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Coronavirus Dramatically Increases Risk For Already Stressed Retail And Restaurant Sectors


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Coronavirus Dramatically Increases Risk For Already Stressed Retail And Restaurant Sectors

Over the next several weeks we will conduct reviews on many subsectors within the global retail and restaurant sectors to reflect our updated views on the state of credit quality in the industry. We expect most rating actions to reflect the heightened risk for issuers exposed to social activity and discretionary spending. This includes most restaurants and mall-based retailers. In the next weeks and months, our rating actions will likely reflect the broad uncertainty around the severity of the impact. As new developments occur, we expect to refine our projections to reflect more precise expectations of the impact and timing of potential normalization for these issuers. At minimum, we suspect there will be very significant disruptions and sales deterioration through the second quarter because of store closings and economic contraction. Europe, Canada, and the U.S. are following a similar path, as increasing restrictions on person-to-person contact leads to an unprecedented demand collapse for many discretionary retail and restaurants segments that are witnessing a sharp drop in demand.

Liquidity Concerns Are Front Of Mind

The turmoil in the financial markets echoes the 2008 global financial crisis and is reminiscent of the shutdown of the high yield market in late 2018. Consistent with our approach across the corporate ratings sector, we are closely monitoring liquidity access across the retail and restaurant universe, especially those that rely on commercial paper and with maturities in the next one to two years. Similarly, companies with limited cash balances, availability under revolving credit facilities, or financial covenant requirements could face urgent near-term issues. Therefore, we will monitor issuers' progress on reducing potential cash burn and those who need to approach lenders for additional liquidity or for waivers and amendments associated with potential covenant issues. We believe most of the refinancing concerns reside with issuers we already rate in the low-'B' or 'CCC' categories.

Our base-case assumptions are fluid but we expect material short-term weakness

Retailers across North America and Europe without urgent liquidity needs will have an equally daunting task of managing an unprecedented shock to demand. Our economist recently published an updated forecast of a global recession with flat to slightly negative GDP growth in the U.S. in 2020, which assumes the second quarter contracts 6% on an annualized basis due to the restrictions on economic activity. A dramatic decline in consumer spending will likely be a primary driver of the slowdown as mandates to reduce face-to-face contact proliferate. We are seeing several retailers being forced to close stores either through government directives, voluntarily to limit transmission, or due to sharp drop in footfall. Following the announcement by the French government on March 14 to close all nonessential places used by the public, all of DIY and home improvement retailer Kingfisher's Castorama and Brico Dépôt stores in France have closed for a month. As the virus continues to spread in Europe, an increasing portion of the Eurozone population remains at or near lockdown. We now expect the Eurozone economy to contract 0.5% to 1.0% this year.

Operations that require only limited social interaction (for example, take-out, delivery, and drive-thru for restaurants; e-commerce, buy online pick up in store {BOPS} or click-and-collect for retailers) may offset some of the negative impacts from social distancing. However, we expect consumers and also increasingly, retailers' workforce to be cautious about any interaction in the coming weeks and possibly months. Similarly, consumers are likely to be cautious about discretionary spending, regardless of channel. We expect a return to normalcy to be gradual. Social distancing limitations and lockdowns will likely be lifted in stages to avoid a resurgence of COVID-19. Furthermore, by then we expect consumers to have curtailed discretionary spending as the recession and risk of income loss will have fully sunk in.

Under this scenario, we envision the brunt of the shock from social distancing to last about six weeks. We believe issuers in the hardest-hit subsectors of restaurants and retail could face year-over-year declines of more than 50% for about eight weeks. Assuming single-digit contraction year over year remain through the end of 2020, the full year impact to the topline could be 20%. If the situation prolongs, some smaller business will unable to resume normal operations without additional funding support or government relief.

Government actions to ease the stress on the financial system and broader economy are developing daily in the U.S. and Europe. At the time of this publication, the U.S. government was considering direct support to consumers. In our view, this is unlikely to soften the blow to retail and restaurants, at least in the short term.

The U.K. Government recently announced that all retail, hospitality and leisure businesses in England would be given a 100% business rates holiday for the next 12 months. Various governments across Europe have also announced tax moratoriums, payment extensions on social charges, grants, liquidity facilities and credit guarantee packages to help businesses. However, several details regarding the timing and implementation of many of these policies and the impact on several rated companies remains unclear.

We expect retailers and restaurants to take immediate actions to reduce costs as they limit operations. Reducing hourly workers and inventory may provide some reprieve. However, some issuers with the resources to absorb the margin compression are making efforts to support their employees, for example by maintaining benefits while hours are reduced or eliminated. These efforts will only go so far in preserving margins and are not an option for many small, already-stressed issuers concentrated in the traditional brick-and-mortar retail sector. Other levers we expect issuers to exercise include cutting general and administrative expenses such as travel, and paring back capex. We also expect some issuers to reduce share buybacks and potentially cut dividends.

As we review each issuer, we will consider variations to this scenario, recognizing issuer-specific characteristics that may soften or intensify the shock.

Supply Chain Risk Has Receded Somewhat

When the coronavirus spread in China in late 2019 and developed more seriously in January and February of this year, our focus was more on supply chain risk as the country shut down. However, recent reports of plants reopening and people returning to work has given us some confidence that the industry averted a material supply chain disruption. We expect lingering logistical and transportation bottlenecks to work themselves out and have only marginal impact across the retail sector. Regardless, given the evolution of the pandemic, lower demand would likely offset any supply chain impact.

Some Retailers Will Benefit

We expect grocery to be a bright spot as consumers hunker down and stock up for an indefinite period of homebound life. Media stories have highlighted basic household goods selling out and massive traffic at grocery and big box stores such as Wal-Mart, Target, and Costco. Recent sales for some grocers have been many multiples of the typical volume. This trend has also played out across many grocers in countries in Europe such as the U.K., France, Germany, and Spain, with many retailers resorting to a rationing system whereby they limit purchases in some categories of household goods and food items with a longer shelf life.

If stores continue to experience stock shortages and surging sales for a prolonged period, there is a risk this could inevitably lead to supply chain and stock flow pressures. This could especially occur at distribution and delivery points, which are less automated and rely on employees coming to work and in some cases working overtime.

Pharmacies should also benefit from their position as a necessity and are more likely to remain open, and the demand for staple items in their retail offerings. In Canada, where grocery stores Loblaw and Metro have a large proportion of pharmacy stores (Shoppers Drug Mart and Jean-Coutu, respectively), we expect them to benefit to a larger extent. Sobey's will benefit but probably to a lesser degree than its other Canadian grocery peers because it does not have meaningful exposure to pharmacies. As Canadian provinces declare states of emergency, we expect social distancing and restrictions on daily life to hit general merchandise retailers. Given the low-price offerings and convenience, Dollarama should weather the shut down well; we also expect Dollarama to reduce its share buybacks if needed. For Canadian Tire Corp., it will be a mixed bag where higher revenues from necessities at Canadian Tire retail could be more than offset by lower revenues at SportChek and Mark's retail banners.

Globally, companies with e-commerce capabilities will be better positioned than those without. We expect the social distancing dynamic to accelerate the long-term shift to e-commerce that has been building over the past five years in the U.S. E-commerce generated 11% of total retail sales in 2019 per the U.S. Census Bureau, and has been steadily growing as a percentage. We expect a meaningful jump in 2020 and beyond as comfort grows with the channel, particularly in the lightly penetrated U.S. grocery segment.

Online sales account for more than one-fifth of total retail sales in Great Britain. While the industry has a well-developed online grocery market, many online and mobile platforms struggle to cope with a surge in demand for essential goods, as shoppers stock up in due to fears of shortages or store closures. For instance, even the world's largest pure-play online grocer Ocado's website and mobile app crashed several times over the past few days with a surge in orders.

Risk Is Heightened For Restaurants

We expect restaurant sales to decline substantially, particularly for casual diners, as more people eat-in and are commuting less or not at all, and potential economic slowdown reduces propensity to spend for food away from home. We believe casual diners are more exposed than quick service operators given the substantial drive-through/takeout penetration of most QSR operators. While casual diners may see an uptick in takeout orders, we expect demand to fall significantly and extend a weak traffic trend the industry has experienced over the last couple of years. Sysco's (BBB-/Watch Neg/--; the largest foodservice distributor in the U.S.) revenues could drop by 50% due to restaurant closures and social distancing.

In the U.K., while the public have curtailed visits to pubs, clubs, and restaurants, these businesses have not been ordered to close (as is the case in some countries of Europe) at least at the date of publication. This has significant implications for insurance claims for many businesses, which are experiencing a sharp drop in footfall, and accordingly decided to close their doors to customers.

We believe franchisees will suffer more relative to franchisors as they absorb the operating costs but if the decline is more protracted, we expect more broad-based effects on casual dining, quick service franchisees and franchisors.

Chart 1



We expect the transition of consumers to e-commerce channels to accelerate over the coming months as social isolation initiatives are protracted. Retailers with robust IT infrastructures will benefit from this shift. In addition, we expect retail trade to be driven by nondiscretionary food retailing, while weaknesses for nonessential items such as clothing, footwear, and personal accessory retailing continue to intensify.

Social distancing measures put in place, as in many other affected regions globally, to slow the transmission of COVID-19 will have a profound effect as it will fundamentally alter the behavior of households and businesses for the next three to six months at least. Slow tourism traffic within the region should also decrease retail sales in subsectors such as department stores and duty-free shopping.

Conversely, we are seeing very small signs of recovery from retail activities in the severely impacted areas of China. It is too early to determine whether this is likely to be a leading indicator for the broader retail industry in China.

Of our coverage in APAC, we expect stable operational performance for e-commerce, convenient store, and food grocer operators, while specialty stores, especially of brick-and-mortar, will deteriorate significantly owing to weaker consumer confidence and household income.

Latin America

Latin America is currently behind the other regions. As such, the social distancing mandates have not proliferated to the same extent. Nevertheless, we believe it is a matter of time before the same dynamics reach the region and we expect the impacts to be similar in terms of subsegments of retail and restaurants. We are therefore closely reviewing our portfolio of exposed issuers in the same manner.

Although LatAm is still some weeks behind Europe, Asia, and the U.S. in terms of the coronavirus spread, we expect to see similar effects. Most governments in the region have decided to close borders, reduce domestic traffic, suspend events and highly recommend self-isolation. In our universe of rated entities in LatAm, we believe companies that may suffer the most are the traditional channels exposed to discretionary spending. This includes apparel, electronic devices, home improvement, department stores such as Lojas Renner S.A. (brAAA/Stable/--), Magazine Luiza S.A. (brAAA/Stable/--), El Puerto de Liverpool (BBB+/Negative/--), Grupo Famsa (CCC-/Negative/--), Grupo Unicomer (BB-/Stable/--) and S.A.C.I. Falabella (BBB+/Negative/--).

Probably those that have larger online operations such as Magazine Luiza (50% of 2019 sales) are better prepared to deal with a longer and deeper crisis as shoppers would likely migrate to electronic platforms to avoid contagion partially offsetting the potential sales drop as stores shut down and families reduce discretionary spending. The sale of essential products may increase, but won't be sufficient to support Magazine Luiza's operations during the still uncertain timeframe. On the other hand, Magazine Luiza recently concluded a follow-on equity issuance raising a significant cushion of R$4.3 billion that we expect to provide sufficient comfort to operations.

Traditional retailers of durable consumer goods such as Liverpool, Grupo Famsa, and Grupo Unicomer are highly exposed to a potential slump in discretionary sales if generalized shutdowns in their regions of operations continue, as their online sales have historically represented less than 10% of revenues. Liverpool and Grupo Famsa are vulnerable to Mexico's economic conditions, while Grupo Unicomer has presence in 27 countries in the LatAm and Caribbean region, which may provide relief, although most of these economies rely on remittances and tourism, a sector that is currently facing significant pressures. Their product portfolio mostly consists of discretionary goods such as home appliances, electronic devices, and furniture, though Liverpool has also a significant apparel portfolio. Additionally, these companies have important consumer finance operations, hence, a potential worsening of their credit portfolio would bring additional pressures. Our ratings on El Puerto de Liverpool remain capped by our sovereign rating on Mexico, while our 'CCC-' rating on Grupo Famsa reflects the company's high refinancing needs in the short term.

Restaurants such as International Meal Company Alimentacao S.A. (brAA/Stable/--) may use its delivery operations to partially offset the lower volumes in stores, but they will be severely affected if store closures last for an extended period, in which case we could lower the rating.

Retailers exposed to basic consumption, such as the supermarket chains Atacadao S.A. (brAAA/Stable/--) and Companhia Brasileira de Distribuicao in Brazil (brAA-/Stable/--) and Peruvian pharmacy retailer InRetail Pharma S.A. (BB/Stable/--), would be relatively less exposed than other retailers. This is because their products tend to be more resilient during economic downturns and their stores are likely to remain open despite generalized shutdowns. We believe the key aspect will be how these companies manage inventories and general working capital need through this crisis.

For Falabella (BBB+/Negative/--), despite its good diversity (department stores, home improvement, supermarkets, shopping malls and banking operations) and superior e-commerce capability, we see greater downgrade risks. The outlook on Falabella is already negative outlook, following very weak performance in 2019 and we believe the coronavirus will pose huge challenges for a recovery this year. While its supermarkets and online business might remain quite resilient, we believe shopping mall operations and department stores are likely to suffer the most amid coronavirus-related shutdowns.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Sarah E Wyeth, New York + 1 (212) 438 5658;
Secondary Contacts:Raam Ratnam, CFA, CPA, London (44) 20-7176-7462;
Ryohei Yoshida, Tokyo (81) 3-4550-8660;
Sam Playfair, Melbourne + 61 3 9631 2112;
Aniki Saha-Yannopoulos, CFA, PhD, Toronto (1) 416-507-2579;
Fabiana Gobbi, Sao Paulo + 55 11 3039 9733;

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