7% 1.2x 1.0x 0.8x
Rossi Residencial S.A. RSID3 R$ 10.15 R$ 2,705.36 4.7x 24.2% 16.6% 4.7% 9.9% 1.1x 0.9x 0.8x
Tecnisa S.A. TCSA3 R$ 10.35 R$ 1,684.74 3.1x 29.0% 21.3% 7.9% 12.5% 1.7x 1.3x 1.1x
Cyrela Brazil Realty S.A CYRE3 R$ 14.39 R$ 5,928.34 5.6x 16.7% 14.1% 5.1% 8.4% 1.4x 1.2x 1.1x
MRV Engenharia e Participações s.a. MRVE3 R$ 11.11 R$ 5,417.15 1.5x 36.2% 25.0% 12.9% 15.3% 1.9x 1.5x 1.2x
EZTEC Empreendimentos e Participacoes SA EZTC3 R$ 15.00 R$ 2,169.93 - 1.0x 43.8% 33.4% 17.7% 15.3% 2.0x 1.6x 1.3x
Homebuilder Peer Median -- -- R$ 2,661.22 3.6x 24.2% 21.1% 7.9% 9.9% 1.4x 1.2x 1.1x
Even Construtora e Incorporadora S.A. EVEN3 R$ 6.38 R$ 1,488.45 3.1x -12.8% 15.9% 6.8% 16.7% 1.1x 1.0x 0.9x
2011 EBITDA Margin 2011 ROE 2011 P/TBV
40% 18% 16.7% 1.8x 1.6x 15.3% 15.3% 35% 33.4% 16% 1.6x 1.5x 14% 1.4x 1.3x 30% 12.5% 1.2x 25.0% 12% 1.2x 25% 1.0x 21.3% 9.9% 9.7% 1.0x 21.1% 10% 1.0x 0.9x 20% 8.4% 16.6% 16.2% 15.9% 8% 0.8x 14.1% 0.6x 15% 6% 5.2% 0.6x 10% 4% 0.4x
5% 2% 0.2x
0% 0% 0.0x EZTC3 MRVE3 TCSA3 BISA3 RSID3 GFSA3 EVEN3 CYRE3 EVEN3 MRVE3 EZTC3 TCSA3 RSID3 BISA3 CYRE3 GFSA3 EZTC3 MRVE3 TCSA3 CYRE3 BISA3 EVEN3 RSID3 GFSA3
Source: Company accounts; Bloomberg Investment Rationale
I. Attractive secular story • Great macroeconomic outlook coupled with rising consumer purchasing power II. Strategy focused on highly-attractive middle-income segment • Ability to pass through costs while maintaining growth profile III. Best-in-class capital allocation • Industry leading asset turnover + 20% internal hurdle rate → top tier ROE ratio IV. Incentivized Leadership Team • CEO holds 8.84% shares outstanding representing a value of R$ 132m, not including options V. Trading at discount to both peers and 3-yr historical valuations • Buying equity at P/TBV of 0.95x provides downside support Target Price and Sensitivity Analysis
Discounted Cash Flow Price Target Sensitivity
Discount Rate (%) 14.5% PV FCF Equity (2011-18) (R$m) 1477.09 WACC (%) PV Terminal Value of Equity (R$m) 1390.87 12.29 12.5% 13.5% 14.5% 15.5% 16.5% 17.5%
1.4% 13.49 12.40 11.48 10.70 10.02 9.43
DCF (R$m) 2867.96 2.4% 13.92 12.71 11.71 10.86 10.14 9.51 Shares Outstanding (m) 233.30 3.4% 14.45 13.08 11.97 11.05 10.27 9.60
Price Target (R$) 12.29 (%) Growth TV 4.4% 15.10 13.54 12.29 11.27 10.42 9.71 5.4% 15.95 14.11 12.69 11.54 10.61 9.83 Current Price (R$) 6.38 6.4% 17.08 14.85 13.18 11.88 10.83 9.98
Price Target (Base) 12.29 93% 7.4% 18.66 15.84 13.82 12.29 11.11 10.16 Price Target (Upside) 16.68 161% Note: Base Case Sensitivity Price Target (Downside) 4.81 -25%
• Inputs and assumptions guided by discussions with management Base Case
• 1 day incremental improvement in receivable, inventory, and payable days Upside Case • Real GDP growth rate ramping up to 6% by 2013, leading to buoyant demand for launches
• 2.5 day incremental deterioration in receivable, inventory, and payable days Downside Case • Negative real GDP growth and labor/material cost pressure squeezing gross margins Catalysts
I. Inflation turns the corner I. Inflation expected to go from 7.1% in Q3 to 6.4% in Q4 II. All economists expect a decline, marking an important inflection point II. Accommodative monetary policy I. Easing inflation concern leading to additional monetary easing throughout 2012 III. Multiple expansion on analyst upward revisions I. Analysts concerned with increasing land acquisition costs given rapid asset turnover. Conversations with management indicate degree of concern may be unfounded II. Potential for diminished concerns within the next couple quarters Risks and Mitigants
Risks Mitigants
• Land price appreciation may lead to • Management believes concern over reduction in cash flow increasing land prices may diminish over time
• Increased competition for resources • Management recognizes the issue and (exacerbated by World Cup and remains focused on supplier relationships Olympics) leading to higher labor and material costs
• Overheating in economy, forcing BCB to • Management actively monitoring raise rates economy via internal economic advisors
• Market risks (e.g. currency) • Forex hedging
Source: Management Interviews Macro Outlook UNITED STATES Severe Structural Impediments (1)
Change in New Home Purchased • Stagnant demand for new homes due to: 60% 40% • High unemployment 20% • Low consumer confidence 0% • Concern about house prices has led -20% to slowdown in housing starts -40%
-60%
• Interest rates have nowhere to go
4Q09 4Q00 3Q01 2Q02 1Q03 4Q03 3Q04 2Q05 1Q06 4Q06 3Q07 2Q08 1Q09 3Q10 2Q11 but up 1Q00 Source: Deutsche Bank
Housing starts vs Unemployment Rate US Consumer Conference Units Index 2,000 12% 160 1,800 140 1,600 10% 120 1,400 8% 1,200 100 1,000 6% 80 800 60 600 4% 40 400 Unemployment (RHS) 2% 200 Housing starts (LHS) 20
0 0% 0
2001 1977 1979 1981 1983 1986 1988 1990 1992 1994 1996 1999 2003 2005 2007 2009
1970 1973 1976 1979 1981 1984 1987 1990 1992 1995 1998 2001 2003 2006 2009
Source: US Census Bureau Source: Bloomberg Severe Structural Impediments (2)
FHA Loan Limit Changes • Financing availability remains an issue $800,000 -14% Before Now -29% $600,000 -28% • Previous Homebuyer tax credits have -22% -22% pulled future demand forward -7% $400,000 • Decreased FHA loan amounts $200,000
$- Maricopa Orange Riverside Orange Orlando, Clark County, County, County, County, FL County, AZ CA CA FL NV
Financing Availability New Home Purchase Prices (US) % of Mortgage Originations with FICO Score Greater than 740 $350,000 80% 74.4% 75.1% 74.4%
70% $300,000 60% 55.8% 50% $250,000 Mean 41.2% 41.5% 39.7% 40.1% 40% $200,000 Median 30% 20% $150,000 10%
0% $100,000
2001 - 2005 2006 2007 2008 2009 2010 2011
1987 2008 1991 1992 1994 1996 1998 1999 2001 2003 2005 2006 2010 2004 YTD 1989 Source: Fannie Mae and FBR Research Source: US Census Bureau Recommendation (Short – Event Driven) KB HOMES Company Overview
Revenue by Region • Mid-size regional homebuilder $ m West Coast • Significant exposure to 1,000 Central South West California 800 South East • Specializes in affordable build- 600 to-order homes (ASP: $215k) 400 • Customer mix heavily skewed 200 to first-time homebuyers 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 • Typical buyer has FICO score 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 below national median of 723 • KB Homes recognized land and 4Q 2010 Total Inventory Breakdown* lot impairments of $2.1bn in 2007 and 2008 21% West Coast 49% Central 14% South West South East 17%
Note: * By Value Source: Company accounts; Company annual reports; Broker research: RBC (Feb 2011) Comparables Analysis
United States Homebuilder Group Comparables Table Mkt Cap LTM Cash Cash on Current LTM LTM P/TBV Company Name Ticker PRICE ($ MM) Total Debt Burn Rate Hand Inventory ROIC ROE CY10 CY11E CY12E
Homebuilder Peer Group
Standard Pacific Corp. SPF $ 3.13 $ 543.2 $ 1,323.7 $ (338.4) $ 420.0 $ 1,512.4 1.0% -1.0% 0.9x 0.9x 0.9x
PulteGroup, Inc. PHM $ 5.59 $ 2,122.1 $ 3,335.4 $ (416.8) $ 1,142.5 $ 5,024.2 1.5% -2.0% 1.2x 1.4x 1.3x
Lennar Corp. LEN $ 18.37 $ 3,575.5 $ 4,109.0 $ 409.0 $ 869.9 $ 4,265.0 2.0% 2.7% 1.4x 1.3x 1.3x
Meritage Homes Corporation MTH $ 19.93 $ 643.7 $ 606.3 $ (73.3) $ 157.1 $ 798.1 2.0% -0.9% 1.3x 1.3x 1.3x
MDC Holdings Inc. MDC $ 18.81 $ 878.5 $ 1,006.7 $ (183.9) $ 1,103.0 $ 850.7 -3.2% -5.2% 0.9x 1.0x 1.0x
DR Horton Inc. DHI $ 11.54 $ 3,675.5 $ 1,588.1 $ 981.1 $ 1,013.1 $ 3,449.7 4.1% 1.6% 1.4x 1.4x 1.3x
Toll Brothers Inc. TOL $ 19.55 $ 3,285.7 $ 1,605.0 $ (204.1) $ 1,184.4 $ 3,423.6 2.6% 0.0% 1.3x 1.3x 1.2x
NVR Inc. NVR $ 639.61 $ 3,713.2 $ 7.4 $ 13.8 $ 492.3 $ 581.2 12.5% 11.9% 2.2x 2.0x 1.8x
Brookfield Residential Properties Inc. BRP $ 8.07 $ 427.6 $ 1,299.6 $ - $ 1.3 $ 2,129.3 -3.6% -2.7% 1.1x 1.1x 1.0x
Ryland Group Inc. RYL $ 14.08 $ 623.6 $ 831.8 $ (103.7) $ 493.2 $ 805.8 -0.2% -4.2% 1.2x 1.4x 1.3x
Homebuilder Peer Median -- -- $ 1,500.3 $ 1,311.7 $ (88.5) $ 681.6 $ 1,820.9 1.7% -0.9% 1.3x 1.3x 1.3x
KB Home KBH $ 7.51 $ 579.3 $ 1,615.8 $ (443.4) $ 257.4 $ 1,900.6 -0.1% -33.5% 0.9x 1.4x 1.5x
2011 Cash Burn / Cash on Hand 2011 Inventory ($ in Billions) 2011 P/TBV 2.0x 1.7x $6 2.5x $5.0 2.0x 1.5x $5 $4.3 2.0x 1.0x 0.8x 0.5x $4 $3.4 $3.4 1.4x 0.4x 1.5x 1.4x 1.4x 1.4x 1.3x 1.3x 0.5x 0.2x 0.2x 0.2x 1.3x 0.0x $3 1.1x 1.0x $2.1 0.9x 0.0x $1.9 1.0x 0.0x $2 $1.5 -0.5x -0.5x $0.9 $0.8 $0.8 0.5x -1.0x $1 $0.6 -1.0x -1.5x $0 0.0x DHI LEN NVR BRP MDC TOL RYL PHM MTH SPF KBH PHM LEN DHI TOL BRP KBH SPF MDC RYL MTH NVR NVR KBH DHI PHM RYL LEN MTH TOL BRP MDC SPF
Source: Company accounts; Bloomberg Investment Rationale
I. Liquidity issues at the forefront → potential to get much worse I. Rating agencies have confirmed to us this remains issue #1 II. Six straight quarters of cash burn ($120mm on average each quarter) II. Business and inventory located in hardest hit areas I. 70% of inventory in California and Florida → 5% annual depreciation in home values for three straight years (CA) II. Potential for meaningful land and lot impairments III. Heavy exposure to first-time buyers, who may struggle to access financing I. 73% of revenue from first time home buyers → segment among the hardest hit in crisis IV. Structural problems will overhang for foreseeable future I. 3.7mm existing inventory + 7.0mm in shadow inventory will likely overhang market for years II. Interest rate cycle to remain headwind for years to come V. Low inventory levels vis-à-vis peers → poorly positioned to benefit from recovery Declining ASPs deteriorating cash position
Average Selling Prices (by region) Cash Flow Profile
$ 000s $ m $ m 450 1,200 250 1,000 400 200 800 350 150 600 100 300 400 200 50 250 0 - 200 -200 (50) 150 -400 (100) -600 100 (150) -800 50 -1,000 (200) 0 -1,200 (250) Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 Cash Balance (LHS) West Coast Central CF Operations (RHS) Southwest Southeast Total CF (RHS)
Source: Company accounts; Company annual reports Capital Structure (Event Issue)
CAPITAL STRUCTURE AS OF 8/31/2011
TOTAL RATINGS Cum. ISSUE OUTSTANDING Issue MATURITY COUPON Price YTM MOODYS S&P Outlook % of Cap. 3.0% - 7.0% M / S&P Mortgages and Land Contracts Due 28.4 1.3% Total Secured Debt 28.4 1.3%
Senior Notes 249.6 May-04 Feb-14 5.750% $94.00 8.890% B2 B+ Stable / Negative 11.4% Senior Notes 299.2 Dec-04 Jan-15 5.875% $89.00 10.010% B2 B+ Stable / Negative 13.7% Senior Notes 449.8 May-05 Jun-15 6.250% $89.00 9.980% B2 B+ Stable / Negative 20.6% Senior Notes 260.7 Jul-09 Sep-17 9.100% $91.00 11.240% B2 B+ Stable / Negative 11.9% Senior Notes 299.0 Mar-06 Jun-18 7.250% $85.00 10.460% B2 B+ Stable / Negative 13.7% Total Senior and Secured Debt 1,586.7 72.6%
Capitalized Operating Leases 29.1 1.3% Total Senior, Secured, and Off BS Debt 1,615.8 73.9%
Market Capitalization 569.2 26.1% Capitalization 2,185.0 100.0%
Cash (PF for $220mm Legal Payment; 257.4 excl. restricted cash) Net Debt 1,358.4
Important Capital Structure Notes ● No financial maintenance covenants on Senior Notes ● S&P recovery rating on bonds is "4", which implies 30%-50% recovery in event of default → equity worth nothing ● S&P review period to end 12/31/2011 at which time it would "lower our rating on KB Home by one notch if the company… ends the fiscal year with less than $500 million of unrestricted cash." → high probability case ● Moody's notes "a return to consistent profitability and reducing its debt/capitalization leverage to about 60% could lead us to consider the rating for an upgrade." → we view this as unlikely during the next 12 months. ● Moody's also notes "Continued losses, weakening liquidity, and debt/capitalization increasing to about 85% could create downward pressure on the ratings." → we view this as increasingly likely as market and book value erode. ● KB has ability to issue Secured Debt at an amount up to 20% of Consolidated Net Tangible Assets
Source: Company reports; S&P; Moody’s Market Perceptions Changing
Source: Bloomberg Financial Valuation & Recoveries Analysis
LTM Recoveries Analysis US$ 'Millions Q3'11A Q4'11E 2012E 2013E Q3'14E % Recoverable Distributed Assets Homes Delivered 1,603 2,106 5,551 5,540 5,481 Cash and Cash Equivalents $476.28 100% $476.28 Average Selling Price ($000s) $ 227.4 $ 234.8 $ 231.0 $ 243.1 $ 249.3 Restricted Cash 113.19 100% $113.19 Receivables 81.69 80% $65.35 Growth in Homes Delivered 9.8% -6.3% -0.2% -1.1% Inventories 1,663.09 80% $1,330.47 Growth in ASP 0.5% 3.3% 5.3% 5.4% Investments in JV's 51.26 100% $51.26 Other Assets 80.98 50% $40.49 Revenue $ 367.3 $ 497.4 $ 1,291.5 $ 1,356.1 $ 1,379.4 Financial Services 21.83 50% $10.91 Net Income $ (9.6) $ (53.4) $ 26.8 $ 57.3 $ 66.8 Net Value from Asset Sales $2,087.95 EBITDA $ 4.1 $ 42.1 $ 140.3 $ 175.8 $ 178.2 Interest Coverage 0.0x 1.6x 1.3x 1.7x 1.8x Accounts Payable $179.86 $179.86 Accrued Expenses and other 384.85 $384.85 Beginning Cash Balance $ 627.2 $ 477.4 $ 567.6 $ 405.2 $ 251.9 Mortgages and Notes Payable 1,580.17 $1,580.17 Change in Cash $ (146.2) $ 90.2 $ (28.8) $ 37.8 $ (237.5) Financial Services 3.32 $3.32
Ending Cash Balance $ 481.0 $ 567.6 $ 538.9 $ 443.0 $ 14.4 Net Amount to Unsecured $2,148.21
Long-Term Debt $ 1,586.7 $ 1,585.4 $ 1,320.7 $ 1,319.2 $ 1,320.7 Value to Bonds as % of Par 97.20% Net Debt $ 1,105.7 $ 1,017.8 $ 781.8 $ 876.2 $ 1,306.3 Shareholder's Equity $ 432.0 $ 373.7 $ 452.3 $ 470.1 $ 452.3 Value Left to Equity $0.00
# Shares (mm) 77.047 77.047 77.047 77.047 Price $ 7.60 $ 9.95 $ 10.34 $ 9.95 P/B Ratio 1.4x 1.7x 1.7x 1.7x Market Capitalization $ 585.6 $ 766.5 $ 796.6 $ 766.5
Case Share Price Probability Wtd. Avg. Price Today's Price Target Return Bankruptcy $ - 25% $ - Liquidation Value $ - 25% $ - Normal Operation $ 9.95 50% $ 4.97 Total Price $ 4.97 $ 7.51 33.8%
Source: Standard & Poors Interviews; Company accounts Catalysts
I. Potential S&P downgrade I. S&P review period finishes at year end → analyst has indicated that revised review to be provided in first quarter II. Dividend cut I. Constrained liquidity driving dividend cut → nominal impact not important but signaling effect could be huge III. Failed bond auction in 2012 I. Company needs to address 2014 maturities in late 2012 / early 2013 → current YTM’s indicate financing will be expensive, if available at all II. Failed bond auction significant trigger for equity re-rating IV. Q411E Cash Flow Miss I. Recent market and confidence volatility → potentially leads to lower than expected performance in Q4
Source: Interview with S&P Risks and Mitigants
Risks Mitigants • Economy grows faster than expected, • Better than expected growth likely to resulting in lower unemployment and lead to increased interest rates and rising consumer confidence decreased home affordability
• Housing price deflation reverses due to • Significant backlog of existing homes and decreased distressed sales “shadow” inventory will keep downward pressure on prices due to oversupply
• Company able to execute secured debt • Projected liquidity position and future deal to address upcoming maturities free cash flow profile not supportive of any new debt
• Increased access to mortgage financing • 2.5 years of home inventory and 4.1 for first time buyers years of home and land inventory ranks at lowest amongst peers; low cash hinders investments required to maintain market share
Source: Interview with S&P Additional Information APPENDIX EVEN DCF Model: Income Statement Base Case
[R$ '000s] 2010 2011 2012 2013 2014 2015 2016 2017 2018
Income Statement
Revenue Real estate 2,008,211 1,758,780 2,019,311 2,325,146 2,578,793 2,741,808 2,906,021 3,185,580 3,492,033 Other Revenues (52,280) (53,798) (62,786) (72,788) (80,693) (85,694) (91,031) (99,789) (109,388) Total Revenue 1,955,931 1,704,982 1,956,525 2,252,358 2,498,099 2,656,114 2,814,990 3,085,792 3,382,645
COGS (1,420,128) (1,232,473) (1,414,450) (1,631,102) (1,808,651) (1,923,450) (2,038,473) (2,234,574) (2,449,540) Gross Profits 535,803 472,509 542,075 621,256 689,449 732,664 776,517 851,218 933,105 Gross Margin 27% 27% 27% 27% 27% 27% 27% 27% 27% Operating Costs Selling Expenses (86,865) (90,774) (94,859) (99,127) (103,588) (108,250) (113,121) (118,211) (123,531) G&A (100,217) (104,727) (109,439) (114,364) (119,511) (124,889) (130,509) (136,381) (142,519) Other Costs (12,274) (12,274) (12,274) (12,274) (12,274) (12,274) (12,274) (12,274) (12,274) EBIT 336,447 264,734 325,503 395,490 454,076 487,252 520,613 584,351 654,781 Operating Margin 17% 16% 17% 18% 18% 18% 18% 19% 19%
Financial Costs (66,840) (70,182) (73,691) (77,376) (81,244) (85,307) (89,572) (94,051) (98,753) Financial Income 54,527 47,531 54,544 62,791 69,641 74,047 78,476 86,025 94,301 Profit Before Tax 324,134 242,083 306,355 380,905 442,473 475,991 509,517 576,325 650,329
Income Tax (69,090) (42,365) (53,612) (66,658) (77,433) (83,298) (89,165) (100,857) (113,808) Net Income 255,044 199,718 252,743 314,247 365,040 392,693 420,351 475,468 536,521 NI Margin 13% 12% 13% 14% 15% 15% 15% 15% 16% EVEN DCF Model: Balance Sheet Base Case
[R$ '000s] 2010 2011 2012 2013 2014 2015 2016 2017 2018
Balance Sheet Current Assets 2,589,309 2,848,769 3,095,596 3,392,024 3,739,056 4,121,295 4,530,652 4,981,444 5,485,430 Cash and Cash Equivalents 528,462 1,039,845 1,046,218 1,060,865 1,177,862 1,415,984 1,681,897 1,884,586 2,118,359 Accounts Rec. 1,471,164 1,277,675 1,460,741 1,675,354 1,851,202 1,960,920 2,070,393 2,260,993 2,469,104 Properties for Sale 448,389 385,716 438,738 501,409 550,964 580,593 609,650 662,091 718,980 Other 141,294 145,533 149,899 154,396 159,028 163,798 168,712 173,774 178,987
Long Term assets 471,572 413,112 465,267 525,834 574,451 603,593 632,213 682,964 737,757 Receivables 434,904 374,369 424,166 482,045 527,699 553,700 579,000 626,129 676,966 PPE 18,947 20,845 23,023 25,530 28,311 31,268 34,402 37,837 41,602 Other 17,721 17,898 18,077 18,258 18,441 18,625 18,811 18,999 19,189
Total Assets 3,060,881 3,261,881 3,560,863 3,917,857 4,313,507 4,724,888 5,162,865 5,664,408 6,223,187
Current liabilities 1,065,924 1,060,761 1,143,660 1,237,370 1,324,880 1,399,714 1,477,283 1,578,034 1,686,882 Borrowings (inc. Debentures) 617,910 648,806 681,246 715,308 751,073 788,627 828,058 869,461 912,934 Accounts payable 170,601 151,481 177,777 209,538 237,371 257,780 278,858 311,891 348,699 Advances from customers 159,578 139,104 159,626 183,763 203,812 216,704 229,666 251,760 275,979 Others 117,835 121,370 125,011 128,761 132,624 136,603 140,701 144,922 149,270
Long Term Liabilities 742,474 774,632 816,886 862,757 910,286 958,415 1,009,045 1,065,488 1,125,863 Borrowings (inc. Debentures) 558,168 586,076 615,380 646,149 678,457 712,380 747,999 785,398 824,668 Accounts payable 29,004 28,595 36,746 46,905 57,035 65,998 75,607 89,088 104,462 Others 155,302 159,961 164,760 169,703 174,794 180,038 185,439 191,002 196,732
Total Liabilities 1,808,398 1,835,393 1,960,547 2,100,127 2,235,166 2,358,129 2,486,328 2,643,522 2,812,745
Shareholders Equity 1,409,837 1,559,626 1,749,183 1,984,868 2,258,648 2,553,168 2,868,431 3,225,033 3,627,424 EVEN DCF Model: Cash Flow Statement Base Case
[R$ '000s] 2010 2011 2012 2013 2014 2015 2016 2017 2018
Cash Flow Statement
Net Income 255,044 199,718 252,743 314,247 365,040 392,693 420,351 475,468 536,521 Dep/Amort 5,425 6,627 7,605 8,754 9,710 10,324 10,941 11,994 13,148 (+/-) Change in WC (657,121) 304,688 (242,751) (283,362) (222,076) (124,917) (121,268) (229,280) (247,596) CFO (396,652) 511,034 17,597 39,640 152,674 278,100 310,025 258,182 302,073
Capex (17,459) (8,525) (9,783) (11,262) (12,490) (13,281) (14,075) (15,429) (16,913) CFI (17,459) (8,525) (9,783) (11,262) (12,490) (13,281) (14,075) (15,429) (16,913)
New debt raised 285,561 58,804 61,744 64,831 68,073 71,477 75,050 78,803 82,743 Equity raised 236,941 - 0 ------Dividends - (49,930) (63,186) (78,562) (91,260) (98,173) (105,088) (118,867) (134,130) CFF 522,502 8,874 (1,442) (13,730) (23,187) (26,697) (30,038) (40,064) (51,387)
Total Cash Flow 108,391 511,383 6,373 14,647 116,996 238,123 265,913 202,689 233,773 Opening Cash 313,791 528,462 1,039,845 1,046,218 1,060,865 1,177,862 1,415,984 1,681,897 1,884,586 Closing Cash 528,462 1,039,845 1,046,218 1,060,865 1,177,862 1,415,984 1,681,897 1,884,586 2,118,359 EVEN DCF Model: Valuation Base Case
[R$ '000s] 2010 2011 2012 2013 2014 2015 2016 2017 2018
Discounted Cash Flow Analysis EBITDA 341,872 271,361 333,107 404,245 463,786 497,575 531,555 596,345 667,929 Financial Cash flow (12,313) (22,651) (19,148) (14,585) (11,603) (11,260) (11,096) (8,026) (4,453) Taxes (69,090) (42,365) (53,612) (66,658) (77,433) (83,298) (89,165) (100,857) (113,808) Capex (17,459) (8,525) (9,783) (11,262) (12,490) (13,281) (14,075) (15,429) (16,913) (+/-) Change in WC (657,121) 304,688 (242,751) (283,362) (222,076) (124,917) (121,268) (229,280) (247,596) Free Cash Flow (414,111) 502,509 7,814 28,378 140,183 264,820 295,950 242,753 285,160
New Debt 285,561 58,804 61,744 64,831 68,073 71,477 75,050 78,803 82,743 Equity Raised 236,941 0 0 0 0 0 0 0 0 Free Cash Flow of Equity 108,391 561,313 69,558 93,209 208,256 336,296 371,001 321,556 367,903 Terminal Value 3,646,215
FCFE 108,391 561,313 69,558 93,209 208,256 336,296 371,001 321,556 4,014,118 Period 0.12 1.12 2.12 3.12 4.12 5.12 6.12 7.12 Discounted Cash Flows 552,106 59,759 69,942 136,494 192,517 185,504 140,433 1,531,209
Discounted Sum of Cash Flows 2,867,964
Number of Local Shares (m) 233.30 Price Target 12.29
Implied Expected Return 93% Top EVEN equity holders
Source: Bloomberg EVEN: historical price/book
Source: Bloomberg EVEN: historical volatility
Source: Bloomberg EVEN: WACC
Source: Bloomberg Brazil: Deficit breakdown by region
Source: Fundação João Pinheiro Brazil: Distribution of Population
Source: U.S. Census Bureau Brazil: Estimated annual increase in average real income from 2009-2015 by region
Source: MB Associados Quarterly Brazil economic indicators
Source: Bloomberg Brazil unemployment
Source: Bloomberg Monthly SELIC rate
Source: Bloomberg SELIC projections
Source: Bloomberg BRL rate
Source: Bloomberg KBH DCF Model: Income Statement Base Case
KB Homes Income Statement ($Millions)
Fiscal Year End (November 30) Quarterly 2008A 2009A 2010A 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E
Revenues 3,033.9 1,824.9 1,590.0 1,318.6 1,202.1 1,226.3 1,224.8 1,266.3 1,288.7 1,310.2 1,340.0 COGS 2,695.0 1,579.4 1,284.6 1,109.6 990.7 1,010.9 1,010.3 1,045.1 1,064.0 1,082.4 1,107.5 Gross Margin 338.9 245.4 305.4 209.1 211.4 215.4 214.6 221.2 224.6 227.8 232.5
SG&A 501.0 303.0 289.5 226.4 95.7 96.8 95.1 98.3 99.1 99.9 101.5 Pre-tax Operating Margin (162.1) (57.6) 15.9 (17.3) 115.7 118.5 119.4 123.0 125.5 127.9 130.9
Net Interest Expense 32.0 (43.4) (66.2) (62.7) (106.6) (106.4) (93.5) (65.5) (45.5) (42.4) (13.5)
Unusual Items Income/(Loss) from Affiliates (152.8) (49.6) (6.2) (55.8) ------Other Non-Operating Inc. (Exp.) - - - (37.4) ------Impairment of Goodwill (68.0) ------Asset Writedown (606.8) (159.7) (20.0) (23.6) ------Other Unusual Items (10.4) (1.0) - (68.8) ------EBT Incl. Unusual Items (838.0) (210.3) (26.2) (185.6) ------
Income Tax 8.2 (209.4) (7.0) 0.1 3.8 4.0 5.4 10.1 14.0 15.0 20.5
Net Income (976.3) (101.9) (69.5) (265.8) 5.3 8.2 20.5 47.4 66.0 70.5 96.9
EBITDA (152.8) (52.4) 19.2 (15.7) 115.7 118.5 119.4 123.0 125.5 127.9 130.9 KBH DCF Model: Balance Sheet Base Case
KB Homes Balance Sheet ($Millions) Fiscal Year End (November 30) Quarterly 2008A 2009A 2010A 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E Assets Cash and Cash Equivalents 1,135.4 1,174.7 904.4 547.0 476.3 467.8 206.4 (508.5) (460.4) (666.6) (877.3) Restricted Cash 115.4 114.3 115.5 113.2 113.2 113.2 113.2 113.2 113.2 113.2 113.2 Receivables 357.7 337.9 108.0 89.6 81.7 83.3 83.2 86.1 87.6 89.0 91.1 Inventories 2,106.7 1,501.4 1,696.7 1,663.5 1,663.1 1,663.3 1,670.4 1,672.6 1,675.9 1,680.2 1,679.8 Investments in Unconsolidated Joint Ventures 177.6 119.7 105.6 51.3 51.3 51.3 51.3 51.3 51.3 51.3 51.3 Other Assets 99.3 154.6 150.1 88.8 81.0 82.6 82.5 85.3 86.8 88.3 90.3 TOTAL HOMEBUILDERS ASSETS 3,992.1 3,402.6 3,080.3 2,553.5 2,466.5 2,461.4 2,206.9 1,499.8 1,554.3 1,355.3 1,148.2 Financial Services 52.2 33.4 29.4 21.8 21.8 21.8 21.8 21.8 21.8 21.8 21.8 TOTAL ASSETS 4,044.3 3,436.0 3,109.7 2,575.3 2,488.3 2,483.3 2,228.8 1,521.7 1,576.1 1,377.1 1,170.1
Liabilities and Stockholder's Equity Accounts Payable 541.3 341.0 233.2 201.4 179.9 183.5 183.4 189.7 193.2 196.5 201.1 Accrued Expenses and other liabilities 721.4 560.4 466.5 431.0 384.9 392.7 392.5 406.0 413.3 420.5 430.2 Mortgages and Notes Payable 1,941.5 1,820.4 1,775.5 1,585.4 1,580.2 1,574.7 1,319.2 564.1 561.0 300.2 1.3 TOTAL HOMEBUILDERS LIABILITIES 3,204.2 2,721.7 2,475.3 2,217.9 2,144.9 2,150.9 1,895.1 1,159.9 1,167.5 917.2 632.6 Financial Services 9.5 7.1 2.6 3.3 3.3 3.3 3.3 3.3 3.3 3.3 3.3 TOTAL LIABILITIES 3,213.7 2,728.8 2,477.9 2,221.2 2,148.2 2,154.2 1,898.4 1,163.2 1,170.8 920.5 635.9 Stockholder's Equity Common Stock 115.1 115.1 115.1 115.1 115.1 115.1 115.1 115.1 115.1 115.1 115.1 Paid-in Capital 865.1 860.8 873.5 879.0 879.0 879.0 879.0 879.0 879.0 879.0 879.0 Retained Earnings 927.3 806.4 717.9 432.9 418.9 407.8 409.1 437.3 484.1 535.4 613.0 Accumulated Other Comprehensive Loss (17.4) (22.2) (22.7) (22.7) (22.7) (22.7) (22.7) (22.7) (22.7) (22.7) (22.7) Grantor Stock Ownership Trust, at Cost (129.3) (122.0) (120.4) (118.7) (118.7) (118.7) (118.7) (118.7) (118.7) (118.7) (118.7) Treasury Stock (930.2) (930.9) (931.5) (931.5) (931.5) (931.5) (931.5) (931.5) (931.5) (931.5) (931.5) Total Stockholder's Equity 830.6 707.2 631.9 354.1 340.1 329.1 330.3 358.5 405.3 456.6 534.2 Total Liabilities and Stockholder's Equity 4,044.3 3,436.0 3,109.7 2,575.3 2,488.3 2,483.3 2,228.8 1,521.7 1,576.1 1,377.1 1,170.1 KBH DCF Model: Cash Flow Statement Base Case KB Homes Cash Flow Statement ($Millions) Fiscal Year End (November 30) Quarterly 2008A 2009A 2010A 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E CASH FLOW FROM OPERATIONS Net Income (976.1) (101.8) (69.5) (265.8) 5.3 8.2 20.5 47.4 66.0 70.5 96.9 Adjustments: Equity in (income) loss of unconsolidated joint ventures 135.2 35.6 (0.8) 56.2 ------Distributions of earnings from unconsolidated joint ventures 22.2 7.7 20.4 6.3 ------Loss on Loan Guaranty - - - 37.3 ------Gain on Sale of Operating Activity - - (8.8) ------Amortization of discounts and issuance costs 2.1 1.6 2.1 1.7 ------Depreciation and amortization 9.3 5.2 3.3 1.6 ------Loss on voluntary reduction of revolving credit facility 10.4 1.0 1.8 (3.6) ------Provision for Deferred Income Taxes 221.3 ------Tax benefits from stock- based compensation 2.1 4.1 (0.6) ------Stock- based compensation expense 5.0 4.0 8.1 5.8 ------Inventory Build/Investment - (168.9) (1,009.6) (1,030.5) (1,036.8) (1,066.7) (1,086.7) (1,106.1) (1,126.6) Loss on Inspirada JV ------Inventory impairments and land option contract abandonments 606.8 168.1 19.9 23.5 ------Goodwill Impairment 68.0 ------Change in assets and liabilities: Receivables (60.6) 35.7 211.3 (21.4) 7.9 (1.6) 0.1 (2.8) (1.5) (1.5) (2.0) Inventories 545.9 433.1 (129.3) 228.2 1,010.1 1,030.3 1,029.7 1,064.5 1,083.5 1,101.8 1,126.9 Accounts payable, accrued expenses and other liabilities (282.8) (252.6) (199.2) 36.9 (21.6) 3.7 (0.1) 6.3 3.4 3.3 4.6 Other, net 32.6 8.3 (1.7) (163.3) (38.3) 6.2 (0.2) 10.7 5.9 5.7 7.8 Net Cash Provided by Operating Activities 341.3 349.9 (134.1) (234.2) (46.3) 16.3 13.2 59.4 70.5 73.8 107.5
Cash Flow from Investing Activities Investments in Unconsolidated Joint Ventures (59.6) (19.9) (15.7) (2.0) ------Proceeds from Sale of Operating Property - - - 80.6 ------Purchases of Property and equipment, net 7.1 (1.4) (0.4) (0.1) ------Net Cash From Investing Activities (52.6) (21.3) (16.1) 78.6 ------
Cash Flows from Financing Activities Changed in Restricted Cash (115.4) 1.1 (1.2) 2.3 ------Repayment of Senior Subordinated Notes (305.8) 259.7 - (100.0) - - (249.6) (749.0) - (260.7) (299.0) Repayment of Senior Notes Issuance Costs (4.3) ------Repayment of Senior and Subordinated Notes (453.1) ------Payments of mortgages, land contracts, and other loans (12.8) (79.0) (101.2) (87.3) (5.3) (5.5) (5.8) (6.1) (3.2) - - Issuance of Common Stock under employee stock plans 7.0 3.1 1.9 1.4 ------Excess tax benefit associated with exercise of stock options - - 0.6 ------Payments of cash dividends (63.0) (19.1) (19.2) (19.2) (19.2) (19.2) (19.2) (19.2) (19.2) (19.2) (19.2) Repurchases of common stock (1.0) (0.6) (0.4) ------Net Cash Provided by Financing Activities (491.0) (292.2) (119.5) (202.9) (24.5) (24.8) (274.7) (774.3) (22.4) (280.0) (318.2)
Net Increase in Cash and Cash Equivalents (202.2) 36.4 (269.7) (358.5) (70.8) (8.5) (261.4) (714.9) 48.1 (206.2) (210.7) Cash and Cash equivalents at the beginning of period 1,343.7 1,141.5 1,178.0 908.3 549.8 479.0 470.5 209.1 (505.8) (457.7) (663.9)
Cash and Cash equivalents at the end of period 1,141.5 1,178.0 908.3 549.8 479.0 470.5 209.1 (505.8) (457.7) (663.9) (874.6) KBH 5-YR CDS Spread
Source: Bloomberg KBH short interest
Source: Bloomberg KBH historical volatility
Source: Bloomberg Case Shiller
Source: Bloomberg U.S. Unemployment Rate
Source: Bloomberg U.S. Shadow Inventory