Sudden COVID-19-related stay-at-home orders, extreme hoarding of food and other staples, and the rapid acceleration of e-commerce made food-at-home (FAH) companies one of the biggest winners in the U.S. retail and restaurant sector in 2020.

Our rating actions reflected that. Last year, we took 220 rating actions across the nearly 140 rated companies in the retail/restaurant sector, and 55% of these actions were negative. However, among the roughly 20 rated grocery, distributor, dollar store, and big-box issuers, almost all of the more than 20 rating actions in 2020 were positive.

In the consumer products sector, we took 109 rating actions, with 73% negative. However, ratings for consumer staples companies were relatively stable because of the increased demand. Despite the strong comparable sales and profit results in 2020--including, in some cases, triple-digit percent increases in digital revenue--we still believe S&P Global Ratings' lease-adjusted EBITDA performance will be better in 2021 than in 2019.

Investors often ask us how permanent the food-at-home trend is, and we are confident part of the increase is here to stay. While we expect restaurants to benefit from pent-up demand in the third quarter, a return to consistent dining-out habits could be delayed by vaccine rollout hiccups, new virus variants, and further case waves. In addition, consumers' time at home will likely remain above pre-COVID-19 levels because of greater working from home and an increase in at-home entertainment options. Looking beyond 2021, Americans' improved meal-planning and cooking skills will not go away.

Industry estimates indicate the U.S. grocery industry gained $77 billion in sales in 2020 from 2019, while the U.S. restaurant industry lost more than $100 billion (see table). Clearly, a good portion of the difference went back into Americans' pockets, as the U.S. personal savings rate increased to 20.5% in January 2021 from 7.6% in December 2019, according to the Federal Bureau of Economic Analysis. Meanwhile, the restaurant industry would need to grow 18% in 2021 to return it to the 2019 level.

We believe the investments grocery stores made in curbside pickup, prepared meals, and speedy and seamless online capabilities will have a lasting impact on consumer shopping and dining habits. We also believe this will help supermarkets and similar players maintain market share even after the pandemic is contained. Given the de-leveraging and increased liquidity that's flooded the FAH sector, we expect this will lead to even more grocery acquisitions, IPOs, and perhaps even private equity leveraged buyouts in the coming one to two years. (In January 2021, Ahold Delhaize and Centerbridge Partners completed their purchase of online grocer FreshDirect for an undisclosed price.) It will also mean further reshuffling of market share among the biggest domestic grocery and restaurant players; Chart 1 illustrates the diverging trends.

Chart 1

Further Up the Proverbial Food Chain, Suppliers Are Also Benefitting

Branded consumer staples have also benefitted from pandemic-related market trends. We expect packaged food manufacturers' sales to grow 1%-2% organically post-pandemic, whereas growth had been negative before the pandemic. We expect household product companies to grow at least 3%-4%, slightly higher than previous levels, due to permanent changes in consumer habits and higher product usage rates.

During the pandemic, consumers navigated back to familiar, trusted brands, and companies were able to flex their supply chains to address the associated demand increase and channel shift. Post COVID-19, we expect these companies to maintain some of the market share they gained through actively managing their portfolios through innovation, bolt-on acquisitions, SKU rationalization, and divestitures. Indeed, companies such as Clorox, General Mills, and Procter & Gamble have increased their long-term growth targets, and other players have indicated they should achieve the high end of theirs.

Consumers' investments in cooking equipment during the pandemic should be a positive for companies that participate in breakfast, lunch, and snacking categories--such as General Mills, Kellogg, Campbell Soup, Conagra, Mondelez, and PepsiCo. In addition, consumers' focus on health and wellness accelerated during the pandemic. We believe companies such as Procter & Gamble, Colgate, Kimberly-Clark, Clorox, Church & Dwight, and Estee Lauder will benefit from this trend.

Cleanup Could Still Be Needed In Aisle 6

New risks will emerge for grocers this year. For example, the COVID-19 vaccine rollout is proceeding more quickly at U.S. pharmacies than at supermarkets and big-box stores. This translates into millions of new customer data sets for CVS, Walgreens, and others and less traffic for non-consumable businesses. We expect the big, infrequent supermarket trips amid social-distancing concerns in 2020 will revert to more normalized transactions across the sector as soon as the second half of this year.

Moreover, the battle to raise the minimum wage to more than $15 per hour is prompting many retailers to announce higher wages. This--on top of the COVID-19-related cleaning and other expenses required last year--will only further dent adjusted EBITDA margins in the already super thin-margin grocery sector. In the coming year, we are forecasting as much as a 50-basis-point (bp) impact, even for the biggest players.

Why Push A Shopping Cart When You Can Push A Button?

For many pure-play grocers, online sales made up less than 2% of sales in 2019, but this figure doubled during the economic shutdown in the spring of 2020. Subsequent quarters illustrate a moderating but continued relatively high penetration of e-commerce among grocers and big box retailers.

Before the pandemic, we expected e-commerce sales penetration to grow to 10% by 2024, but we now expect that to be closer to 20% by then. The growth in digital sales channels poses risks and opportunities to grocers. The different rates of e-commerce growth indicate an overall market-share gain for Albertsons but a loss for Walmart, though the latter remains the country's largest grocer (see Chart 2).

Chart 2

Chart 3

Similarly, pre-COVID-19, e-commerce was a small fraction of packaged goods sales. The pandemic advanced penetration by four to five years, and manufacturers intend to grow it further. Branded goods companies invested in the direct-to-consumer channel well before the pandemic and easily adapted to the acceleration. Digital engagement is moving manufacturers closer to consumers, enabling packaged good companies to create an engaging customer experience.

Companies are getting a better return on investment because targeted campaigns can effectively drive on-line and physical store purchases. For example, if there is a regional outbreak of the flu, a company will target coupons to consumers in that area for products such as over-the-counter flu medications to boost sales.

Food Price Inflation: Evergreen Sector Risk Will Moderate In 2021

Food price inflation was much higher in 2020 than in recent years for both FAH and food-away-from-home (FAFH) categories, according to the U.S. Department of Agriculture. The rate was about the mid-3% for both sectors versus the food price inflation 20-year-average of 2%, amid a variety of pandemic-related challenges, including global supply-chain issues for proteins.

After years of fairly stable prices, consumer staples companies are also facing rising commodity costs, such as for packaging, corn, flour, and wheat. These costs come on top of margins already squeezed by labor and freight costs. We expect these companies to offset potential pressures on margins by using levers such as revenue growth management (pricing and promotional optimization), product mix management, cost savings, and price increases.

FAH prices increased dramatically in 2020 from 0.9% in 2019. This perennial issue posed a unique challenge to grocers given they had to pass on higher product costs to preserve margins while also trying to stay competitive and gain the market share that was up for grabs. Having to raise prices will continue to be a challenge in the coming year.

Chart 4

The USDA forecasts that FAH prices will climb only 1%-2% in the coming year versus 2%-3% for FAFH. Similar data from the U.S. Census Bureau is below. We believe supermarkets' lower prices versus restaurants could mean continued gains for the grocery sector in the coming year.

The Rising Tide Has Lifted All Boats, But Regional Players Could Be Left High And Dry

Regional grocers benefitted from the FAH trend and consumers' preference to shop closer to home during the pandemic. As behavior normalizes over the next 12 months, we expect the segment's organic growth to moderate to the low-single-digit percentages. Regional grocers can benefit from effective merchandising and are progressively using scale to compete on price and maintain store traffic. However, their limited digital penetration poses a medium- to long-term risk because of increasing investments in digital channels by larger players and big box retailers. As the effects from the coronavirus pandemic wane, we believe industry margins will decline due to sales deleveraging. We also believe they'll remain under pressure as competition for shifting market share heats up.

Increased Food At Home Also Benefits Food Distributors

Higher demand at grocers translates to increased sales and operating leverage for food distributors. In particular, scale remains a key competitive factor when expanding their client base or delivering higher-margin private brands. Those that successfully navigated kinks in the supply chain due to restrictions and shortages during the pandemic--such as by consolidating distribution centers or investing in automation to improve operating margins--are best positioned to capitalize on the tailwinds.

Appendix: Additional Charts

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