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Brighter outlook a year into COVID-19 eases default risks across US industries

The default risk risks for many U.S. industries are falling in 2021 as access to cash, the thinning out of competitors and a looming economic reopening are helping improve the outlook for companies after a tumultuous year during the coronavirus pandemic, experts say.

The one-year median probability of default scores ranked highest across U.S. industries in the consumer discretionary and communications services sectors at 1.4% and 1.0%, respectively, as of March 1, according to S&P Global Market Intelligence's Market Signals probability of default model. The figure for the consumer discretionary sector was based on the probability of default scores for 420 companies, while the score for communication services was based on data for 146 companies.

The figures represent the median of the probability of default scores for U.S. public companies within each sector that trade on the NYSE, Nasdaq or AMEX stock exchanges. The scores are based primarily on the volatility of share prices and taking into account country and industry-related risks.

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Across many sectors, scores fell from Feb. 1 values and remained well below an initial spike in the early days of the pandemic. The improved outlook is a consequence of less competition in some industries as the pandemic shuttered weaker ventures, and the ability of companies to adapt to a new and changing environment, experts say. The American Rescue Plan, the most recent coronavirus relief package passed by federal lawmakers, includes aid for specific industries and is expected to fuel economic growth.

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For consumer companies across different industries, making online ordering seamless with brick-and-mortar operations through channels like curbside pickup has been especially helpful, Jaime Katz, a Morningstar senior equity analyst, said in an interview.

"It's changing the efficiency of discretionary spend because you have multiple ways to execute the transaction," Katz said.

The pandemic pushed dollars that consumers would have spent on dining out and traveling into savings accounts or toward larger discretionary goods for things like home improvement, Katz said.

"Spend on [the] home has been growing like wildfire in the last year," Katz said.

Government stimulus efforts, including the $1,400 direct payments to taxpayers in the latest coronavirus relief package, are likely to pad online sales for companies like Inc. and Walmart Inc. and benefit retailers selling outdoor items such as Lowe's Cos. Inc. and DICK'S Sporting Goods Inc.

Within communications services, AMC Entertainment Holdings Inc.'s likelihood of default within a year was 10.9% as of March 1, up from 8.5% on Feb. 1, and among the highest within the sector. The company lost $4.59 billion in 2020, but AMC executives said on March 10 that they are hopeful more people will return to theaters as vaccine access expands. AMC did not respond to a request for comment from Market Intelligence.

Elsewhere in the communication services sector, several high-profile telecommunication companies filed for bankruptcy in 2020, including Frontier Communications Corp. But most U.S. telecommunications companies have a stable outlook based on their credit ratings, interest rates at historic lows, and access to capital through repricing or refinancing to extend maturities, Joe McCormack, a Third Bridge Group Ltd. senior analyst, said in an interview.

Still, challenges remain for companies dealing with leverage and high capital costs related to infrastructure investments, McCormack said.

"Companies are obviously challenged and are looking to work through reinvigorating the topline," McCormack said. "There still seems to be ample room for them to work through as it's, for the most part, a slow kind of drag on revenues."

The top three players in the telecoms sector — T-Mobile US Inc., Verizon Communications Inc. and AT&T Inc. — are heavily indebted, but their cash flows are strong with little likelihood they will default, Keith Snyder, a CFRA Research equity analyst, said in an interview. Smaller companies, on the other hand, are struggling with intense competition, Snyder said.

"As a company's size decreases, the likelihood of bankruptcy increases quite dramatically," Snyder said.

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U.S. restaurants remain one of the most vulnerable industries, with a median probability of default score of 2.3% as of March 1, based on 43 companies. The March score, however, is a dramatic drop-off from the April 2020 score of more than 30% as restaurants across the U.S. closed their dining rooms in the early days of the pandemic and shuffled to adapt to on-the-go service to make up for lost revenue.

The outlook for restaurants is broadly improving as more people get vaccinated and the economy begins reopening, Jason Ware, a partner and chief investment officer at Albion Financial Group, said in an interview.

"If you've made it this far, you're probably going to be okay," Ware said of restaurants.

The latest pandemic relief package dedicates $28.60 billion to restaurants through the Restaurant Revitalization Fund aimed at helping smaller operations. Publicly traded companies and restaurants with more than 20 locations are not eligible for the grants.

While the outlooks of restaurant companies with stronger drive-thru and takeout options have improved, many restaurants in the industry are still reeling from the blow struck by lockdown measures. All-you-can-eat pizza chain CiCi's Holdings Inc. filed for Chapter 11 bankruptcy protection in January after the pandemic squeezed its buffet-service business model. Companies that filed for bankruptcy in 2020 during the pandemic were likely already dealing with challenges before the pandemic, which has sped up trends good and bad for restaurants, Ware said.

"There are probably a few more bankruptcies in the restaurant space waiting in the wings," Ware said. "It'll take a big turnaround to repair those deep scars."

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Against the backdrop of defaults and bankruptcies in different parts of the economy are questions around what the government is doing from a monetary policy standpoint, Connor Murphy, a director at Burford Capital, said in an interview. The Federal Reserve is sticking with its low-rate policy as part of a plan to bring inflation in line with its target of just above 2% and see the job market recover.

When the pandemic hit in 2020, companies marshaled as much cash as they could because they did not know if they would be able to get more money from their lines of credit or issue more debt, Murphy said. But government stimulus has given companies a longer runway as interest rates and lending requirements have yet to make it harder for companies to tap into capital markets, Murphy said.

Whether the credit cycle tightens anytime soon or if companies will continue to have such access to cash are open questions, Murphy said.

"You can still issue debt right now at a pretty low interest rate and people are still buying it," Murphy said. "And people are buying distressed paper, but that may not continue forever."