- Slowing economic growth and deteriorating confidence have taken their toll on corporate sectors. The non-financial ratings net outlook bias is its weakest since 2016.
- Our industry reports suggest a difficult operating environment, as companies battle the headwinds of disruption, cost pressures, regulation and adapting to environmental concerns. Economic worries and trade disputes head the list of immediate concerns.
- Nevertheless with the global economic likely to steady into 2020 on our base case assumptions, the corporate growth outlook remains positive if subdued. Capex growth is likely to contract slightly, but many sectors still need to invest heavily. M&A is still likely to feature strongly in some sectors.
Battling The Headwinds
The overwhelming sense from the 25 Industry Top Trends reports presented together here is that almost all industries are battling against powerful headwinds that are constraining growth and posing significant risks to credit quality.
Front and center are macroeconomic concerns – the ongoing impact on revenues and profitability from the global economic slowdown, particularly in manufacturing. The slump in global manufacturing confidence has gone hand-in-hand with a deterioration in the net outlook bias for S&P Global rated non-financial corporates (see chart 1). This bias – a measure of the directional risk of ratings – is now more negative than it was at the height of the commodity and capex slump of 2016.
Growth Forecasts Remain Positive If Subdued
The impact of this slowdown is also clearly apparent in aggregated forecasts of S&P Global rated non-financial companies. 2019 revenues are expected to grow by just 2.6%, down from 7.6% in 2018 (see chart 2). With profit margins also under pressure, 2019 EBITDA growth is expected to be weaker still at 2.0%, versus 8.1% the year before (see chart 3).
Under our base case economic assumptions, which are for a steadying of the growth outlook into 2020, revenue and EBITDA growth rates are expected to improve modestly out to 2021, albeit with the top-line only growing 3-4% each year. This echoes the tone of the industry reports which, while pointing to many sources of pressure, do not suggest that these are amounting to imminent recessionary conditions, particularly with interest rates low and financing conditions broadly supportive.
This picture of weak but still positive growth is similarly reflected in aggregate sector forecasts (see chart 4). All sectors are expected to see some revenue growth in 2020 and nearly all are projected to see some improvement in EBITDA margins.
Capex Under Pressure But Areas Of Resilience Underpin Spending
Deteriorating economic cycles always pose the risk of becoming self-reinforcing and a sharp deterioration in capital expenditure (capex) is one of the key concerns here. We flagged the impending downturn in our annual capex survey (see Global Corporate Capex Survey 2019: Curbed Enthusiasm, June 19, 2019) and capex-sensitive sectors such as capital goods expect 2020 to be difficult. Multiple key demand drivers for this sectors – including autos and commodities – are stagnating or in decline, while construction has peaked. The deterioration has been confirmed by patterns in consensus forecasts, which have just turned negative for the first time since 2016 (see chart 5).
However, it is important not to overstate the gloom here. There are some industries that are likely to see continued positive capex growth (see chart 6). Some notable examples include:
- Aerospace and defense – spending continues to grow in relation to increasing fuel efficiency and, within defense, exploring and countering new areas of threat including hypersonic weapons and cyber security
- Media – heavy investment in streaming/OTT platforms and content
- Retail – higher capex spend into improving omnichannel appeal
- Transportation infrastructure - Capex will remain significant, mainly to address capacity constraints, tightening emissions regulations, and digitalization, including continue conversion by roads to all-electronic toll collection.
And even in areas where growth rates are expected to be low, absolute spending is likely to hold up. For example, telecoms capex is already high $ 250 billion globally, as per S&P our projections for 2019, and we forecast that it will stay at similar levels in 2020 and beyond, with 5G investments a pivotal driver.
That said, much of the capex being spent is due to battle for dominance amidst technological disruption and the emergence of new platforms. As such, it represents significant credit risks both in terms of the outlay but also as to whether it translates to market position and cash flow. The cyclical downturn also poses risks here too – for example, the chemicals report highlights the risk of being able to curtail planned investments quickly enough should economic conditions prove weaker than our base case.
Trade and political uncertainty
Of the other risks that cut across nearly all sectors, trade disputes and political uncertainty loom largest. The trade conflict between the U.S. and China features most prominently, but a disruptive Brexit and the failure to ratify the USMCA trade agreement also feature. There are three strands of concern here:
- First, short-term effects. For example, the consumer products report highlights how the consequent extra costs on goods imported from China has been bad news for some companies, hurting smaller speculative-grade durable and apparel companies in the U.S. and some seafood processors in Canada that rely heavily on Chinese imports. A disruptive Brexit, while not our base case, would present similar short-term challenges.
- Second, the risk of escalation. While the immediate risk appears to have passed, the threat of the U.S. imposing section 232 tariffs on European and Japanese auto imports has affected confidence and uncertainty around investment plans and supply chains.
- Third, the risk of longer term disruption to supply chains. For example, the U.K. is currently the EU's biggest defense spender and Brexit could alter EU defense strategy and cause the relocation of production. It has already led to divergence with regard to development plans for the next generation of fighter aircraft, potentially increasing risks for companies involved. With regard to U.S.-China tensions, Global supply chains pull back and diversify. U.S.-China trade tensions are leading corporates to diversify their manufacturing sourcing away from China, potentially changing freight transportation patterns.
Aside from trade, political risks loom large for real estate. Increasing political risk from Brexit, policy uncertainty in Latin America, growing sentiment for rent regulation in Germany, and social unrest in Hong Kong is clouding the prospects for landlords.
Credit Market Risks
With credit markets increasing the risk premiums attached to the most risky credits over the past year, even as yields remained exceptionally low and the hunt-for-yield continued, it isn't surprising that credit market risks have been flagged by some sectors in relation to access to financing and the vulnerabilities of the most speculative credits. This includes sectors already under intense pressure like retail and oil and gas, as well as metals and mining where a maturity wall looms in 2022 and 2023 and where the proportion of speculative-grade issuers is amongst the highest. Absent substantial changes in operating conditions and as reflected in current ratings, sectors like this face significant default risks even without a sharp deterioration in the economic cycle or a decisive shift in the credit cycle.
Regulation And Environmental Concerns
Although highly sector-specific in their nature, environmental, social and regulatory costs, concerns and regulations loom large across many sectors. Many aren't new, but it is striking how central these risks have become to sector credit conditions and outlooks.
There are three broad clusters of risks:
- Environmental – examples include IMO 2020 regulations reducing sulfur content to 0.5% from 3.5% in marine fuel which has direct or indirect implications for shipping, oil and gas, airlines and CO2 emissions regulations which are relevant to utilities, autos, cement manufacturers amongst others.
- Regulatory – examples include rent regulation in EMEA, retail pricing regulation of Australian utilities, scrutiny of e-cigarettes and the increasing attention paid to media and tech companies with regard to social media and content.
- Litigation –for example, opioid litigation for healthcare and emissions breaches for autos.
Unsurprisingly given the burden of new regulations and costs, many sectors report pressure on margins. This is being met with cost-cutting, pressure on suppliers and consolidation efforts, but is another example of why zero interest rates and continued economic growth are not translating as positively as hoped for to corporate sector performance.
One new feature this year is a greater concern about labor costs apparent in some sectors. Some specific examples:
- U.S. homebuilders - Homebuilders in the U.S. should get some relief from lower commodity costs, but that affects less than one-third of the cost of a new home. We expect tight land and labor availability will persist, which should continue to constrain volume growth while pressuring costs.
- European healthcare services - Monitoring cost structures will remain key in health care services in Europe, as shortages of qualified medical staff, changing legislation in certain markets like Germany, and low unemployment in Europe are raising staff costs, which when combined with limited fee increases can hamper margins.
- Transportation - Shortages in key labor groups—pilots(less so in the EU), aircraft mechanics, and truck drivers--have pushed up compensation in some markets.
M&A Likely To Be Remain Relatively Subdued
Global M&A activity fell in 2019 (see chart 7) and the industry reports suggest 2020 will see a similar subdued pattern. Sectors that have seen intense burst of M&A such as metals and mining and telecoms are moving into a digestion and consolidation mode.
That said, as long as interest rates remain low and financing conditions, there are certainly quite a few sectors likely to see M&A continue apace. More M&A may emerge in sectors such as autos, commercial aerospace, gaming, healthcare, gaming, real estate, regulated North American utilities and unregulated EMEA utilities.
As with capex, though, much of this potential activity is a reflection of how challenging operating conditions are for many industries, with growth low, margins under pressure and intense disruption. On a more positive front, some companies in sectors such as capital goods are seeking to gain exposure to new technological capabilities in terms of digitalization, software and A.I.
- Industry Top Trends 2020: Foreword And Recap, Dec. 3, 2019
- Industry Top Trends: Latin America Utilities, Nov. 22, 2019
- Industry Top Trends 2020: Asia-Pacific Utilities, Nov. 21, 2019
- Industry Top Trends 2020: Metals And Mining, Nov. 21, 2019
- Industry Top Trends 2020: Telecommunications, Nov. 21, 2019
- Industry Top Trends 2020: Technology, Nov. 21, 2019
- Industry Top Trends 2020: Transportation Infrastructure, Nov. 21, 2019
- Industry Top Trends 2020: Homebuilders And Developers, Nov. 20, 2019
- Industry Top Trends 2020: Real Estate, Nov. 20, 2019
- Industry Top Trends 2020: Building Materials, Nov. 20, 2019
- Industry Top Trends 2020: Chemicals, Nov. 20, 2019
- Industry Top Trends 2020: Oil And Gas, Nov. 20, 2019
- Industry Top Trends 2020: Midstream Energy, Nov. 20, 2019
- Industry Top Trends 2020: Retail And Restaurants, Nov. 19, 2019
- Industry Top Trends 2020: Consumer Products, Nov. 19, 2019
- Industry Top Trends 2020: Hotels, Gaming, And Leisure, Nov. 19, 2019
- Industry Top Trends 2020: Health Care, Nov. 19, 2019
- Industry Top Trends 2020: Media And Entertainment, Nov. 19, 2019
- Industry Top Trends 2020: Aerospace And Defense, Nov. 18, 2019
- Industry Top Trends 2020: Transportation, Nov. 18, 2019
- Industry Top Trends 2020: Autos, Nov. 18, 2019
- Industry Top Trends 2020: Capital Goods, Nov. 18, 2019
- Industry Top Trends 2020: EMEA Unregulated Utilities, Nov. 13, 2019
- Industry Top Trends 2020: EMEA Regulated Utilities, Nov. 13, 2019
- Industry Top Trends 2020: North America Merchant Power, Nov. 7, 2019
- Industry Top Trends 2020: North America Regulated Utilities, Nov. 7, 2019
This report does not constitute a rating action.
|Primary Credit Analysts:||Gareth Williams, London + 44 20 7176 7226;|
|William P Buck, London + 44 20 7176 3606;|
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