U.S. commercial printers continue to suffer from the secular decline of the industry. Despite its still sizable total annual revenue of roughly $77 billion (see IBISWorld industry report "Printing in the U.S.," August 2019), the printing industry has had consistent revenue declines because of consumers shifting to digital formats from print. We lowered our ratings throughout 2019 on several commercial printers in the face of declining volumes, pricing competition, rising costs, and substantial debt burdens. We believe these challenges will continue, and in some select cases even accelerate, as printers compete for client spending, manage their own legacy cost structures, and address upcoming debt maturities. As a result of these trends, our ratings outlook for most companies in the print sector is negative.

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In this report, S&P Global Ratings answers frequently asked questions about our ratings in this sector.

Frequently Asked Questions

Which print products are most exposed to revenue declines and vulnerable profits?

Printers produce a wide range of products for their commercial clients such as magazines, catalogs, books, retail inserts, business statements, checks, direct mail, and business cards. Each of these products is sensitive to its unique use case and business dynamics. For example, a magazine printer is most concerned with advertising spending, which drives total page count and circulation of any particular magazine, whereas a company that prints forms and statements for the U.S. government is more concerned with long lead time, contracted volume, and pricing. Across the industry, the products most sensitive to revenue declines are those that depend on advertising or seasonal business spending. Specifically, we expect the steady shift in client advertising spending to digital from print formats to mostly affect long-run (i.e., large volume) advertising-dependent products like magazines and catalogs. As advertisers move their budgets to digital formats, magazine page counts shrink and circulation suffers. As a result, long-run printers such as Quad/Graphics Inc. and LSC Communications Inc. are at risk of lower profitability levels if they cannot offset the volume losses with cost reductions. To offset these declines and diversify their core offerings, companies are expanding their product lines to include marketing services, logistic services, and consulting solutions.

In what areas do printers face the most competition?

Printing, especially long-run commercial printing, has historically been a highly competitive industry because printers need to feed sufficient volume through their production systems to offset their substantial fixed-cost base. As a result, we expect traditional commercial printers to continue to compete aggressively against one another. In addition, secular declines have caused some commercial printers to focus on niche higher-margin products such as in-store marketing and point-of-sale signage traditionally served by specialty printers. Consequently, smaller specialty printers such as The Imagine Group LLC suffered from client losses in 2019 because of increased competition. Indeed, competition has also heated up in the customized print markets for web-to-print players such as Cimpress and Digital Room, which has caused modest price and margin pressures. Nevertheless, web-to-print companies remain somewhat protected from the significant secular and competitive challenges faced by traditional commercial printers thanks to their web-based sales platforms, ability to sell mass-customized products, and large client base, which is focused in micro to midsized businesses.

What is the outlook for industry consolidation and printer credit implications?

We believe some degree of consolidation or capacity reduction in the print industry will continue and, in fact, is inevitable as overall industry volumes decline. In our view, consolidation is a natural step in managing the overcapacity in the industry, which includes not only excess machinery but also factory locations relative to a declining demand curve. However, a number of obstacles may impede an orderly consolidation through mergers and acquisitions (M&A). First, regulators may inhibit meaningful and profitable consolidation over concerns that the few remaining print providers of scale will create a monopoly. This was exemplified by the U.S. Department of Justice's lawsuit to block the proposed merger of Quad/Graphics Inc. and LSC Communications Inc. in 2019. The suit claimed that a consolidation between Quad and LSC would reduce price competition for certain products. Second, we believe that meaningful consolidation remains costly for this industry not only because of its fixed-cost base but also its history of pension obligations. For example, in most mergers in this space, companies must restructure excess capacity of both machines and real estate, often with substantial cash outlays, which could dissuade potential acquiring companies. Further, many commercial printers of scale are legacy businesses and retain pension obligations, which may be unattractive for any potential buyer.

As a result of these regulatory and economic considerations, we believe significant M&A consolidation of the industry is unlikely, although one-off plant closures and smaller asset sales will continue. Specifically, we expect the large printers that we rate, including R.R. Donnelley and Quad/Graphics, to primarily be sellers of traditional, lower-margin commercial print assets but buyers of marketing and solution service assets as they seek to manage their debt burdens while growing their product lines. However, the valuation multiples for most traditional print assets are fairly low, so the net result from any potential commercial printing asset sales will likely only modestly lower leverage.

What is S&P Global Ratings' outlook for printers' ability to manage costs and cash flow?

Cost management in the face of organic volume declines is of paramount importance to the U.S. commercial printers we rate. A printer's ability to manage cost and sustain meaningful EBITDA generation in the face of falling revenue is a key factor in managing leverage. The cost base of most commercial printers relies on fixed costs such as machinery and factory locations, and variable costs such as paper, ink, and labor. We believe printers are better able to manage variable costs through seasonal swings in volume. However, costs for some key variable inputs such as U.S. labor have been rising across the industry in recent years. Reducing fixed costs is more challenging. For example, closing underutilized print facilities often incurs substantial restructuring costs up front. Often these costs recur year after year as printers gradually reduce their print capacity in response to lower volume demand. As a result, we treat these costs as operating expenses in our credit ratios and adjustments. In our view, there will always be some level of restructuring expense for these companies, albeit the magnitude of these initiatives may change from year to year. Reduction in working capital investment will also be challenging for printers as clients will likely use the significant competition amongst printers to get favorable terms. As a result, we expect EBITDA margins and cash flows to be challenged for most players.

How will commercial printers prioritize capital allocation and what is their ability to access capital markets?

It is essential for U.S. commercial printers to manage their cost footprints while striving to satisfy client demands for quantity and quality. Capital expenditures, such as adding new machinery for printing capabilities, will likely constrain free cash flows. However, we expect that most printers will prioritize leverage reduction through voluntary debt prepayments with their excess cash flows, if they have any. Companies realize that their access to capital markets is constrained and it will be difficult for them to refinance their debt when it matures if they do not right size their balance sheets. We have also seen several instances of companies cutting dividends and suspending buybacks in the last year (e.g., Quad and LSC) in this regard. Other companies have sold their less productive assets and used the proceeds to repay debt.

Overall, we have a negative outlook for our rated universe of print companies, and we could downgrade certain commercial printers over the next 12 months if we expect worsening operational challenges, diminishing liquidity, or substantial delays in refinancing upcoming debt maturities. While certain subsectors such as web-to-print and mass customization do not face secular challenges, a vast majority of commercial printers are challenged by the need to cut costs and pay down debt in light of falling revenues. Initiatives such as product and service expansion into marketing and digital solutions are not yet large enough to offset print declines for these companies, and most companies in the sector are highly leveraged. As a result, companies have cut shareholder returns and are using excess cash flows to moderate their debt burdens in the face of this challenged industry.