BZH - Beazer Homes: 9.25% Yielding Debt Is Attractive

Summary

• Beazer Homes reported its Q1 results earlier this month. Both bond and equity prices rallied briefly before retreating.
• The company is taking action to improve its balance sheet by decreasing debt.
• While Beazer burned cash in Q1, investors need to examine the seasonality of the business.

Earlier this month, Beazer Homes ( BZH ) reported mixed results for the first quarter of its fiscal year. Shares of the home builder rallied briefly before retreating to their January levels. The company's debt also rallied but ended up selling off a bit more. The company's 2029 maturing bonds are currently priced back at their December levels, yielding 9.25%. While the housing industry is facing a difficult year, I believe Beazer's debt is a good buy for income investors.

Beazer's revenue fell approximately 2% compared to the same quarter a year ago. Costs related to the construction of houses rose slightly, leading to a decline in gross profit by $12 million. SG&A costs also rose slightly but was mostly offset by the decline in commissions. Ultimately, operating income dropped from $40 million to $28 million.

Beazer's balance sheet showed a few changes in the quarter. The company's cash balance declined with an increase in inventory. On the debt side, the company paid down its accounts payable, which should help cash flow in future quarters. There was no increase in long term debt and shareholder equity climbed by $20 million. The company earnings presentation exemplified their efforts to reduce leverage, with debt down over $500 million in the last seven years.

Beazer's cash flow statement showed the company had burned $87 million of cash in the first quarter. While a negative $90 million free cash flow quarter shouldn't excite fixed income investors, it's important to note that Beazer's cash flow is seasonal. For example, last year, the company burned $9 million less cash in the first quarter but ended the year with $81 million in cash flow from operations and $66 million in free cash flow. While current trends indicate free cash flow and operating cash flow will be $20 to $30 million lower in fiscal year 2023, that decline would still leave the company with positive free cash flow.

Beazer's debt maturities are responsibly spread out with $211 million coming due in a little over two years. While the company already has half of the 2025 maturity in cash, Beazer also has an untapped revolving line of credit that it can tap into for a total of $265 to $400 million. Beazer could utilize some of its cash to buy back debt at a rate below par, further deleveraging the organization.

The threats to Beazer are obvious and not being hidden by management. Higher interest rates are creating strong headwinds and will threaten sales for home builders. In its earnings presentation, Beazer revealed that its cancellation rate had jumped to 37%, three times higher than the first quarter last fiscal year. Fortunately, Beazer has a backlog buildup from excess demand to help buoy headwinds for the near future. The cancellation rate of its backlog is on par with fiscal years 2015 through 2020 and while down from a year ago, the backlog is still around $1 billion.

Beazer currently has a credit rating of B and B2, respectively. Moody's upgraded the company's rating from B3 to B2 this past October. Despite the upgrade and S&P's positive outlook, the company's 2029 bonds with a 9.25% yield are priced more than 100 basis points better than the benchmark rate , making it more attractive compared to other similar credit rating debt.

Beazer Homes is undoubtedly in a tough industry facing significant economic headwinds. Management is aware of the challenges ahead and continues to deleverage the business while generating positive free cash flow. Beazer's untapped revolving credit facility will provide it with much needed liquidity should economic conditions further deteriorate. In the meantime, fixed income investors can take advantage of the bonds discounted price and higher returns.

CUSIP: 07556QBT1

Price: $90.16

Coupon: 7.25%

Yield to Maturity: 9.256%

Maturity Date: 10/15/2029

Credit Rating (Moody's/S&P): B2/B

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