- Global consumer products companies invested heavily in digital capabilities and their supply chains ahead of the COVID-19 pandemic and should meet the acceleration of demand from the online and offline channels.
- Discretionary subsectors face material declines in sales and profits because of social distancing mandates and the recession. It will likely take credit metrics 2-3 years to recover to 2019 levels.
- The demand increase related to COVID-19 is a modest credit positive for staples. This subsector will use innovation and value propositions to retain some recent share gains.
- Since year-end 2019, we have downgraded approximately a quarter of the sector; 46% of the issuers either have negative outlooks or are on CreditWatch with negative implications.
- We continue to believe most rating actions will be at the low end of the rating spectrum given many of these issuers entered the pandemic with significant debt burdens, faltering operating performance, and have issued more debt to cover operating losses and/or shore up liquidity.
The COVID-19 pandemic forced consumer products companies to adapt to sudden changes in demand and periodic supply chain disruptions, but large branded staple companies were prepared and benefitted from the crisis. The industry has dealt with a faster-paced environment for at least the past decade because digital platforms and the availability of co-packers lowered barriers to entry. That enabled small to midsize, agile, and digital savvy competitors to take share. At the same time, consumer tastes and preferences changed more rapidly. Large branded goods companies responded by investing heavily into digital capacities and logistics to serve customers both online and offline, and to become more nimble. Moreover, they shifted their focus from cost cutting to top-line growth, and repositioned their portfolios for faster growth through investing more in innovation, renovating products, and acquisitions.
As such, the industry was more consumer centric and channel agnostic coming into the pandemic. Companies have met the accelerated demand growth because of COVID-19 thus far this year. We believe they will focus on building greater consistency in the online and offline channels such that consumers have a good experience wherever they shop. This includes pricing, selection, and ease of checkout.
Industry Changes During And After The Recovery
We believe the industry will focus on digital (e-commerce and marketing), support green efforts and employee health and safety, and increase the agility of their supply chains, including assuring more local supply in case of logistics disruption. Consumer products companies are adding manufacturing lines for categories with a sustained uptick in demand because of consumers' nesting-at-home behavior. In addition, some companies are shifting their portfolios to offset declines in demand in their core categories, but we expect this will have a meaningful impact in the near term. For example, Sysco Corp. is providing services to retail grocers, Coty Inc. and Natura Cosmeticos S.A. are producing hand sanitizer and more soap and hygiene-related products, and Hanesbrands Inc. is manufacturing masks, to mention a few.
We expect supply chains for grocers and consumer products companies will be back to pre-COVID-19 levels toward the back half of the year unless there is a second wave of the coronavirus. We believe manufacturing lines and plants could periodically close because of safety measures to contain outbreaks of COVID-19; however, we do not expect this to have a significant impact on sales and profits. We expect staples subsectors' organic sales to be up mid-single– to high-single–digit percentages and to generate relatively stable margins this year as higher costs related to COVID-19 (labor, transportation, cleaning, and protecting employee health) will be largely offset by efficiencies gained by stock-keeping unit (SKU) rationalization, sales leverage, and lower promotional activity. Next year, we expect organic sales of consumer staples to be down because companies will lap tough comparison and margins will be flat to down slightly because of sales deleveraging. For discretionary subsectors, we expect sales and margins to significantly decline in 2020 because their channels were highly disrupted as they were deemed nonessential and/or their products are highly discretionary. We expect sales and profits to improve in 2021 because of economic growth and greater social activity. 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.
Key industry trends we believe have emerged because of the pandemic and recession:
- The structural shift to in-home consumption will support growth for consumer staples over the near term, and the sector will use innovation and value propositions to retain some of the share it gained during the pandemic. During shelter-in-place mandates, consumers increased interest in cooking and they have gotten into the routine of cooking. We expect companies to introduce innovation this fall, increase product offerings, and offer good value proposition (price-value and/or convenience). We believe food companies such as Conagra Brands Inc., Campbell Soup Co., Hormel Foods Corp., Kraft Heinz Foods Co., McCormick & Co. Inc., and Post Holdings Inc. will benefit from this trend. In addition, protein companies have adapted products that used to be sold to the on-premise channel to the retail channel, adding packaged options--especially in Latin America. These companies' sales increased as they repositioned their portfolios.
- Unfavorable mix shift as consumers focus on value, which will likely slow the premiumization trend and result in private-label gaining share. We believe consumers will trade down to lower-priced items, shift to private label, make shopping lists, use coupons, and compare prices because of the recession and rising unemployment rates. These trends will be more prominent in emerging markets. Branded goods companies will respond by marketing their value offerings and slowing the introduction of premium products. In addition, retailers will try to protect margins and gain consumer loyalty by increasing private-label offerings. We expect this to keep a lid on pricing as branded goods companies, to maintain or increase share, will need to be price competitive with private label. The confluence will pressure margins.
- Barriers to entry have risen, and large brands and private label will take share from small and midsize challenger brands. Consumers have navigated back to large brands as they seek comfort and familiarity. Retailers are increasing shelf space for branded goods because of their scale, better distribution capabilities, and ability to flex manufacturing to meet shifts in demand. Brands also offer greater product segmentation and targeted offerings than private label and small- and mid-tier brands. We expect challenger brands to lose share to branded goods players and private label because it could be difficult for them to access funding in the current environment and their lack of scale and channel diversity.
- Increased investments in supply chains to become more agile. For the most part, consumer products' supply chain performed well. Still, there were periodic disruptions because manufacturing line(s) or plants shutting down because of the COVID-19 pandemic; government mandates restricting nonessential manufacturing and border crossings; and the interdependence of the supplier base as final production was disrupted because input were sourced in a region where manufacturing was disrupted by mandates related to COVID-19. As a result, companies are looking across their supply chains to make them more efficient and nimble. This includes diversifying sourcing and working with suppliers to reduce costs, shorten delivery time, and increase sustainable practices. They are also focusing on the last mile and meeting changing demand. This could result in localized manufacturing, distribution centers closer to consumers' homes because of the acceleration the online channel, and need to service their own direct-to-consumer offerings. In our view, the shift to a more local and sustainable supplier base will be gradual. It will likely be more pronounced in developed markets, which would enlarge the gap between emerging, less wealthy countries with increasing populations that favor cost-efficient solutions and mature economies where consumers are increasingly attentive to health and sustainability.
- Online will continue to be the fastest expanding channel. Sales have accelerated since the pandemic. U.S. e-commerce sales in April and May 2020 constituted 22% of all retail sales, compared with 11% in 2019, according to the U.S. Census Bureau. Moreover, purchases were across broad categories, and food with historically slow adoption rates enjoyed a big uptick. This trend has accelerated across the globe. In Great Britain, for instance, non-store retailing reached new highs since the start of the pandemic, 53.6% higher from February, according to the Office for National Statistics, June 2020 data. Although growth will decelerate as the retail environment opens up more and/or consumers feel more comfortable moving about, we believe it will remain above 2019 levels because new users have entered the channel out of necessity during shelter-in-place mandates and consumers like the convenience and safety of the channel. In addition, manufacturers are establishing or increasing direct-to-consumer offerings, and many retailers are reducing their brick–and-mortar footprints. Omnichannel offerings such as hyperlocal delivery and click-and-collect will also support growth of the online channel. Brands will also drive growth by personalizing marketing, capitalizing on emerging trends, and reformulating products and/or changing packaging to reduce the cost of delivery.
The Path Back To Normalcy
The damage to credit quality in the consumer discretionary subsectors has been significant. The recovery time will depend on the time it takes to contain COVID-19 and the health of the job market. However, the shape of the recovery will differ from previous crises, with a wide variety of outcomes, and also differ among subsectors. As regions move in and out of reopening phases, we examine what the recovery could look like.
While consumer staples benefitted from the crisis and will likely decline in organic sales next year as they lap strong comparisons, discretionary subsectors might benefit from pent-up demand and an increase in social activity, given they were hit hard by the pandemic and related fallout. We believe most discretionary subsectors can regain a meaningful portion of their previous business absent a prolonged recession; however, there's potential for longer-term structural changes in the food service sector if independent and small chains exit and new entrants do not emerge. Travel retail could also not regain its pre-COVID-19 demand given airlines' cutback in flights and businesses finding virtual meetings effective. This could have a lasting impact on issuer credit quality within these channels. As a result, for many discretionary subsectors, we believe it could take 2-3 years for credit metrics to return to 2019 levels (Tables 1 and 2).
Luxury. Personal luxury has been severely hit by COVID-19. We assume about a 15%-25% drop for global luxury industry value for 2020 and for it to modestly strengthen in 2021. We see the industry returning to the pre-COVID-19 level only toward the end of 2022. The sharp decrease in revenues and operating profits is due to the combination of various factors: lockdowns, the fall in travel spending due to the reduced mobility, and recessionary macroeconomic conditions. The last two factors are likely to affect 2021 as well. We expect soft luxury to recover more quickly than hard luxury (watches, jewelry), and note that China is already showing signs of rebound, which is a very good indication as Chinese customers represent about 40% of luxury buyers. Restrictions imposed because of COVID-19 favored a boost in digital sales that were relatively low in luxury, and we expect this to drive growth. We assume global luxury houses are likely to gain market share during the recovery phase.
Food service. We continue to believe it will take at least two years for food service issuers' credit metrics in the U.S. to approach pre-coronavirus levels. The recent large increase in COVID-19 cases does not change our view since we assumed consumers' willingness to dine away from home would remain depressed for multiple quarters. Our 25%-50% sales decline expectation for 2020 reflects deterioration above 50% in the second quarter, followed by better results in the second half, albeit uneven. We believe there was a snap back in June or early July partly because of restaurant restocking and outdoor dining, the latter of which will fade during colder months. We expect double-digit percentage declines in the second half as periodic food service rollbacks are instituted by local governments and many consumers remain hesitant to dine out. Distributors overindexed to quick service/drive through and takeout/delivery restaurants will outperform the industry; those overindexed to independents, bars, casual/fine dining, and taverns will underperform. It is likely a large number of independent restaurant operators will permanently close as they won't be able to recover from the slump in demand and lower capacity due to distancing guidelines. That will hurt industry profits since these customers tend to be more profitable to distributors. According to a June 25, 2020, report, "Yelp: Local Economic Impact Report", 53% of restaurant closures since March 1 are indicated as permanent. We assume sales partly recover in 2021 (though still 10%-20% below 2019), reflecting that a vaccine or effective treatment will be widely available, but possibly not until the second half.
Apparel manufacturers. The industry has been hit hard by the COVID-19 pandemic because of a drop in spending on discretionary products and massive store closures. On average, we estimate sector revenues will decline 15%-25% in 2020, reflecting very steep revenue drops in the second quarter and gradual recovery into the third and fourth quarters. Profitability will suffer even more, with EBITDA dropping on average 25%-40% because of sales deleverage, promotional environment, and need to clear excess inventory that will weigh on companies' gross margins. Recovery will vary, and most companies won't return to pre-COVID-19 credit metrics until 2022 or even 2023. We believe companies with products focused on children's wear, basic and replenishment, or athletic apparel will recover faster than companies that carry seasonal inventory or whose inventory carries a lot of fashion risk.
Durables. The sector is one of the hardest hit by the pandemic, with small appliances faring better than others given increased at-home food consumption. The remainder of the subsectors have experienced high risk. We estimate, on average, sector revenues will decline between 15% and 25% in 2020 from 2019, and EBITDA will fall faster, about 25%-40%, due to fixed overhead costs. We do not expect a recovery in operating performance until the back of 2021. As a result, we do not forecast a recovery to 2019 credit metrics until 2022 for the majority of companies, after they lap the poor results of 2020 and likely in the first half of 2021. We believe home décor will recover faster than larger average-ticket items such as high-end mattresses or large appliances. They are more affordable luxuries, and consumers are spending more on their homes as they shelter in place. For the mattress industry, we expect a recovery in the back half of 2020 as specialty retailers reopen and the industry catches up with pent-up demand. However, we do expect the shift to online to continue, with lower-priced mattress sales outpacing higher-priced items, driving down average selling prices. We believe this could drive the industry mix for some time, especially if a recession is prolonged and consumers trade down. Among office and office-related companies such as Steelcase Inc. and ACCO Brands Corp., we don't expect recovery until the back half of 2021 and into 2022 as many white-collar workers continue to work from home. If this trend continues, we expect long-term demand will shift, and they will have to modify their channel mix and products.
Beauty. Companies' sales will decline significantly and profit will erode in fiscal 2020. Lockdown measures, massive shutdowns of retail locations, and travel bans had an unprecedented impact on the sector's performance. On average, we forecast 15%-25% sales decline in fiscal 2020 and EBITDA falling about 25%-40%. Recovery will be slow and uneven. We forecast companies with product portfolios skewed toward color cosmetics, makeup, and fragrances will rebound slower as work-from-home movement and lower participation in social events reduce need for these product categories. Credit metrics for these companies will likely remain below 2019 levels until the end of 2022 and early 2023. Conversely, companies with a strong presence in skincare should recover faster given the products' replenishment nature. Credit measures should recover sooner, likely toward the end of 2021 and early 2022.
Beverages-alcoholic. The sector has been severely affected by the pandemic, particularly in March through May, when the on-premise channel was closed throughout much of Western Europe and the Northeastern U.S., while China slowly reopened without a meaningful rebound in sales. We expect a gradual opening of the on-premise channel in geographies hard hit by the pandemic, but consumption at bars and restaurants to return to pre-COVID-19 levels until sometime in 2021 at the earliest. We expect total sales declines in 2020 for the sector to range from 5%-10%, on average. Sales trends will depend on the companies' exposures to the on-premise channel, which varies by geography. Companies with more U.S. exposure, where on-premise sales are closer to 20% of industrywide sales, are better positioned. On-premise sales in geographies such as Western Europe, South America, and Asia can range anywhere from 30% to over 50%. Premium sales, which benefitted from spirits companies' top lines for several years running with strong growth in bourbon, tequila, and gin, so far have held up better than expected (especially in the U.S., where retail sales remain robust). But if unemployment remains high or government stimulus in hard-hit economies such as the U.S. falls off abruptly, premium sales may lose share to more value-based offerings. This could keep sales flat once economies fully reopen and hold any rebound in 2021 to historical growth rates.
Beverages-nonalcoholic. We expect only modestly negative sales (on average 0%-5%) and EBITDA (0%-10%) in 2020 and 2021 across the industry, with the vast majority of deterioration affecting issuers with sizable on premise and single-serve customer footprints. Coca-Cola Co. in particular generates close to 50% of sales from on-premise sales (syrups sold direct to away-from-home establishments) and will see at least temporary credit ratio deterioration over the next 12-24 months. Growth in its off-premise business is expected to only partly offset the on-premise deterioration. Industry peers, such as PepsiCo Inc. and Keurig Dr Pepper Inc. (KDP) will perform much better due to more off-premise business and greater product diversity (PepsiCo has a large snacks portfolio and KDP single-serve coffee). The sector is however reducing costs by cutting unnecessary advertising, eliminating most travel and other discretionary expenses, and in the case of Coca-Cola pruning its portfolio of small brands with weak growth prospects. Financial policy for this sector has generally been quite aggressive. Consequently, there is little room at current ratings for material unexpected shareholder enhancing transactions.
Tobacco. We expect relatively stable performance over the next two years. Distribution channels for this defensive sector remained overall open during lockdowns, and the global supply chain proved resilient. Moreover, people have more opportunities to consume tobacco while they are increasingly at home--away from formal work environments and venues where smoking is restricted. We do not expect significant EBITDA decline in 2020, but believe there may be some pressure in 2021 if there is trade-down to less expensive options because employment does not rebound or unemployment benefits are reduced. Thus far, we have seen no evidence that volume declines will accelerate above pre-coronavirus levels because of smokers' health concerns. We expect issuers that over index to developed economies will outperform those that over index to developing economies, though we believe the latter are beginning to rebound after harsh lockdowns in some countries. In general, global tobacco players are following a common approach, focusing on fewer SKUs and the most profitable markets. Furthermore, they are putting more emphasis on strengthening balance sheets and deleveraging. We believe growth in next-generation products into new geographies may be hindered over the near term since the adoption of some products such as heat-not-burn (HNB) benefit from face-to-face demonstrations, which is tougher to accomplish in the pandemic. Nevertheless, the U.S. Food and Drug Administration recently authorized the marketing of Philip Morris International Inc.'s IQOS tobacco heating system in the U.S. as a modified-risk tobacco product with a reduced exposure claim. This could bode well for sales of IQOS and other HNB products, albeit at least partially at the expense of combustible cigarettes.
Agribusiness. Our outlook for the rest of 2020 and into 2021 remains stable as demand from global food manufacturers benefits much of the sector. Commodity food processors and ingredient solutions providers stand to benefit the most from higher at-home food consumption. They have global supply chains to serve the packaged food industry and less direct exposure to areas affected more acutely in the first half by the pandemic, most notably meat packers and fluid milk processors that faced lost food service sales and plant closures because of infected workforces. Protein processors' (particularly in Latin America) sales rebound should continue into 2021 as global demand remains strong. The world is still rebuilding livestock supplies in the wake of the African Swine Fever epidemic that depleted much of China's pork supply. Still, margins will be lower year over year for many companies because of higher production costs and logistics bottlenecks. Certain sectors will continue to face profit pressure for the rest of the year. These include sugar refiners, because of excess global production; ethanol producers, given low oil prices and less driving during the pandemic; feed producers, because of weak farmer profits; and an uncertain rebound in Chinese crush margins as local feed demand remains pressured in some regions. Key risks to our outlook include geopolitical risk and a possible deterioration in the U.S.-China trade war, litigation risk in the U.S. protein sector, and workforce disruptions from renewed infections. We believe these risks are well mitigated given the political incentives to support farmers (particularly in a U.S. election year) and the high product and geographic diversification of most issuers, which should offset volatility from local market or supply chain disruptions.
Household products personal care. The sector has benefitted from COVID-19, putting health center stage for many consumers, and people have defined higher hygiene standards. Skin cleansers and at-home hair color products have gained space at the expense of beauty products while in-home care disinfectants and sanitizers boomed in the first part of the year from pantry loading. The boost in demand is confirmed by the strong first-half results reported by Reckitt Benckiser Group PLC and Unilever N.V. in these divisions. We assume sales related to stockpiling will be reabsorbed with the end of lockdowns and consumption expected to return to more normal. Still, we believe attention to hygiene will remain high until there is a COVID-19 vaccine. During the pandemic, customers have preferred familiar and trusted brands, and branded companies have also been fast in adapting SKUs and product formats to retailers' and consumers' needs. This preference might be reverted if a tough recession pushes people to choose convenience products in private label.
Packaged foods. The sector has benefitted from the pandemic with increased at-home food consumption, and we classify the sector as low risk. We estimate that for the sector, on average, revenues will increase in the mid- to high-single–digit percentages in 2020 and EBITDA to increase as well, albeit at a slower pace, given higher labor and supply chain costs related to the pandemic. We expect favorable trends to continue as long as more consumers stay home and the pandemic persists, shifting consumption to in-home. The majority of center-of-the-store or shelf stable categories have expanded. Baked goods and cereal are revitalized, reversing declines prior to the pandemic. Meals and meal-related categories are outpacing snacking as consumers allocate more dollars to meals. More discretionary categories dependent on impulse buying and foot traffic such as chocolate and nutrition bars (e.g., The Simply Good Foods Co.) experienced some pressure initially. But trends are improving as retailers and economies open up. Some drag for companies with meaningful food service exposure will partially offset the increase in the retail and consumer parts of their businesses. Packaged food issuers with the largest food service exposure, about 20%-25% of revenues, include Flowers Foods Inc., McCormick, and Post. General Mills Inc., The J.M. Smucker Co., Conagra, Kraft Heinz, and Campbell also participate in food service, which accounts for less than 10%-15% of their revenues.
Shifts In Ratings
While issuers shifted to more conservative financial policies and shored up liquidity, and consumer staples demonstrated resiliency, the material shutdown of the travel and food service channels and economic fallout from the pandemic dramatically affected consumer discretionary subsectors--especially issuers at the low end of the rating spectrum. In total, we have taken 184 negative rating actions related to COVID-19 and the economic recession (Table 3). The rating actions were mostly at the low end of the rating spectrum and issuers in discretionary categories because of liquidity issues and/or already stretched credit metrics further deteriorating because of the drop in demand (Charts 1 and 2).
The environment has been modestly credit positive for investment-grade food, household products, and beverage companies that do not have a large exposure to food service. However, we do not expect many positive rating actions as a good portion of these companies are acquisitive and may undertake bolt-on acquisitions in the low-interest-rate environment and lower valuations compared with 2017-2019.
|Number Of Downgrades Among Subsectors|
|Total issuers||Downgrades||Outlook revisions/CreditWatch placements|
|Household products and personal care**||51||16||12|
|*Includes food service and concession operators. **Includes cosmetics companies.|
|Source: S&P Global Ratings.|
Rating Actions To Come
The only shifts in rating categories are to 'CCC' from 'B', and it's been moderate. The remainder of the categories are relatively steady. We attribute this to the large amount of consumer stables within the sector. Rating stability is supported by the counter cyclical nature of their products and generally strong cash flows (Chart 1).
As of July 10, 2020, we rated approximately 12% of global consumer products issuers in the 'CCC' category, up from 7% at year-end 2019. By definition, they're more vulnerable over the next 6-12 months to conventional defaults or distressed transactions that we would view as tantamount to a default. Additionally, we rate approximately 12% of issuers 'B-', and they all have negative outlooks or are on CreditWatch with negative implications. While only 13, or 3.7%, of issuers have defaulted or are in default, we expect these numbers to rise as the year progresses. We expect the trailing-12-months speculative-grade corporate default rate to rise to 12.5% by March 2021 from 3.5% in March 2020 in the U.S. and to 8.5% from 2.4% in Europe. And a Latin America study indicates the region's default rate can reach 10% in the current market environment.
Given that a 'CCC' category rating implies at least a 1-in-2 chance of default, this would suggest a default rate close to the corporate average for consumer products issuers in developed regions over the next year. Most defaults will be U.S.-based as 16% of the issuers are in the 'CCC' category, and 10 have already occurred. In Europe, the Middle East, and Africa, 8% of the issuers are in the 'CCC' category with one default. While this is likely a high estimate because we believe some 'CCC' category issuers could strengthen operating performance when they begin to expand, we expect default rates to approach corporate averages given many entered the pandemic with significant debt burden and faltering operating performance. These estimates include selective defaults, which could consist of credit amendments to defer obligations such as principal payments, interest payments, or excess cash flow sweeps, without offsetting compensation to lenders. We continue to believe the majority of rating actions will be in discretionary subsectors and at the low end of the rating spectrum (Charts 3-5).
This report does not constitute a rating action.
|Primary Credit Analyst:||Diane M Shand, New York (1) 212-438-7860;|
|Secondary Contacts:||Raam Ratnam, CFA, CPA, London (44) 20-7176-7462;|
|Barbara Castellano, Milan (39) 02-72111-253;|
|Bea Y Chiem, San Francisco (1) 415-371-5070;|
|Chris Johnson, CFA, New York (1) 212-438-1433;|
|Gerald T Phelan, CFA, Chicago (1) 312-233-7031;|
|Mariola Borysiak, New York (1) 212-438-7839;|
|Flavia M Bedran, Sao Paulo + 55 11 3039 9758;|
|Flora Chang, Hong Kong + 852 2533 3545;|
|Aniki Saha-Yannopoulos, CFA, PhD, Toronto (1) 416-507-2579;|
|Research Contributor:||Sylvia Miller, New York;|
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