S&P Global Ratings recently revised its forecast of U.S. GDP contraction in 2020 to 4%--significantly better than the 5% drop we forecasted in June (see "The U.S. Economy Reboots, With Obstacles Ahead", Sept. 24, 2020), in part due to largely resilient consumer spending through the summer and the unemployment rate declining a bit more than we had in our prior forecast. Still, the recovery, which we expect to slow in 2021, faces meaningful risks: a resurgence of COVID-19, a lack of new fiscal stimulus, and trade tensions with China. All of these risks have direct impact on retail, so despite better than expected results for many issuers through August (see "Retail Trends In August Illustrated Consumers' Resilience And Shifts In Spending", Sept. 22, 2020), our outlook for the sector remains largely negative.

The U.S. retail and restaurant sectors have emerged from the economic shutdown into a dramatically different competitive landscape centered around consumers' life at home. Near-term prospects for these companies depends on how consumers can use their products and services in the new normal, a trend we addressed in July in "As The North American Retail And Restaurant Sector Braces For Another Wave Of Downward Rating Actions, A Few Subsectors See Signs Of Hope".

As a result, many specialty retailers have performed better than we expected. These include retailers that sell home décor, furniture, materials for home improvement projects, gardening, hobbies such as crafting and musical instruments, fitness wear and equipment, athleisure apparel, gaming, and electronics for working and learning from home. Even L Brands Inc. was able to offset some of the decline at Victoria's Secret with strong demand at Bath & Body Works. In addition, receptive debt markets have enabled issuers to address near-term maturities. Recent rating actions (see Table 1) reflect our view of the improving outlook for these issuers and their ability to resolve near-term liquidity or maturity risk. We believe, barring another national shutdown, retailers that offer home-related products are relatively well-positioned for the next 12 to 18 months, or at least until consumers are comfortable returning to pre-pandemic behavior. When that occurs, we expect consumers to reallocate funds for traveling and entertainment.

Table 1

Overall, the pace of negative rating actions in the retail and restaurants sectors slowed over the summer. We believe this could be an inflection point in the recovery for many issuers. This is not to say that risk of further pressure has abated--far from it in fact, as our rating outlooks illustrate. Our outlook on about two thirds of the issuers we rate is still negative or are on CreditWatch with negative implications. Though each rating and outlook has its own story, the overarching risk of a meaningful resurgence of COVID-19 and economically damaging social distancing measures in the fall or winter keeps us focused on the downside risk. That said, the shift from exclusively negative to some positive rating actions suggests credit quality across much of the sector could be near the bottom.

Chart 1

Currently, we now see the areas of the sectors that have been hit the hardest, in which recovery will likely be years' long. In retail, these are mall-based specialty apparel and department stores. The pandemic's impact has been evident in the myriad bankruptcy filings, as we anticipated in May in "Shakeout In Retail, Restaurant Sectors Begins With J. Crew". Mall-based retail has been gradually declining for years as the industry struggles to adapt to shifting consumer preferences in the products they are buying (less formal, more casual) and how they buy (less in-store, more digital). The pandemic has accelerated these trends. Our recent rating action on Nordstrom Inc. ("Nordstrom Inc. Downgraded To 'BB+' From 'BBB-' On Declining Competitive Position; Outlook Negative," Sept. 3, 2020), the second department store to become a fallen angel in 2020 following Macy's Inc. which we downgraded prior to the broad COVID-19 impacts, illustrates how these shifts are affecting credit. In our view, much of the mall foot traffic that has been lost will never return. Given store closure announcements, we believe many retailers have accepted this reality (see table 2 for of store closures, which we believe are likely concentrated in malls) and will continue to shift to a leaner store fleet and smaller total square footage.

Table 2

Full service casual dining restaurants will also have a difficult road to recovery because of limited indoor dining capacity, which will become more important in cooler weather. Many restaurants have made impressive pivots to off-premise dining (for example, Darden Restaurants Inc. reported that online ordering grew 300% at Olive Garden in the fourth quarter). However, a resurgence of COVID-19 in the fall could reverse the re-opening of dine-in operations, which could be especially painful in the colder months. Unlike mall-based retailing, we are sanguine that the restaurant industry will eventually recover. Consumers will eventually return to food away from home as they tire of home-cooked meals. Additionally, the permanent closure of many independent restaurants leaves significant market share to larger restaurant chains who have the resources to weather temporary closures. Quick service restaurants (QSRs) and fast casual chains will likely continue to fare better than dine-in restaurants until the pandemic is contained because they focus on take-away, delivery, and drive-thru operations. For instance, we recently upgraded PHD Group Holdings LLC (Portillo's) on stabilizing performance. The outlook for many restaurants is still uncertain, but the relative value offering of QSRs also positions them well during times of economic stress.

On the other side of the spectrum are the retailers that benefitting from pandemic-driven changes to consumer habits. These include grocers, discounters, and big box retailers. Consumers' preference to limit the number of shopping trips supports demand for big box discounters where consumers can also purchase groceries, such as Walmart and Target, who reported sales growth across all categories in the second quarter. Consumers continue to stock their pantries, which has strained some supply chains (such as the widely reported paper towel shortages). Recent rating actions reflect positive dynamics in the grocery space. We upgraded Ingles Markets Inc. to 'BB' from 'BB-' on better performance ("Ingles Markets Inc. Upgraded To 'BB' From 'BB-' On Debt Redemption And Better Performance; Outlook Stable", Aug 19, 2020). Similarly, we upgraded BI-LO LLC to 'B' from 'B-' based on its turnaround strategy with support from the pandemic-induced surge in demand ("BI-LO LLC Upgraded To 'B' On Strengthening Operating Performance; Outlook Stable", Aug 14, 2020).

Perhaps a reflection of the confidence that essential retailers have regarding their prospects even in a COVID-19 resurgence scenario, we have observed issuers reduce the excess cushion of cash on hand and in some cases, return to shareholder-friendly activities. For instance, we believe Target will use cash on hand to fund its recently announced tender for up to $1.75 billion of its notes. Also, Dollar Tree announced its board authorized the resumption of its share buyback program, of which $800 million remains. Both of these issuers have benefitted from the elevated demand for groceries and other consumer basics, and are in a good position in the slow recovery.

We believe that most of the sector has weathered the worst of the impact from COVID-19. Mall-based retail remains the riskiest subsector, while specialty retailers appear to be improving at a healthy clip. Nevertheless, until an effective vaccine is widely available and accepted, the risk of more shutdowns and the resulting economic damage will continue to cast a shadow over the entire sector.

S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The current consensus among health experts is that COVID-19 will remain a threat until a vaccine or effective treatment becomes widely available, which could be around mid-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.