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COVID-19 Will Shape The Future Of Consumer Goods

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A large chunk of consumption has shifted from outside to inside the home under coronavirus lockdowns and social distancing. Here, S&P Global Ratings examines these trends and what they mean for the consumer goods sector, highlighting several new facets that are likely to shape credit quality. For starters, packaged foods and home care businesses should continue to see healthy demand. On the flip side, demand for personal luxury goods and parts of the beauty segment are not expected to pick up significantly. We believe the pandemic will accelerate the shift to e-commerce, but a step change will mean greater collaboration in the areas of branding and distribution between consumer product companies and retailers. Global supply chains have proven to be complex and fragile, which should prompt strategic but only gradual changes. These could add to input costs and exacerbate global trade tensions. As economies recover, we believe that big brands will likely get bigger, thanks to their resilience and consumer appetite for familiar, better-known brands. Furthermore, companies with global brands and diversified product ranges catering to different price points are likely to gain market share in a more volatile environment.

Staples To Grow At Robust Pace, While Luxury Goods And Prestige Beauty Will Struggle

The lockdowns have pushed certain consumer product segments to the fore, especially those seen as essential, such as the packaged foods and home care segments. While the stockpiling and stocking up seen during the initial days of the lockdown have subsided, these segments will continue to benefit from the general shift to in-home consumption. Before the pandemic, staples had suffered from low growth and some global brands were battling to stay relevant in the eyes of consumers. At the same time, luxury goods and prestige beauty grew rapidly, fueled by an upswing in global travel and demand from Chinese consumers, both at home and abroad. COVID-19 has led to sharp turn of fortunes across the different segments of the consumer goods sector.

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Despite the gradual reopening of economies around the world, it is clear that social distancing will continue in some shape or form across many areas of human activity. Places of work and leisure including offices, shops, restaurants, bars, and cafes--when they open--will have to comply with a plethora of strict regulations including some level of social distancing. This, coupled with reduced leisure and business travel and increased working from home, will hinder any rebound in consumption outside the home to pre-pandemic levels, for at least the next year. We foresee that consumer product companies will focus more on products that are consumed at home. Those companies that can make this shift should be able to offset the decline in demand in consumption outside the home.

Notwithstanding the beneficial effect for some companies in the packaged foods and home care segment, increased operating costs associated with wages, distribution, cleaning, and sanitization procedures will limit the positive effect of the topline growth on margins. While we expect higher wages to be phased out in the second half of this year given the recession, we believe the costs associated with greater levels of hygiene and sanitation and protecting employees and customers are here to stay for the foreseeable future.

In our view, the shift in consumer preferences will become more noticeable over the next few quarters. The increasing demand for safe and healthy products is particularly pronounced in the packaged food and beverage segments. The pandemic has also put health and wellness center stage for many consumers. People believe that healthy habits are now even more important, and since more meals are prepared at home, there is a greater focus on food constituents and healthy ingredients. We note that organic, vegan, and "free of" products are priced at the premium end and are not yet an affordable option for most consumers.

Strong Value Proposition And Multichannel Distribution Will Help Mitigate Falling Incomes And Restricted Travel

The economic downturn will erode personal disposable incomes and further accelerate the tendency for customers to seek value and gravitate toward discounters, as in the previous recession. This trend will become even more pronounced over the next quarters when government furlough and income support schemes adopted in many countries are slowly withdrawn. A strong value-for-money proposition will become strategic to maintain or even enlarge the customer base for consumer product companies. We note that for branded consumer goods, this will mean a rethink of the appeal of some products so they can offer the benefit of brands at the best possible price.

A notable exception will be Chinese customers whose incomes and standard of living will progressively rise. In our view, this should continue to be the underlying driver for the healthy prospects of some discretionary and luxury segments, which will continue to grow, albeit more slowly.

Consumer goods companies with retail operations will become more selective in the nature and number of store sites and push for more flexible lease contracts. We will also see greater prevalence of supply arrangements based on revenue sharing as retailers, restaurants, and other distributors try to balance their cost structures and share some of the risks with their consumer goods manufacturers or suppliers.

Consumer products relying on travel retail such as luxury goods, premium alcoholic beverages, cosmetics, and beauty products will have to redouble their e-commerce efforts, as well as focus on national flagship stores and partnerships, because global travel is set to be subdued for the foreseeable future. We also see the risk that both leisure and business travel might not rebound after the pandemic, with airlines having reduced their capacity. We think global air passenger traffic could drop 50% in 2020 and 55% in Europe, which is approximately in line with the most recent forecasts by the International Air Transport Association. For 2021, we believe passenger volumes could remain as much as 30% below 2019 levels, both globally and in Europe, and we don't expect air traffic to rebound to pre-pandemic levels before 2023. The risk of renewed outbreaks over the next 12-18 months is real and will likely make consumers wary.

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

Consumer Goods Companies Will Aim For Greater Control And Visibility Over Supply Chains

The pandemic has brought home a stark realization that supply chains for both food and nonfood products have become overly complex and interdependent. This makes them fragile, with a risk of disruption arising from events like the pandemic, and vulnerable to trade conflicts.

With the huge surge in demand, the priority for consumer goods companies in the packaged food and household products sectors has been to ensure a reliable supply of essentials on retailers' shelves. In the months to come, many will look to trim down their product ranges and focus on fewer stock-keeping units (SKUs). To cater to consumer demand and to improve the availability of staples and essential products, we will see larger pack sizes for many product categories in these areas.

In many developed economies, we also expect a greater emphasis on more local, socially responsible, and sustainable sourcing and packaging, which also plays to greater customer expectations for fresh, organic, and healthier food products. This is compounded by concerns for safety in the food supply chain, following high numbers of COVID-19 cases in food-processing factories in the U.S. and Europe.

In our view, the shift to a more local and sustainable base of suppliers is a gradual trend that will continue. There is increasing attention on food sustainability both from consumers and companies. However, since we believe this shift will come at a cost, we assume that it's likely to be more pronounced in developed markets. This will enlarge the gap between emerging, less wealthy countries with growing populations that favor cost-efficient solutions and mature economies where consumers are increasingly attentive to health and sustainability issues.

Private Labels Will Gain Ground Against More Weakly Positioned Brands

Branded consumer goods companies will have to fight harder against private-label products for shelf space, as retailers will look to protect volumes and margins in the face of weaker consumer spending. Western Europe leads in private label packaged foods but other regions, especially emerging markets, are catching up quickly.

Both developed and emerging markets will see growth in private label products, with differences attributable to the maturity of the modern retail sector. In developed markets, we see significant investment in private label from retailers, who are also aiming to secure greater brand loyalty through premiumization of their private label products. Many retailers are also seeking to consolidate and bring their supply chain closer to their main operations with a view to limiting reliance on imports. Specialty retailers with niche private label brands, targeting specific customer segments, are also another source of competition for larger and more diversified consumer product companies. However, we think this will also come at the expense of small and midsize players, given that scale is an important factor in meeting current demand.

In emerging markets, price-oriented private-label offerings could see greater demand momentum, as consumers trade down amid the recession. In response, branded consumer products will continue to transform their portfolio to position products at the premium and discount end of the price spectrum. However, segments such as beauty and personal care will be able to sustain more products with premium price positioning.

E-Commerce Moves From "Nice To Have" To "Must Have" As Brands Battle Consumer Attrition

The pandemic will also lead to an enduring change in shopping habits. Even before this, consumers expected to be able to shop in-store, online, and on mobile devices, accompanied by a range of home delivery, click, and collect options. Brands that failed to retain visibility and availability during the lockdowns will become the casualties of a slow post-COVID-19 recovery as consumers readjust their habits and spending priorities.

It is no longer enough for consumer goods companies to rely on retailers to develop their online business and distribution channels. For branded consumer goods companies in particular, e-commerce capability has become an essential medium to influence and engage with customers and share product knowhow and differentiation with customers. Consumer goods companies' capability to operate across different platforms will become a more critical element of their competitive advantage. For higher-end beauty, furnishings, and apparel brands, stronger e-commerce will also include more advanced inventory control, a more refined virtual customer service and online shopping experience, and tiered delivery options.

Even food retail continues to see a sharp growth in e-commerce, with several offshoots of click and collect (such as the drive format in Europe). Home consumption will remain strong, so we expect packaged food and home care product companies to benefit from larger order sizes, as the operational efficiency of distribution networks improves faster. Even though nonstore retailing still represents only less than 4% of all sales of packaged food globally, it has grown at a 16% compound annual growth rate over 2014 to 2019. In Asia-Pacific, which leads in e-commerce, nonstore sales of packaged food constituted 6% (Euromonitor data).

Retailers are focused on reducing the cost of the last mile for deliveries to customer homes, and consumer goods companies are investing substantial resources to integrate their supply chains, warehousing, distribution, and stores into a cohesive unit to offer a seamless omnichannel experience. Innovation in product design and packaging to facilitate ease of storage and distribution will go a long way to help accelerate e-commerce. While there is potential for more growth, in our view, consumer product companies will have to work more closely with and perhaps partner with retailers to enable further growth in this segment. It is already not unusual for many large consumer products companies to have their employees working in close collaboration with large retailers.

Selective Investment Into Inventories And Terms Will Increase Working Capital Needs

Historically, many companies in the sector have paid greater attention to increases in volumes, especially in emerging markets, as greater global scale and topline growth was seen as a route to higher profitability. However, in the fallout from this pandemic, many companies will reevaluate their working-capital management and ensure that stock levels, orders, and payment terms are optimized for emerging consumer demand patterns. Following widespread bottlenecks to retail activity and footfall, brands will have to offer selective support to wholesalers and distributors to maintain the right product mix and uninterrupted supply to consumers.

It's critical that companies be able to collect receivables from retailers in time. It is inevitable that consumer product companies will see at least some part of their customer base, especially smaller retailers and family businesses in emerging markets, struggle from the effects of the lockdowns and economic recession. These companies will have to balance the near-term risks of bad debts and weaker receivable quality with the need to preserve their retail distribution networks over the longer term. They will have to evaluate the cost versus the benefit of extended credit terms and inventory cycles as a number of retailers and restaurants are likely to suffer financial distress and struggle to make timely payments to their suppliers.

The challenges of receivables management and timely cash collection will be even more acute in the nonfood discretionary segments, across both emerging and developed markets. Many smaller retailers have suffered or gone out of business because of store closures and suppressed demand. In the near term, retailers are focusing on cash preservation by liquidating their inventories, through e-commerce and promotions in store. We expect stock levels in seasonal categories such as apparel to take several quarters to wind down, resulting in increased levels of markdowns, pack-and-hold storage, and write-offs. Some nonfood retailers with weaker credit quality will struggle to emerge from the lockdowns with a sustainable business model.

Brands Are Getting Ready To Inject Capital To Reclaim Market Share And Profit

In the near term, many companies have rightly focused on liquidity to weather the pandemic. When the lockdowns and restrictions ease, many businesses will have to make significant changes to their operating models, as well as capital structures and financial policies.

Aside from ongoing business transformation programs, many companies have issued debt to shore up liquidity during the shutdowns. These debt issuances have taken the form of bonds or in a few cases government-backed commercial paper programs (primarily by investment-grade issuers), additional bank debt in the form of loans, drawings under the revolving credit facilities, or other loan guarantee schemes or forms of government funding. For many, aside from improving liquidity coverage, the additional financing will mean higher leverage and the need to take tough financial policy decisions in form of discontinuing share buybacks and even suspending dividends.

Investment-grade consumer product companies, many of which are geographically diversified and have solid brands and pricing power, will remain largely resilient. Those companies catering to essentials or staples may even emerge stronger from this crisis following defensive actions to reduce costs and investments. Other players, especially smaller companies specializing in discretionary products or those with limited financial flexibility, will see their credit quality weaken further. The decline in topline revenue will exacerbate weaker margins and cash flow for many of these companies, diminishing the already-low headroom in their credit ratings.

Since more than 40% of rated consumer product companies globally have ratings of 'B' or below and nearly half of all ratings in the sector have a negative bias (have a negative outlook or are on CreditWatch with negative implications), the pandemic increases their vulnerability to further downside risks. Because it is difficult for them to fill the void in topline revenue, the success of cost management and cash preservation initiatives, which almost all the companies are pursuing, will be key to maintaining credit quality.

Related Research

This report does not constitute a rating action.

Primary Credit Analysts:Raam Ratnam, CFA, CPA, London (44) 20-7176-7462;
raam.ratnam@spglobal.com
Barbara Castellano, Milan (39) 02-72111-253;
barbara.castellano@spglobal.com
Rocco A Semerano, London +44 20 7176 3650;
rocco.semerano@spglobal.com
Secondary Credit Analysts:Anna Overton, London (44) 20-7176-3642;
anna.overton@spglobal.com
Nicolas Baudouin, Paris (33) 1-4420-6672;
nicolas.baudouin@spglobal.com
Maxime Puget, Paris (33) 1-4075-2577;
maxime.puget@spglobal.com
Remi Bringuier, Paris + 33 14 420 6796;
remi.bringuier@spglobal.com

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