Since the COVID-19 pandemic hit, within the U.S. consumer products industry, we have taken the most negative rating actions in the consumer durables and apparel subsectors. Key macroeconomic indicators such as GDP, unemployment, and consumer confidence directly affect performance.

Unlike consumer staples, these subsectors are highly cyclical and rely heavily on consumer discretionary spending. They have been especially hurt by mandated retail store and factory closures, as many are deemed nonessential.

Since mid-March, after the pandemic declaration, of the 53 durables and apparel issuers we publicly rate, we took rating actions on over 80%--all negative except one upgrade. We downgraded over 30% of the issuers, and over 90% of the ratings have negative outlooks or are on CreditWatch with negative implications, indicating risks for further downgrades. We have nearly 15% in the 'CCC' category. Libbey Inc. is rated 'SD' (selective default) after a mandatory excess cash flow payment deferral. Outerstuff LLC missed an interest payment on its term loan, but remains current on its asset-based lending facility; as a result, we lowered the ratings to 'SD'. The pace of recovery will largely depend on when the economy is expected to recover.

Credit Risk Assessment

Consumer durables' revenue will decline in the double-digit percentages during the second calendar quarter ending June 2020. The pace of recovery will depend on when retail stores reopen and macroeconomic conditions improve. 

We anticipate a precipitous drop in revenues and profitability for the second quarter. Since stay-at-home orders rolled out, many durables issuers' plants were partially or fully shut down because they were deemed nonessential, depending on the state. Additionally, many of their retail end customers shuttered stores. As a result, we believe many will report double-digit percentage declines in revenues and profitability, operating in cash-burn mode. While we believe many companies reduced fixed costs since the last recession, many have not lowered costs rapidly enough to align with the faster fall in revenues. Many diversified their product portfolios since the last downturn. However, we believe the impact of the COVID-19 pandemic will be even more severe than the financial crisis because of the degree of retail and plant closures and large unemployment figures.

A few companies diversified and reduced their cost bases since the last recession. Heading into the next economic down cycle, we anticipated Whirlpool Corp., Steelcase Inc., ACCO Brands Corp., Samsonite International S.A., and bedding companies Serta Simmons Bedding LLC and Tempur Sealy International Inc. would be better positioned. Whirlpool reduced its fixed-cost base and expanded geographic reach into Europe and Asia with acquisitions. Steelcase also reduced fixed costs and expanded its brand and product offerings with acquisitions. ACCO similarly made the transformative acquisition of Mead Corp. that expanded its consumer portfolio, making it less reliant on commercial customers and more recession resilient. Samsonite transitioned to a majority outsourced manufacturing model and made several acquisitions to expand its brand portfolio and price points from value to premium. For highly cyclical mattress companies, the industry consolidated, leaving the leaders with value to premium priced portfolios and lower overhead. Unfortunately, it's not enough to withstand the COVID-19 pandemic impact.

The only investment-grade U.S. durables are Whirlpool and Steelcase. We revised the outlook on Whirlpool to negative given our expectation for a substantial drop in revenues in 2020 and the company's little headroom against its 3x leverage downgrade trigger. We lowered the issuer credit rating on Steelcase to 'BBB-' from 'BBB' and placed it on CreditWatch with negative implications, reflecting its plant closures and highly cyclical office furniture business tied to white collar employment and office occupancy rates. Although the company had minimal leverage, we expect revenues and profitability to fall substantially in fiscal 2021 because it shut down a large portion of operations.

Newell Brands Inc., a more diversified durable, will experience top-line and margin deterioration in the upcoming quarters because of store closures, weakening consumer confidence, and supply chain disruption with temporary closures of some of its manufacturing and distribution facilities. While some of its operating segments, especially food and commercial, could benefit from consumers' shift into these categories, its other segments such as home and outdoor and appliances and cookware will likely decline severely given the more discretionary nature of these products and depressed consumer confidence. The company's learning and development unit will also see near-term stress on revenues, mainly reflecting weaker demand in the writing segment because of the shift to work-from-home arrangements and schools adopting online learning. The baby segment will rebound faster given the less-discretionary nature and strong e-commerce sales penetration. The negative outlook on Newell reflects the risk of a downgrade if operations suffer significantly due to store closures and a sharp drop in consumer spending, preventing it from improving leverage toward the low-4x area in fiscal 2021.

Among speculative-grade durable issuers, these companies participate in a variety of end-markets with varying degree of impact:

• White-collar employment: Steelcase and ACCO.
• Travel and travel retail: Samsonite and Brown Jordan International Inc.
• Housing: Whirlpool, Hayward Industries Inc., Innovative Water Care Global Corp., Latham Pool Products Inc., Serta Simmons, SIWF Holdings Inc., Tempur Sealy, The Hillman Cos. Inc., and Visual Comfort & Co.
• Highly discretionary, with purchases likely to be deferred during an economic downturn: Callaway Golf Co., Fender Musical Instruments Corp., and Steinway Musical Instruments Inc.

The COVID-19 pandemic will significantly hit apparel companies given the nonessential nature of the industry and consumers rapidly shifting disposable income toward essential purchases such as food and hygiene products.  

The pace of recovery will depend on when retail stores reopen, macroeconomic conditions improve, and the vulnerability of products to fashion risk. The majority of our rating outlooks on apparel companies are negative or the ratings are on CreditWatch with negative implications. In our rating actions, we distinguished between companies with better recovery prospects because of less discretionary products, fashion risk, dependence on department stores, or substantial cushion in credit metrics to withstand near-term volatility. We believe they should recover faster from the current drop in economic activity. We revised the rating outlooks to negative and affirmed the ratings on these companies (Carter's Inc., Hanesbrands Inc., Levi Strauss & Co., PVH Corp., VF Corp.).

For companies that face significant fashion risk and carry seasonal inventories that would require heavy promotional activities, rely heavily on department stores for distribution, or could face more severe hit from the economic downturn, we placed the ratings on CreditWatch with negative implications (Calceus Acquisition Inc., Callaway, Fossil Group Inc., G-III Apparel Group Ltd., Ralph Lauren Corp.). Nike Inc. is the only apparel company with a stable outlook. While its operations will also experience pressure because of the economic slowdown and store closures, Nike's strong brand recognition, solid digital capabilities, and marketing strategy allow it to pivot demand to online channels. Nike's strong push to increase user engagement of its activity applications is also paying off as more people work out at home while gyms and fitness studio locations are closed. The company recently issued $6 billion of notes and entered into a new $2 billion revolving credit facility (total revolving credit facility is now $4 billion) to enhance its liquidity position.

Base-Case Forecast

Durables

We forecast 10%-60% revenue declines during the second calendar quarter ending June 2020, for many durables issuers. We expect a less severe drop in the third quarter as states and countries open up, and recovery to gradually begin in the fourth quarter. We believe the pace of recovery will depend on the pace of economies reopening in the U.S. and globally, more so if the cases of the coronavirus level off. The biggest risk to our forecast is a second wave of the pandemic in the fall to early winter.

We anticipate profitability to drop faster than revenues as many companies incur negative fixed cost overhead absorption, especially those with sizable plant closures. We expect some to also incur working capital outflows because of the need to lengthen receivables terms for customers whose operations are also under severe stress. As a result, we expect some to burn cash in the next few quarters, including Steelcase, Libbey, Serta Simmons, and Samsonite. These companies took aggressive actions to reduce their costs, including salary reductions, furloughs, and cutting shareholder returns. These measures are not sufficient to offset the minimal revenue generation.

Apparel

Our assumptions incorporate high-double-digit percentage revenue declines in the second and third quarters from store closures and the cancellation of inventory orders by wholesale partners. We expect some rebound toward the end of the year and into 2021, but the companies won't rebound to 2019 levels until 2022 or even 2023. Companies are responding by implementing very aggressive cost-cutting measures: furloughing or laying off employees, seeking rent concessions, reducing advertising spending, and reducing management salaries. Still, profitability will significantly deteriorate in fiscal 2020 because of sales deleveraging and an increasingly promotional retail environment to clear inventory.

Larger companies have more levers to pull: more power to manage working capital, cut share repurchases, or re-evaluate dividend payments. Issuers for which we net cash could offset some expected deterioration in leverage measures through these actions. Smaller, less diversified companies with already lean cost structures will face steeper deterioration of credit measures. We anticipate leverage rising to the high-single- or double-digit percentage area, and we could view their capital structures as unsustainable, leading to more 'CCC' category ratings.

Sector Liquidity Overviews

Of the 53 durables and apparel issuers we publicly rate, six are investment-grade and 47 speculative-grade. We expect investment-grade issuers to be able to refinance upcoming maturities. Speculative-grade debt is over 60% 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 durables companies. Many have had to shut down some plants, or customers have closed their doors and are burning through cash. Libbey, Serta Simmons, and KNB Holdings Corp. have been most hurt.

Durables

We expect ample liquidity for Whirlpool and Steelcase, investment-grade issuers. Whirlpool recently issued $500 million unsecured notes due in 2050 at 4.6%. Companies in the 'BB' category will also have sufficient liquidity and access to the markets. For instance, Samsonite recently completed a $600 million term loan B add-on transaction to bolster its liquidity position, despite pressure to the business. Tempur Sealy entered into a short-term arrangement with its term loan lenders. Tupperware Brands Corp.'s $600 million notes become current in June 2020, which we believe the company may have difficulty refinancing with favorable terms given its deteriorating operating performance.

Apparel

Large apparel companies have sufficient liquidity to withstand the demand shock and resulting sales decline. A number of large apparel issuers (Nike, VF, PVH, Levi Strauss, Hanesbrands, Carter's, Wolverine) accessed the markets recently to issue bonds and used proceeds to enhance their liquidity position. Many successfully amended financial covenants recently to allow for more cushion given expectation for significant EBITDA decline in the upcoming quarters. However, we believe small apparel issuers, with ratings at the low end of the 'B' category or in the 'CCC' category will likely face significant liquidity pressures stemming from significant decline in sales, substantial cash flow erosion or near-term debt maturities. Outerstuff recently missed an interest payment on its term loan, resulting in a selective default.

Upcoming Debt Maturities

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 categorize 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, 50% of investment-grade issuers are expected to have ample headroom, 33% with medium headroom, and 17% with some tightness. We expect them to receive waivers and amendments if necessary to remain in compliance.

For speculative-grade issuers, we deem 64% have medium headroom. This reflects the many covenant-light or springing maturities. We believe defaults will not be triggered by covenant defaults, but rather debt restructurings, payment defaults, and/or the inability to refinance. Still, 36% 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.

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 33% of investment-grade issuers have high access to the debt markets and 67% medium access. Given the cyclicality of these businesses, we believe the appetite for consumer discretionary issuers is lower than for consumer staples. 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

Consumer cyclicals such as durables and apparel companies will experience unprecedented revenue declines in 2020. 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. We have negative outlooks on over 90% and anticipate more downgrades as the year progresses.

We are not rating to the bottom of the cycle, but the focus will be on the rate of recovery. It is still unclear what that recovery looks like, but the issuers that make it through will have to endure several years of lean cost management to restore profitability and credit measures.

Table 1