Since the spread of the coronavirus, over 90% of the U.S. population has been under stay-at-home orders. Sales for packaged food and household products and personal care increased double- to triple-digit percentages in March, after the World Health Organization declared COVID-19 a pandemic.

These companies are benefitting from consumer trends and behavioral changes associated with the pandemic--including increased at-home food consumption, a focus on cleaning, heightened personal wellness, and increased online purchases. The degree of the benefits from pantry loading and panic buying largely reflect each company's product portfolio and customer mix. We believe the largest beneficiaries are large packaged food companies that sell shelf-stable products, especially meals and meal solutions. For household products and personal care, those with cleaning supplies and personal care products such as toilet paper and paper towels are getting the most lift.

In contrast, food companies with food service exposure will likely decline double-digit percentages, and those with larger convenience store exposure will face pressure. The pace of purchases for personal care products has also softened. Cosmetics companies will face the most dramatic declines the longer specialty and department stores remain closed.

We have maintained our ratings on the majority of packaged food and household products and personal care companies because of positive sales trends. In contrast, we have taken negative actions on every cosmetic company we rate.

As expected, liquidity will be sufficient for the majority of investment-grade issuers. However, some companies have drawn down on their credit facilities to ensure access to liquidity in the event markets dry up or the cost of borrowing in the commercial paper market exceeds revolver borrowing costs. Others have issued debt opportunistically to shore up their balance sheets and take advantage of favorable rates. The speculative-grade debt market was limited previously, but opened for 'BB' category issuers in recent weeks. We believe a flight to quality and stability will result in more defaults this year, largely in the 'B' category.

Here we discuss our outlook for packaged food, household products and personal care, and cosmetics companies given the changing economic landscape because of COVID-19; the key risks and opportunities each sector faces; and provide a summary of rated issuers and our view of their liquidity positions.

Credit Risk Assessment

Packaged food companies have positive volume, reversing the secular sales decline trends. It is still uncertain what the long-run trends will be following the effects of the pandemic. 

Volumes have been flagging for years, and consumer tastes and preferences were shifting away from traditional brands. With the pandemic, has the industry permanently benefited and should we expect a sustained return to organic growth? It is too early to tell what the industry run-rate growth rate will look like after this pandemic. It is unclear if consumers have shifted their behaviors and if there is staying power for some products with new trials. There is no doubt this has also accelerated online purchases in grocery and will change buying habits for packaged goods.

Overall, we expect sustained positive momentum for packaged food companies, but the magnitude is unclear. These companies have historically benefited from recessions, with increased at-home consumption taking share from food-away-from-home. With unprecedented restaurant closures, we expect these companies to continue to benefit. They could also benefit from reduced competition from disruptor brands. Retailers prefer brands with scale given the increase in demand, and consumers look for well-known brands as they seek security.

Some drag for companies with meaningful food service exposures will partially offset the increase in the retail and consumer parts of their business. Packaged food issuers with the largest food service exposure include Flowers Foods Inc., McCormick & Co. Inc., and Post Holdings Inc. McCormick has about 20% of its revenues exposed to restaurants and food service in its flavors segment, and we expect that to pressure profits in fiscal 2020. Flowers has about 25% of its revenues exposed to food service, but it may be less affected given the substantial growth in the retail segment and ability shift manufacturing. Post has about 25% exposure, but an offset is the increase in demand for eggs and the rise of egg prices.

General Mills Inc., The J.M. Smucker Co., Conagra Brands Inc., Kraft Heinz Foods Co., and Campbell Soup Co. also participate in food service, which accounts for less than 10%-15% of their revenues. Additionally, companies reliant on impulse purchases, the convenience channel, and seasonal eating occasions will face downward pressure. Notably, The Hershey Co. recently announced it expects meaningful declines in the convenience channel, and it is unclear how its next key selling season, Halloween, will fare with continued cautiousness and likely social distancing measures in the fall.

Household products and personal care also have continued favorable trends, but with slower growth for certain categories in personal hygiene products.  

The household products and personal care industry has expanded beyond its 3%-4% historical rate. We expect similar trends in packaged food for single-use household items and cleaning products given cleaning and hygiene are top-of-mind to the consumer. We believe changes in consumer behavior such as increased hand washing and staying at home more will increase use of paper and cleaning products for many years. We expect moderation in growth or declines in certain personal care categories such as shaving, deodorants, hair styling, and other beauty items, as these are lower replenishment items.

We expect unprecedented revenue declines for cosmetics companies.  The beauty industry has been relatively stable during past recessions due to the "lipstick effect", consumers indulging on lower-priced discretionary items such as lipstick instead of bigger ticket purchases. But it will face unprecedented challenges during 2020 because of the COVID-19 pandemic. Lockdown measures, massive shutdowns of retail locations, and travel bans to contain the spread of the disease continue to disrupt tourist spending and social occasions. Impact from the economic downturn could be less on companies that sell through mass market channels and have strong e-commerce capabilities. But beauty players that rely heavily on travel retail and traditional department stores or specialty retail will see significant top-line impact in the upcoming quarters.

We believe demand for color cosmetics, especially in North America and Western Europe, and fragrances will decline the most as consumers focus on essential items. Skin-care products should be more resilient, but customers could gravitate from high-end products toward "masstige" substitutes--beauty products sold in the mass channel at competitive prices, but positioned as having similar quality as premium-priced products--given depressed consumer confidence amid high sustained unemployment. We also expect promotional activity to be up this year to clear inventory.

Base-Case Forecast

Packaged food, household products, and personal care

We do not foresee immediate upgrades from these near-term benefits. We anticipate, especially in the next two quarters, at least mid-single–digit percentage revenue growth. This has tapered off as consumers shifted from pantry loading to consumption purchasing. As a result, we expect the pace of growth to start normalizing to low-single–digit percentages in the back half of the year, depending on when stay-at-home orders are lifted.

While we expect some margin improvement, we do not foresee a material boost in the near term. Many companies have incurred additional operating costs with heightened plant safety measures, protective equipment, and higher labor costs to meet the demand surge. These cost increases will be partially offset by the focus on fewer SKUs, primarily higher velocity items. This would boost margins given the lower plant changeovers and more efficient long runs.

Cosmetics

We forecast significant top-line stress on beauty companies during the second quarter of 2020, improving somewhat into the third. It will abate slowly toward the end of 2020 into the Christmas/holiday season and into the fourth quarter, assuming consumer confidence improves. Overall, we expect a double–digit percentage top-line decline during 2020 with a relatively solid sales rebound in 2021. However, we believe 2021 sales will remain below 2019 levels with a favorable mix as consumers shift back to premium products.

We expect companies to implement strict measures to control costs, which could mitigate margin deterioration to some extent. But lack of sales leverage due to a steep sales decline will lead to significant margin erosion in fiscal 2020.

Sector Liquidity Overviews

Investment-grade issuers account for the majority of dollar value debt outstanding, but they are fewer in number. Of the 57 issuers we publicly rate, 18 are investment-grade and 39 are speculative-grade. These companies have rolling debt maturities, and we expect they can fund and access the markets. Speculative-grade debt is less than 15% of the maturing dollar debt outstanding in the next few years. We believe many issuers in the low 'B' and 'CCC' categories may have difficulty refinancing.

Covenants will not be primary drivers of default in the near term. Many speculative-grade issuers have covenant-light packages or springing covenants. Instead, liquidity constraints are relative to cash burn and fixed charges. The weakest liquidity positions are for speculative-grade household products companies, largely driven by cosmetics.

Packaged food, household products, and personal care

Sector liquidity is adequate because of favorable trends and strong cash flow generation. Speculative-grade issuers with less than adequate liquidity are those with upcoming maturities or refinancing risk. With a continued flight to stability in the debt markets, we believe these issuers will have greater market access and receptivity, with likely more favorable terms than consumer cyclicals and most other consumer products sectors. Notably, General Mills, McCormick, Campbell, and Procter & Gamble Co. issued long-term notes at favorable rates to proactively fund upcoming maturities and for liquidity cushion. There is less issuance activity among speculative-grade issuers, but the market has gradually started to open.

Cosmetics

Liquidity is constrained for some cosmetic companies we rate. Revlon Inc. faces significant near-term debt maturities that it has not been able to address so far. Anastasia Holdings LLC and Rodan & Fields LLC faced operational challenges over the past several quarters that weakened cash flow generation. Recent store closures and depressed consumer confidence will continue to hurt the companies' operations and further erode their liquidity positions.

We expect pH Beauty Holdings I Inc. and Coty Inc. to maintain adequate liquidity. The Estee Lauder Cos. Inc. maintains a strong liquidity position with solid cash balances supplemented by the recent draw under the revolving credit facility. It recently issued $750 million of unsecured notes to further enhance its liquidity position.

Upcoming Debt Maturities

Below are the aggregate maturities for our 57 rated issuers during the next two years (Chart 1). Investment-grade packaged food companies have over $13 billion due in the next 12 months, and $10.8 billion in the year after. Investment-grade household products and personal care firms have $13.1 billion due in the next 12 months, $4.5 billion the year after. Speculative-grade maturities for both packaged food and household products and personal care total about $2.5 billion during the next 12 months and over $3.5 billion in the next 24 months. While speculative-grade maturities are relatively lower, we believe companies with upcoming maturities during the next 12-24 months will have a more difficult time addressing them in the current market environment.

Chart 1

Covenant compliance

As detailed in the issuer list (Table 1), we estimate each company's ability to comply with its maintenance or springing financial covenants, and categorized each issuer as high, medium, or low.

High:   There are no financial covenants (including no springing covenants), or we expect over 50% cushion (e.g., an issuer's EBITDA will not deteriorate over the next 6-12 months and covenant cushion exceeds 50% with no major steps).

Medium:   Even with likely EBITDA contraction, a violation seems improbable over the next 12 months. This also includes issuers with springing covenants in which springing utilization noncompliance risk is low.

Low:   Low cushion, typically less than 15%, and EBITDA contraction is probable.

In aggregate, 72.2% of investment-grade issuers are expected to have ample headroom, 22.2% with medium headroom, and 5.6% with some tightness. We expect them to be able to receive waivers and amendments if necessary to remain in compliance.

For speculative-grade issuers, we deem 64% to have medium headroom. This reflects the many covenant-light or springing maturities under existing agreements. We believe defaults will not be triggered by covenant defaults, but rather debt restructurings, payment defaults, and/or the inability to refinance. Still, 33% have low cushion, which we believe will support additional defaults or a need for renegotiation (Charts 2 and 3).

Chart 2

Chart 3

Ability To Access The Debt Markets

We assess each issuer's ability to access capital markets under difficult conditions. We apply a low, medium, or high assessment to each issuer as defined below.

High to medium:   Large, stable investment-grade issuers.

Medium:   Midsize speculative-grade issuers that are reasonably capitalized, have adequate liquidity, and are not extremely sensitive to the COVID-19 pandemic or the economy.

Low:   Typically less than adequate or weak liquidity, or doubts about survival over the near to medium term.

We deem just under 90% of investment-grade issuers to have high access to the debt markets and just 11% medium. In contrast, no speculative-grade issuers have high access to the markets, and the majority have low access (Charts 4 and 5).

Chart 4

Chart 5

Outlook And Conclusions

Amid COVID-19, we expect investment-grade U.S. packaged food and household products and personal care companies to on average fare better than consumer discretionary companies and food service. Within personal care, cosmetics will face the most pressure due to the relatively discretionary nature of the products and exposure to specialty retail and department stores. We believe investment-grade issuers will still have access to the debt markets and should fund upcoming maturities. Many have headroom relative to the downside triggers. Highly leveraged companies may deleverage more rapidly if they have a favorable portfolio. For instance, we believe General Mills and Smucker will benefit.

In contrast, we believe McCormick will not deleverage as quickly this year given its food service exposure. Clorox Co., which lost market share last year, has seen a boost to organic revenue growth this year.

There will likely be more pressure and defaults with speculative-grade issuers, especially those with sizable near-term maturities because of limited access to the debt markets. Many do not have sufficient headroom in their leverage relative to downgrade triggers. These companies already had highly leveraged balance sheets, allowing little room for a severe shock such as the COVID-19 pandemic. These include 'CCC' rated issuers such as Anastasia, Revlon, and Isagenix Worldwide Inc. Others may not be able to refinance. As speculative-grade markets gradually open, we will gauge investors' risk appetite.

Table 1