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Coronavirus Dramatically Increases Consumer Products Risk, But Staples Benefit

As the country copes with surging cases of COVID-19 and volatile capital markets, S&P Global Ratings believes U.S. consumer products companies in shelf stable foods, home cleaning products, and personal care are well-positioned to benefit with modest positive impact on credit quality. We attribute this to the initial spike in demand from pantry-loading and consumers replenishing at a rapid rate because of the shift to at-home consumption.

But there are heightened risks for sectors exposed to social activity and discretionary spending. For instance, we have taken rating actions on all issuers in the food service sector and many durable issuers. Over the next few weeks and months, our rating actions will likely reflect broad uncertainty around the severity of the economic and social impact from the coronavirus pandemic. The impact on our ratings will depend on the duration of shutdowns and trajectory of a rebound.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

We expect a U-shaped economic recovery, but the question is how long the bottom of the U will last. At a minimum, we suspect there will be significant disruption and sales deterioration for issuers not in consumer staples through the second quarter of 2020 because of increasing restrictions on person-to-person contact, economic contraction, and massive closure of retail stores (Tables 1 and 2).

Table 1

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Table 2

S&P Global Ratings Economic Overview: March 2020 (Baseline)
Key indicator 2019 2020f 2021f 2022f 2023f
Real GDP (year % change) 2.3 -1.3 3.2 2.5 2
Real GDP (Q4/Q4 % change) 2.3 -1.2 3.5 2.1 1.8
Real consumer spending (year % change) 2.6 -1.4 2.6 2.8 2.2
Core CPI (year % change) 2.2 0.9 1.9 2.8 2.3
Unemployment rate (%) 3.7 7.1 5.7 4.7 3.8
Housing starts (annual total in mil.) 1.3 1.3 1.3 1.3 1.3
U.S. Federal Reserve's Federal Funds policy target rate range (year-end %) 1.5-1.75 0-0.25 0-0.25 0.5-0.75 1.25-1.5
Notes: All percentages are annual average percentage changes, except for real GDP Q4/Q4.
Core CPI--Consumer Price Index excluding energy and food components. Forecasts were generated before the third estimate of Q4 2019 GDP was published by the U.S. Bureau of Economic Analysis. F--Forecast.
Sources: Oxford Economics, S&P Global Economics forecasts.

Liquidity Concerns Are Front Of Mind

The turmoil in the financial markets echoes the 2008 global financial crisis and brings to mind the high-yield market shutdown in late 2018. Consistent with our approach in corporate ratings, we are closely monitoring liquidity access across the consumer products universe, especially issuers that rely on commercial paper and with maturities in the next 1-2 years. Similarly, companies with limited cash balances, low availability under revolving credit facilities, or restrictive financial covenants could face urgent near-term issues.

Therefore, we will monitor their progress on reducing potential cash burn and those that need to approach lenders for additional liquidity, waivers, and amendments associated with potential covenant issues. We believe most refinancing concerns reside with issuers we already rate in the low-'B' or 'CCC' categories. Given the downturn of the economy, we believe defaults will surge. S&P Global Ratings expects the U.S. speculative-grade corporate default rate to rise to 10% over the next 12 months from 3.1% in December 2019.

Consumer Products Companies Have Fewer Cost Reduction Levers To Pull Than In The Great Recession

Cost-cutting was a primary response in the last economic downturn. This time around, product and channel mix management will play larger roles since companies diversified their product and customer bases. During and after the Great Recession, consumer products companies undertook major restructuring programs. The benefits peaked in 2016. We do not expect companies to repeat this given their leaner cost structures. We expect significant, near-term margin pressure for many issuers we rate given the unanticipated steep drop in product demand for companies not in consumer staple categories. We think the impact will lessen throughout the year as companies cut back on advertising and promotions, reduce labor, and take out nonessential costs.

The sector is also lapping cost pressures and getting some benefit from lower commodity costs. Oil, pulp, resins, cocoa, sugar, and dairy prices are all lower. Nevertheless, low input costs may not have much impact on large sales declines. Moreover, many companies are lapping price increases. Prices could roll back if retailers increase shelf space for private-label products, which are gaining share. As commodity costs drop, the price gaps with branded-goods companies could widen. This could lead to further penetration if branded-goods makers don't narrow the gap.

Our Base-Case Assumptions Are Fluid. We Expect A Divergence In Performance With Several Sectors Hit Hard, But A Handful With Relative Strength

Subsectors hardest hit by retail and restaurant store closures and economic fallout

Consumer durables.   These companies will be materially affected by the economic impact of the coronavirus and social distancing. They are highly cyclical, and their fates are directly tied to key macroeconomic indicators. Products that require installation face the hurdle of social distancing, as consumers are reluctant to have delivery people and installers in their homes during the pandemic. Given our forecast for a recession and high unemployment in developed markets and many emerging markets, we forecast organic sales will decline around 25% this year and rise in the mid-single–digit percentages in 2021 because of a better economic outlook. We revised the outlook on Whirlpool Corp. to negative from stable and on Tempur Sealy International Inc. to stable from positive, and took negative actions on a number of highly speculative-grade durable companies on our belief that a recession will curtail demand (Table 3).

Food service.  Issuers with links to the restaurant and live entertainment sectors are vulnerable. Food service companies' sales and profits will plummet because of event cancellations and closures of restaurants, schools, and other institutions. Issuers with many independent restaurant customers may not rebound quickly, as it will be difficult for under-capitalized restaurants to weather the current environment. New entrants may be wary if demand does not fully return or obtaining financing is difficult and/or costly. This subsector is also vulnerable to economic downturns given the discretionary nature of on-premise consumption. We believe organic sales could decline more than 25% this year and not fully return to 2019 levels until 2021.

Alcoholic beverages.  These companies will also be impaired by the closure of bars and restaurants, but we do not believe the impact will be as severe as in food service. Outside of mainstream beer, the sector has had good growth because of the benefits from the move to premium products. We believe the sector's organic growth will decline in the mid-single–digit percentages this year as increases in at-home consumption will not offset the sales decline in the on-premise channel. In addition, we believe there will be a negative mix shift because of our expectation that developed markets will be in a recession in the first half of 2020. We revised the outlooks on Molson Coors Beverage Co. and Constellation Brands Inc. These companies have little cushion in their credit metrics to face prolonged sales and EBITDA declines.

Apparel manufacturers.  These companies will likely be hard hit by the massive store closures mandated by governments to reduce face-to-face contact. We believe sales will materially decline despite the category's well-developed position in the e-commerce channel given the large amount of store closures and economic fallout. Some wholesale customers have already announced they are no longer taking orders through mid-June. We believe reduced demand will continue at least through the end of the summer and that there will be material markdowns to move inventory, especially fashionable or seasonal merchandise. We expect large multinational issuers will withstand this, assuming retail stores re-open in the U.S. and Europe by late summer. There is cushion in their credit metrics relative to the ratings, and they are taking measures to protect liquidity and profitability. Speculative-grade issuers will likely feel the brunt of the dislocation. We expect organic sales to decline more than 20% this year and only rise in the high-single–digit percentages next year. The majority of these companies were highly leveraged before the coronavirus outbreak. Thus far we have taken six negative rating actions in apparel manufacturing.

Cosmetics.  Similarly, these companies are being hit by massive retail store closings in developed markets. In addition, the travel retail channel has essentially halted. However, we do not expect sales to decline as much as in apparel because of the replenishment nature of skin care products. In addition, the sector generally has good performance in a recession because consumers continue to spend on small indulgences. We forecast organic sales will fall more than low-double–digit percentages in 2020 and increase in the mid-single-digits in 2021. Companies heavily skewed toward color cosmetics and makeup will feel a more severe impact. We already downgraded Coty Inc. and Revlon Inc. and revised the outlook on The Estee Lauder Cos. Inc. to negative related to the impact of store closures. We believe there could be more rating actions, especially for highly speculative-grade issuers.

Subsectors benefitting in the near term

Packaged foods.  These purchases have surged because of the uncertainty of the spread of the coronavirus. Consumers are replenishing food they have eaten rather than pantry-loading as eating patterns shift to at-home consumption. We expect the vast majority of packaged-goods companies to generate stronger organic sales in the first half, especially those with portfolios skewed to shelf-stable food. Typically, subsector sales growth is in the low-single-digit percentage area. Our baseline forecast now expects high-single-digit percentage rate expansion in the first half, tapering off in the second half. For the full year, we expect sales to be up in the mid-single-digit percentages. We forecast an organic sales decline slightly in 2021 given the strong growth in 2020. Although categories such as cereal, soup, and canned fruit and vegetables benefit from increased trial of their products and returning consumers, we believe sales trends will normalize when the potential of quarantines subsides and/or economic conditions strengthen.

We believe Campbell Soup Co., The J.M. Smucker Co., Conagra Brands Inc., General Mills Inc., Kellogg Co., Mondelez International Inc., Flowers Foods Inc., Post Holdings Inc., and Kraft Heinz Foods Co. will generate the strongest growth given their product portfolios and U.S. footprint. We believe TreeHouse Foods Inc. and B&G Foods Inc. will also generate good growth. However, we do not expect this to result in positive rating actions unless the issuers demonstrate a longer-term uptick in organic sales growth. Companies with meaningful food service exposures will experience some drag that will partially offset consumer side benefit. Specifically, McCormick & Co. Inc. has about 20% of its revenues exposed to restaurants and food service in its flavors segment. General Mills and Smucker have less exposure.

Protein.  The subsector should also benefit from increased demand to a lesser degree than packaged foods because of lost food service sales. The consumer rush to stock the pantry and strong replenishment demand also apply to the freezer, with frozen protein meals and to-be-frozen fresh protein offerings. The more commodity nature of many protein products usually means higher volumes don't always correlate with higher profit because supply gluts and promotional pricing from competing proteins can squeeze margins despite healthy demand. But outside of food service, a rising tide of demand should lift pricing and margins for all protein players. The key will be the degree to which companies can offset a lost food service sales dollar with a retail one. Although the shift means lost scale and downtime to reconfigure packaging and production lines, we believe industry leaders such as Tyson Foods Inc., JBS S.A., and even those with more concentrated portfolios such as Smithfield Foods Inc. and Pilgrim's Pride Corp. will adapt and ramp up additional production for their retail businesses, albeit at modestly lower growth rates than packaged foods. Our base-case forecast calls for the subsector to expand in the mid-single-digit percentages in 2020 and 2021.

Nonalcoholic beverages.  Outside the on-premise channel, they won't necessarily take a large volume hit. But product mix management will be key to offsetting lost volumes to higher-margin sales channels. This subsector in recent years expanded faster than packaged foods because players moved gradually from traditional offerings such as carbonated soft drinks toward energy drinks, teas, single-serve coffees, and flavored waters. Consumption of nonalcoholic beverages in aggregate is not likely to decline as people working at home continue to drink beverages. We expect the category to expand at low-single-digit percentages this year as its higher-margin fountain sales dry up and highly profitable single-serve offerings in important channels like convenience stores, local restaurants, and delis take a hit. Still, certain portfolios or larger players are better positioned to offset lost demand in higher-margin channels and a negative mix shift to bulk sales.

We expect PepsiCo Inc. to offset declines in its on-premise business with increased demand for its snacking products. Keurig Dr Pepper Inc. should offset its on-premise and food service business with increased sales of single-serve coffee and coffee brewers. The Coca-Cola Co. is the most exposed to the on-premise channel (40% of its sales), and we believe its organic sales will be materially impacted. We believe it will preserve credit metrics with reducing shareholder rewards and cost saving measures.However, its leverage was already elevated because of its acquisition of Acosta. We revised our ratings outlook to negative from stable because the negative impact of the coronavirus on the global economy and consumer behavior could prevent it from reducing leverage to below 3x by year-end 2021.

Household products.  We expect slightly better organic sales growth trends compared with packaged food and nonalcoholic beverage. Category demand materially increased as consumers focus on health and hygiene. It historically expands faster than packaged goods because of the replenishment nature of the products. We believe there will be some lasting increase in demand for cleaning products because of greater health concerns from the coronavirus. We expect sales to increase in the mid-single-digit percentages this year compared to historical growth of 3%-4%. We forecast that organic sales decline slightly in 2021 given strong growth in 2020.

Conclusion: Credit Risk Has Materially Increased

Before the coronavirus outbreak, we had a negative bias on the sector credit quality because of increased competition in an already highly competitive industry, need to reposition product portfolios because of changing consumer tastes and preferences, and dependence on developed markets. Most of the pressure was at the low end of the rating scale, reflecting these companies' refinancing risks, constrained liquidity, unsustainable capital structures, and limited cushion for operating performance mishaps.

The pandemic puts significantly more pressure on most subsectors. We continue to believe most rating actions will be at the low end of the rating spectrum and that the sector's default rate will be in line with S&P Global Ratings' 10% expectation for nonfinancials. See Chart 1 for the increase in ratings at the low end of the 'B' category and in the 'CCC' category, and Chart 2 for the significant increase in negative outlooks. See Table 3 for rating actions thus far related to the outbreak of the coronavirus.

We expect investment-grade ratings to be relatively stable. We believe these firms will materially cut back on shareholder rewards to preserve credit metrics. In addition, demand is meaningfully increasing for many in the 'BBB' categories that leveraged up in recent years for transformational acquisitions. We continue to believe the vast majority of issuers will meet our leverage targets as they prioritize debt repayment. Moreover, the current environment could modestly accelerate deleveraging.

Chart 1

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Chart 2

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Table 3

Rating Changes And Outlook Revisions Related To The COVID-19 Pandemic And Economic Downturn
Rating Outlook Prior Rating Prior Outlook Date
Durables

Samsonite International S.A.

BB+ CW Negative BB+ Negative 3/3/2020

Whirlpool Corp.

BBB Negative BBB Stable 3/18/2020

Libbey Inc.

CCC Negative B- Negative 3/19/2020

ACCO Brands Corp.

BB Negative BB Negative 3/19/2020

Latham Pool Products Inc.

B Negative B Stable 3/19/2020

Lifetime Brands Inc.

B Negative B Stable 3/19/2020

Steinway Musical Instruments Inc.

B Stable B Positive 3/19/2020

Tempur Sealy International Inc.

BB- Stable BB- Positive 3/19/2020

TGP Holdings III LLC

B- Negative B- Stable 3/19/2020

Brown Jordan International Inc.

CCC+ Negative B Negative 3/27/2020

Samsonite International S.A.

BB- Negative BB+ CW Negative 3/27/2020

KC Culinarte Holdings L.P.

CCC+ Negative B- Negative 4/1/2020

Newell Brands Inc.

BB+ Negative BB+ Stable 4/3/2020
Food service

Aramark

BB CW Negative BB+ Negative 3/24/2020

Sysco Corp.

BBB- CW Negative BBB+ Stable 3/18/2020

Edward Don & Co. Holdings LLC

B- CW Negative B Stable 3/19/2020

Chefs' Warehouse Inc.

B- CW Negative B+ Stable 3/20/2020

Performance Food Group Inc.

B+ CW Negative BB- Stable 3/20/2020

US Foods Inc.

BB CW Negative BB+ CW Negative 3/24/2020
Household products and personal care

Coty Inc.

B CW Negative B+ Stable 3/24/2020

Parfums Holding Co. Inc.

B Negative B Stable 3/19/2020

Revlon Inc.

CCC- Negative CCC+ CW Negative 3/25/2020

Spectrum Brands Holdings Inc.

B Negative B+ Negative 3/26/2020

Estee Lauder Cos. Inc.

A+ Negative A+ Stable 3/31/2020
Beverages

Blue Ribbon Intermediate Holdings LLC

CCC Negative B- Negative 3/18/2020

Winebow Group LLC

CCC Negative CCC+ Negative 3/25/2020

Molson Coors Beverage Co.

BBB- Negative BBB- Stable 3/27/2020

Constellation Brands Inc.

BBB Negative BBB Stable 3/30/2020

Coca-Cola Co.

A+ Negative A+ Stable 4/6/2020
Apparel

YS Garments LLC

B- Negative B Stable 3/20/2020

Oak Holdings LLC

B Negative B Stable 3/19/2020

Kontoor Brands Inc.

B+ Negative BB- Stable 4/1/2020

Under Armour Inc.

BB Negative BB Stable 4/1/2020

Carter's Inc.

BB+ Negative BB+ Stable 4/2/2020

G-III Apparel Group Ltd.

BB CW Negative BB Stable 4/2/2020

Ralph Lauren Corp.

A- CW Negative A- Stable 4/6/2020
Consumer services

TruGreen L.P.

B Negative B Stable 3/20/2020

H&R Block Inc.

BBB Negative BBB Stable 3/31/2020
Agribusiness and commodity foods

Sierra Enterprises LLC

B- CW Negative B Negative 3/31/2020
Source: S&P Global Ratings.

This report does not constitute a rating action.

Primary Credit Analyst:Diane M Shand, New York (1) 212-438-7860;
diane.shand@spglobal.com
Secondary Contacts:Mariola Borysiak, New York (1) 212-438-7839;
mariola.borysiak@spglobal.com
Bea Y Chiem, San Francisco (1) 415-371-5070;
bea.chiem@spglobal.com
Chris Johnson, CFA, New York (1) 212-438-1433;
chris.johnson@spglobal.com
Gerald T Phelan, CFA, Chicago (1) 312-233-7031;
gerald.phelan@spglobal.com

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