Credit rating agencies are quick to be pessimistic about the credit risks of homebuilding firms, expecting that the housing market is headed toward a bust due to rising interest rates. Today’s FA Alpha Daily will probe Forestar Group Inc. (FOR), an infrastructure development company, to dissect its real creditworthiness using the Credit Cash Flow Prime.
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The housing market is booming, but rising interest rates have many investors and analysts spooked about the potential for the house of cards to come tumbling down. During the 2008 recession, housing companies were often forced into bankruptcy as expected cashflows dried up.
One company at the very edge of the homebuilding market is Forestar Group (FOR). It’s an infrastructure development company in charge of purchasing and preparing land to sell to its parent company, D.R. Horton (DHI).
Currently, this firm is looked at very pessimistically by the rating agencies, who tend to dismiss any homebuilding firm as a boom-and-bust cyclical company.
Rather than understand each company individually, the credit rating agencies simply stick every company in the industry with a high-yield warning label and walk away. Furthermore, it neglects how the housing industry was able to build out huge cash reserves from the construction boom starting in 2020.
The credit rating agencies currently rate Forestar a B+ high yield risk, implying a 25% risk of bankruptcy in the next five years.
However, we can figure out if there is a real risk for this company by leveraging the Credit Cash Flow Prime (CCFP) to understand the company’s obligations matched against its cash and cash flows.
In the chart below, the stacked bars represent the firm’s obligations each year for the next seven years. These obligations are then compared to the firm’s cash flow (blue line) as well as the cash on hand available at the beginning of each period (blue dots) and available cash and undrawn revolver (blue triangles).
As evidenced by the following chart, Forestar has plenty of cash flow over the next four years, until it reaches material debt headwalls in 2026. Even then, it has substantial cash on hand available to cover that obligation.
This is why we have rated the company a much safer investment-grade IG4+ rating, implying less than a 2% chance of bankruptcy over the next five years.
It seems the credit rating agencies have missed the cash reserve the firm has built up, thanks to the housing boom of 2020 and beyond.
Rating agencies seem to be getting caught up in the story that the homebuilding industry is starting to bust as rates have risen. But by thinking rationally and looking at the data to back it up, we can see that Forestar Group is still in a very healthy position.
It is our goal to bring forward the real creditworthiness of companies, built on the back of better Uniform Accounting.
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SUMMARY and Forestar Group Inc., Tearsheet
As the Uniform Accounting tearsheet for Forestar Group Inc., (FOR:USA) highlights, the Uniform P/E trades at 7.5x, which is below the global corporate average of 20.6x and its historical P/E of 11.5x.
Low P/Es require low EPS growth to sustain them. That said, in the case of Forestar, the company has recently shown 102% Uniform EPS growth.
Wall Street analysts provide stock and valuation recommendations that in general provide very poor guidance or insight. However, Wall Street analysts’ near-term earnings forecasts tend to have relevant information.
We take Wall Street forecasts for GAAP earnings and convert them to Uniform earnings forecasts. When we do this, Forestar’s Wall Street analyst-driven forecast is for an EPS growth of 49% in 2022 and 21% in 2023.
Based on the current stock market valuations, we can use earnings growth valuation metrics to back into the required growth rate to justify Forestar’s $16 stock price. These are often referred to as market embedded expectations.
The company is currently being valued as if Uniform earnings were to shrink by 3% annually over the next three years. What Wall Street analysts expect for Forestar’s earnings growth is above what the current stock market valuation requires in 2022 and 2023.
Furthermore, the company’s earning power in 2021 is around the long-run corporate average. Moreover, cash flows and cash on hand are almost 5x its total obligations—including debt maturities and capex maintenance, with a 350bps intrinsic credit risk. All in all, this signals a moderate credit and dividend risk.
Lastly, Forestar’s Uniform earnings growth is above its peer averages, and the company is also trading above its average peer valuations.
Joel Litman & Rob Spivey
Chief Investment Strategist &
Director of Research
at Valens Research
This analysis of Forestar Group Inc., (FOR) credit outlook is the same type of analysis that powers our macro research detailed in the FA Alpha Pulse.