Overview

Channel mix and the discretionary nature of products have resulted in a bifurcation of the performance of subsectors within consumer products.   S&P Global Ratings has maintained its ratings on the majority of food (including packaged foods and agricultural) and household products and personal care (excluding cosmetics) companies. These subsectors have performed the best since the pandemic began as consumption has increased because of stay-at-home mandates related to COVID-19. In addition, their products are nondiscretionary in nature and they incurred no major disruption with their retail customers (primarily grocers, food warehouses, and online delivery). In contrast, we have taken negative actions on the majority of durable and apparel issuers and all food service and cosmetics issuers (Table 1). Food service has faced significant disruption because of the closure of restaurants, bars, and live entertainment venues, with consumers shifting to predominantly in-home consumption during lockdown mandates. The consumer durables, apparel, and cosmetics subsectors were also hard-hit. Their retail channels were highly disrupted because they were deemed nonessential. In addition, their products are highly discretionary. Beverage companies' performance is also being affected by their channel mix but we have not taken as many actions compared with the discretionary subsectors because many of these companies have been able to make up a substantial amount of the loss of on-premise sales with an uptick in sales to the off-premise channels. We continue to see the most rating pressure in the consumer discretionary and away-from-home consumption subsectors (Chart 1). We have provided links to recent detailed analysis of the subsectors at the end of this report.

We have taken 36 additional rating actions since our last commentary on the U.S. consumer products sector (Coronavirus Dramatically Increases Consumer Products Risk, But Staples Benefit, April 07, 2020). In total, we have taken 76 negative rating actions related to COVID-19 and the economic recession (see Table 5 at the end of this report). Our rating actions continue to be mostly at the low end of the rating spectrum; however, we have seen companies rated on the strong end of the 'BB' category migrate to mid-'BB' (Chart 2). Credits in the 'BB' category were impacted by the decline in the food service and travel channels. At the low end of the spectrum it was because of liquidity issues and/or already stretched credit metrics further deteriorating because of the drop in demand. Rating actions going forward will depend on when retail stores and entertainment venues widely reopen and consumers being willing to go back to these channels as well as when macroeconomic conditions improve.

Table 1

Chart 1

Chart 2

Changes Coming Out Of The Pandemic And Recession

We expect consumer behavior to change because of the pandemic and last even after states widely reopen and consumers become more socially active. After the great recession, we saw consumers de-load their pantries and purchase goods closer to need. They also remained more value-conscious. In addition, consumers saved more compared to prerecession levels even during periods of healthy gains in the stock market, which historically were times when consumers saved less. Changes in consumer behavior we foresee because of the pandemic and current recession include:

• Structural shift to in-home consumption. During shelter-in-place mandates, consumers' interest in cooking has increased and they have gotten into the routine of cooking more at home. We believe food companies such as Conagra Brands Inc., Campbell Soup Co., Hormel Foods Corp., Kraft Heinz, McCormick, and Post will benefit from this trend. These companies are seeing increased sales of their products as they have repositioned their portfolios for faster growth, reformulated products to use natural ingredients, and/or removed genetically modified ingredients.
• Consumers become more value oriented--focusing on price-value. During the current recession, we believe consumers will trade down to lower-priced items, shift to private label, make shopping lists, use coupons, and compare prices. They will also increase purchases of multipack formats given increased time spent at home. The confluence of the above will likely result in negative mix shift, which will pressure margins.
• Consumers will maintain a higher level of shelf-stable goods and cleaning and hygiene products in their pantries given the stock-outs that have occurred this year and concern there will be a second and possibly third wave of an outbreak of the coronavirus.
• Consumers will have greater focus on health and wellness. This should benefit companies that participate in hygiene, probiotics, and vitamins such as Procter & Gamble Co., Clorox Co., Church & Dwight Co. Inc., and S.C. Johnson, and International Flavors & Fragrances Inc., which provides ingredients in these areas.
• Large brands and private labels will take share from small and midsize brands. Challenger brands have gained the most share in recent years because of their digital capabilities and agility, but consumers have navigated back to large brands because they trust their quality, availability, and difference pack sizes. Retailers are increasing shelf space for branded goods because of their scale and better distribution capabilities. We expect challenger brands to lose share as it could be difficult for them to access funding in the current environment and their lack of scale and channel diversity.
• The online channel will see an acceleration in growth. E-commerce share of fast-moving consumer goods grew to 5.6% in 2019, up from 3% in 2018 according to Nielsen. We believe the channel's share could increase to 10% this year.
• Coming out of the last recession, branded companies focused on reducing costs. This time around, we believe they will focus on channel and product mix as well as product innovation. In recent years, large consumer products companies have invested in logistics enabling them to be channel-agnostic.

The above trends should result in sales growth for the food, household products, and personal care sectors (excluding cosmetics) to be above the low-single-digit-percent rate they have been generating prior to this year (Table 2). Moreover, we believe growth will be driven by volume whereas prior to COVID-19 it was primarily driven by price mix. We believe companies will benefit from greater economies of scale, the introduction of high-margin innovative products in the fall, and lower advertising spending as well as lower labor costs in the back half of this year if shelter-in-place mandates are substantially lifted. In addition, higher unemployment should reduce the wage pressure companies experienced before and during COVID-19. Nevertheless, we expect the majority of consumer staples companies' margins to be flat to up slightly as they are investing in innovation and logistics. They are also facing higher transportation and cleaning costs. In discretionary subsectors that have incurred material declines in sales in the first half of 2020, we expect margins to be up because of a recovery in sales, albeit not to 2019 levels, and cost cutting.

U.S. Consumer Products Issuers On The Fallen Angel Cusp

The vast majority of our ratings on investment-grade issuers in the consumer products sector have been stable. The bulk of these issuers participate in staple categories and have products and/or geographic diversity. Moreover, most of them are also benefiting from the current environment because of the counter-cyclical nature of their products. Still, we have lowered the ratings on two of the 48 investment-grade issuers in the sector--Sysco Corp. and Steelcase Inc. In the case of Sysco, it was because of its vulnerability to away-from-home consumption; in the case of Steelcase, it was because of its exposure to the office market. In addition, we revised the outlooks on five issuers to negative from stable, primarily because they participate in channels exposed to social-distancing mandates.

We receive many questions regarding the potential for fallen angels in the sector. There are idiosyncratic reasons behind the negative outlooks on these companies rather than a structural change in the industry. Their funded debt in aggregate only represents 8% of the total investment-grade debt in the sector; hence, we do not expect a downgrade of just a few of the companies to speculative grade will have much impact on financial markets. How the companies manage their operations, direct their cash flow, and potentially adjust channel mix are key factors in the direction of their ratings. Table 3 summarizes what it would take for each company to remain investment grade.

Table 3

Chart 3

Liquidity Concerns For Issuers At The Low End Of The Ratings Spectrum

We expect liquidity will be sufficient for investment-grade issuers as well as those in the 'BB' category. Issuers in the low 'B' and 'CCC' categories may have difficulty accessing capital markets. This will likely result in additional companies in the sector defaulting. In the sector, 17% of the issuers have weak or less than adequate liquidity (Chart 4). Liquidity constraints are relative to cash burn, fixed charges, and in some cases near-term maturities. Covenants will not likely be the primary drivers of default in the near term. Many speculative-grade issuers have covenant-light packages or springing covenants.

Chart 4

More Distressed Exchanges And Bankruptcies Are On The Way

Tighter financing conditions, debt trading at distressed levels, exacerbation of already weak operating performance, and the economic downturn have resulted in distressed exchanges and missed interest payments. Seven issuers in the sector have defaulted thus far this year, up from six last year, and three in 2018 (Table 4). Given that almost 30% of the issuers in the sector are 'B-' and below, we expect the default rate in the sector to be similar to S&P Global Ratings' 10% expectation for nonfinancials (Charts 1 and 5). We recently lowered the ratings on Tupperware Brands Corp. and Serta Simmons Bedding LLC to 'CC' on imminent debt repurchases and debt exchanges at less than par.

Table 4

Chart 5

Conclusion

Credit Risk Has Materially Increased

The pandemic and recession puts significantly more pressure on the discretionary subsectors. We have stable outlooks on only 40% of the issuers in the sector, down from 64% at year-end 2019 (Chart 6) as only 32% of the issuers in the consumer products sector participate in consumer staple categories. We continue to believe most rating actions will be at the low end of the rating spectrum and that the sector's default rate will be in line with S&P Global Ratings' 10% expectation for nonfinancials. See Chart 2 for the increase in ratings at the low end of the 'B' category and in the 'CCC' category. We expect investment-grade ratings to be relatively stable because of their product portfolios and channel mix. Moreover, these companies have shown a willingness to materially cut back on shareholder rewards to preserve credit metrics.

Table 5

Related Research

• U.S. Consumer Durables And Apparel Aren't Wearing Coronavirus Pressure Well, May 14, 2020
• Packaged Food, Household Products Manage Coronavirus Pressure; Not So Pretty For Cosmetics, May 4, 2020
• Food Service, Beverage, And Tobacco Prognosis Mixed From Coronavirus, May 1, 2020
• Protein Processors Scramble To Adjust To Disruption From Pandemic, April 29, 2020
• Coronavirus Dramatically Increases Consumer Products Risk, But Staples Benefit, April 7, 2020