News Column

Fitch Affirms Masco's IDR; Outlook Revised to Positive

February 26, 2014

Fitch Ratings has affirmed the ratings of Masco Corp., including the company's Issuer Default Rating, at 'BB'.

The Rating Outlook has been revised to Positive from Stable.

Key Rating Drivers

The rating for Masco reflects the company's leading market position with strong brand recognition in its various business segments, the breadth of its product offerings, and solid liquidity position. Risk factors include sensitivity to general economic trends, as well as the cyclicality of the residential construction market.

The company's credit metrics have improved significantly from the lows reported during fiscal 2011. Leverage as measured by debt to EBITDA declined from 6.9x at year-end 2011 to 5.1x at the end of 2012 and 3.5x at the conclusion of 2013. Similarly, interest coverage increased from 2.3x in 2011 to 2.8x in 2012 and 4.1x in 2013.

The Positive Outlook reflects Fitch's expectation that Masco will continue to improve its financial and credit metrics this year. In particular, Fitch expects leverage will be roughly 3x and interest coverage will be approximately 5x during 2014. The company's IDR may be upgraded to 'BB+' during the next six to 12 months if the company's leverage is sustained in the 3.0x-3.5x range, interest coverage is consistently above 4.5x, and free cash flow margin above 2.5 percent.

Expected Continued Improvement in Masco's U.S. End-Markets

Masco markets its products primarily to the residential construction sector. Management estimates that 72 percent of its 2013 sales were directed to the repair and remodel segment, with the remaining 28 percent to the new construction market. Revenues in North America accounted for about 81 percent of 2013 worldwide sales.

Housing metrics all showed improvement in 2013. Preliminary data show that total housing starts increased 18.3 percent. Existing home sales gained 9.2 percent to 5.09 million in 2013, while new home sales grew 16.6 percent to 428,000. Average single-family new home prices, which dropped 1.8 percent in 2011, increased 8.7 percent in 2012 and rose 9.8 percent to $320,900 in 2013. Median home prices expanded 2.4 percent in 2011 and then grew 7.9 percent in 2012 and expanded 8.4 percent to $265,800 last year.

Housing metrics should increase in 2014 due to faster economic growth (prompted by improved household net worth, industrial production and consumer spending), and consequently some acceleration in job growth (as unemployment rates decrease to 6.9 percent for 2014 from an average of 7.5 percent in 2013), despite somewhat higher interest rates, as well as more measured home price inflation. Total housing starts should increase 16.5 percent and top 1 million. New home sales are forecast to advance about 20 percent, while existing home volume increases 2 percent.

Fitch projects home improvement spending will advance 6 percent in 2014 following an estimated 5 percent growth in 2013 and a 5 percent increase in 2012. The continued improvement in the housing market, as well as strong home price appreciation seen last year, are likely to drive higher spending on home renovation projects in 2014. However, growth patterns in the near term are likely to be slightly below what the industry experienced during 1999-2006 (7 percent average annual spending growth), due to slower growth in the U.S. economy and only moderately improved housing market conditions.

Fitch expects spending for discretionary big-ticket remodelling projects will continue to lag the overall growth in the home improvement sector somewhat, as credit availability remains relatively constrained and homeowners remain cautious in their spending. However, there are signs that homeowners are somewhat more willing to undertake larger discretionary projects and purchases.

Broad Product Portfolio

Masco is one of the world's leading manufacturers of home improvement and building products, which include brand names such as Delta and Hansgrohe, Kraftmaid and Merillat cabinets, Behr and Kilz paint, and Milgard windows. This broad product portfolio is supplemented by the company's installation services operations, which includes the sale, distribution and installation of building products such as insulation, roofing and gutters, garage doors and fireplaces.

Solid Liquidity Position

The company continues to have solid liquidity, with cash and equivalents of $1.5 billion and about $1.16 billion of availability under its $1.25 billion revolving credit facility that matures in 2018. Fitch expects Masco will have cash in excess of $1 billion during 2014 and will continue to have access to its revolver as the company has sufficient room under the facility's financial covenants. Based on the revolver's leverage ratio, as of Dec. 31, 2013, the company had additional borrowing capacity (subject to availability) of up to $1.2 billion. Additionally, Masco could absorb a reduction to shareholder's equity of approximately $770 million and remain in compliance with the facility's leverage ratio.

The company reduced debt by $200 million during 2013 and has no major debt maturities until 2015 and 2016, when $500 million and $1 billion of senior notes mature, respectively. Fitch expects the company will refinance $1 billion-$1.2 billion of these future debt maturities, thus reducing overall debt by $300 million to $500 million by 2016.

Free Cash Flow Generation

Masco reported stronger FCF (cash flow from operations less capital expenditures and dividends) during 2013, generating $412 million of FCF (5 percent of sales) compared with FCF of $55 million (0.7 percent) during 2012 and negative $19 million during 2011. The company has historically reported strong FCF, generating in excess of $5.7 billion during the 2000-2010 period (approximately 5.2 percent of total revenues during the time period). Fitch currently expects Masco will generate FCF of approximately 2.5 percent -3.5 percent of revenues during the next few years. The lower FCF margin is due in part to higher CAPEX projected in the coming years.

Balance Sheet Improvement

The company has taken steps to improve its balance sheet. Masco has reduced debt by $600 million since year-end 2011. As mentioned earlier, debt to EBITDA declined from 6.9x at year-end 2011 to 5.1x at the end of 2012 and 3.5x at the conclusion of 2013. The company intends to further reduce debt by $300 million-$500 million by 2016. Management has indicated that it is committed to an investment grade rating and will continue to focus on strengthening the company's balance sheet.

Management Discipline

Masco was an aggressive purchaser of its stock from 2003-2007, spending roughly $1.2 billion annually, on average, in share repurchases and dividends during this period. The company has not repurchased stock since July 2008 and has put its share repurchase program on hold, except for share repurchases to offset the dilutive effect of stock grants. In 2009, Masco also reduced its quarterly dividend from $.235 per common share ($.94 annually) to $0.075 per share ($0.30 annually), saving approximately $225 million per year.

Management indicates that investing in the business remains a top priority for the company, with CAPEX totaling about 2 percent-2.5 percent of revenues during the next few years. The company also intends to pay down debt in the near term. In addition to these activities, the company is focused on small bolt-on acquisitions. At some point, Fitch expects Masco will start undertaking shareholder friendly activities. Currently, management indicates that increasing the dividend, rather than share repurchases, may be what the board will first consider when it starts to evaluate returning cash to shareholders.

Fitch does not anticipate changes in management's strategy (including management's commitment to an investment grade rating) with the retirement of Timothy Wadhams as Masco's President and CEO and the appointment of Keith Allman to these positions.

Rating Sensitivities

Future ratings and Outlooks will be influenced by broad end- market trends, as well as company specific activity, particularly FCF trends and uses, and liquidity position.

An upgrade of the ratings to 'BB+' may be considered if the housing and home improvement markets continue to rebound and the company shows sustained improvement in financial results and credit metrics, including debt to EBITDA levels in the 3.0x-3.5x range, interest coverage that is consistently above 4.5x, and FCF margins above 2.5 percent.

On the other hand, a negative rating action may be considered if the recovery in the U.S. housing and home improvement markets dissipate, leading to weaker than expected credit metrics, including EBITDA margins below 10 percent, debt to EBITDA levels consistently above 6x and interest coverage falls below 2.5x.

Fitch has affirmed the following ratings for Masco with a Positive Outlook:

--IDR at 'BB';

--Senior unsecured debt at 'BB';

--Unsecured revolving credit facility at 'BB'.

Additional information is available at 'fitchratings.com'.

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