U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
Primary Credit Analyst: Robert E Schulz, CFA, New York (1) 212-438-7808; robert.schulz@standardandpoors.com Secondary Contacts: Ana Lai, CFA, New York (1) 212-438-6895; ana.lai@standardandpoors.com David M Kuntz, New York 212-438-5022; david.m.kuntz@standardandpoors.com Research Contributor: Trupti Kole, CRISIL Global Analytical Center, an S&P affiliate, Mumbai
Table Of Contents
Economic Outlook Industry Credit Outlook Recent Rating Activity Contact Information Related Criteria And Research
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U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
Standard & Poor's Ratings Services' base-case outlook for the remainder of 2013 reflects our expectation that many U.S. retail and restaurant subsectors will face weak demand in the critical fourth quarter shopping season of 2013 and consumers will direct their spending with some care. Elevated gas prices, unemployment, and rising interest rates are some of the reasons, even before taking the government shutdown and federal budget inertia into account, which may cause households to further delay spending. We do not yet know how much retail sales rose in September, if at all, as much economic data was not being released during the shutdown. U.S. retail sales rose 0.2% in August (the smallest increase in four months) after rising a revised 0.4% in July. The increase among the types of retail companies we rate (excluding the impact of fuel, auto sales, and building supplies) was 0.2% in August, following a 0.5% increase in July. Electronics, furniture, and auto dealerships posted increases in August, while clothing, sporting goods, and building material retailers saw declines. We think there are indications that apparel retailers will not have a good third quarter measured by comparable store sales, so we could see more promotional activity to drive traffic. The First Data SpendTrend retail dollar volume growth, an indicator of consumer spending using credit, debit, and check, declined to 5.3% in September, compared with a growth of 7.3% in August. We continue to assume many U.S. retail and restaurant issuers will report flat same-store sales growth in 2013, with many downward revisions to performance expectations in the recent quarter tracking this assumption. While pent-up demand and potential interest rate increases caused the uptick in spending through the first half of 2013 on big ticket items (auto and housing-related goods and services), we think the average consumer is carefully watching their total spend on more discretionary products. Same-store sales have presented a mixed picture--positive for some and moderately negative for others. Given the consumer's sharper focus on value, we anticipate continued fair results from discounters, dollar stores, and home improvement stores, with flatter or even lower spending at electronics and department stores and restaurants. As of mid-September 2013, our economists' baseline assumptions for the domestic retail and restaurant sectors include: U.S. real GDP growth of 1.7% in 2013 and 2.8% in 2014; An unemployment rate of 7.5% in 2013 and 7.0% in 2014; and Consumer sentiment of 81.5 in 2013 improving to 86.7 in 2014; (For more information, see "U.S. Economic Forecast: Legends Of The Fall", published Sept. 13, 2013, on RatingsDirect.) The majority of our rating outlooks on companies in the retail sector are stable (84%), but most of the remaining
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
outlooks are negative (10% versus 3% positive). Ratings remain very low, with 75% at a speculative-grade level ('BB+' or lower). The 'B' category continues to overshadow all other categories, comprising 57% of total industry ratings. This relative mix of ratings has been consistent for some time.
Economic Outlook
When forming our baseline economic outlook, we focus mainly on the economic indicators most correlated with consumers' willingness to spend because of the predominantly discretionary nature of most purchases in the retail and restaurant sectors. We base the foundation for our outlook on the following factors and expectations: The shutdown will likely shave about 0.3% off annualized growth in the fourth quarter for each week it continues. Given the increased political/policy-driven risks, the risk of the U.S. falling into another recession over the next year has increased to 15%-20% after holding at 10%-15% since January. U.S. real GDP and consumer spending remain in the low-single-digit area; we expect spending to be skewed toward essential items. We expect unemployment to remain around 7% over the next year. We expect the improvement in the housing market recorded during the first half of this year to level off over the next 12 months (30-year mortgage rates are at about 4.5%, up from 3.3% in the start of the year). We expect commodity inflation to remain benign but consistently high fuel prices could pressure margins and restrain consumer purchasing power. We assume most companies will likely continue to have access to capital markets to address debt maturities and fund share repurchases and dividends. Standard & Poor's economists publish a monthly scenario of expectations for the U.S. economy in the next two years. Beyond projecting GDP and inflation, we also include outlooks for other major economic categories. We call this forecast our "baseline scenario", and we use it in all areas of our credit analyses. Our 2013 and 2014 baseline outlook for the retail and restaurant sectors incorporates our economists' U.S. economic forecast for several key indicators (see table 1). Our economists also publish quarterly downside and upside scenarios, which contemplate alternatives to the baseline case. While our ratings do not directly incorporate these alternative scenarios, they do represent an important input into our ratings process, particularly with issuers for which we are considering an outlook revision or rating change. In periods of economic volatility, we believe these alternative scenarios are particularly valuable to consider.
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
Table 1
Downside* Macroeconomic indicators Real GDP (% change) CPI (% change) Consumer sentiment
Baseline*
Upside*
Actual
Comment
2013 1.3
2014 0.4
2013 1.7
2014 2.8
2013 2.0
2014 4.5
2012 2.8 Continued modest economic growth should generally be supportive of the overall retail and restaurant sector. 2.1 We expect inflation to remain benign, helping maintain consumer purchasing power. 77 A further improvement in consumer mood, especially if fiscal uncertainties ease, could lead to more broadly diffused gains in spending. 3.9 8.1 Although unemployment is still high, jobs are being created, which should support consumer confidence and spending. Somewhat favorable Somewhat favorable Neutral Somewhat favorable
1.3 80
0.9 76
1.5 82
1.5 87
1.7 83
2.2 94
1.6 7.6
2.9 8.0
1.8 7.5
4.9 7.0
1.9 7.4
6.0 6.1
The consumer sentiment index remains meaningfully above recent recessionary levels of the upper-50 to lower-60 area. Consumer sentiment was around 77.5 in September 2013. Our baseline expectations are 81.5 and 86.7 for 2013 and 2014, respectively. Still, the index has been relatively volatile given the weak economic recovery in the U.S., concerns regarding fiscal matters in Washington, worries about the economic situation in Europe, and tensions in the Middle East. The index could remain relatively volatile over the next year because many of these items are longer-term issues. In our view, this reflects a cautious U.S. consumer who is willing to spend modestly, but may retreat from time to time if negative events occur. Household wealth has recovered for some demographics but not all. Any spike in gas and oil prices could pressure the retail and restaurant sectors as consumers shift discretionary spending more toward fuel (see chart 2).
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
Chart 1
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
Chart 2
As the U.S. economy continues its slow recovery, we believe the following factors will weigh on consumers' shopping attitudes and financial conditions: Still high unemployment; Lack of agreement on fiscal issues in Washington; Gasoline prices; and Minimal increases in disposable income.
We also realize that financial market participants are interested in how we think the economy could deviate from our baseline forecast. Therefore, our economists also project two additional scenarios--one optimistic and one pessimistic. We set these scenarios approximately one standard deviation from the baseline. We use the pessimistic case to estimate the credit impact of an economic outlook that is weaker than the baseline case.
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
confidence, and a slower housing market recovery. Higher unemployment rates would also reduce consumer spending. Although a global slowdown would lead to lower gas prices, it is not enough to boost consumer spending. Our economists consider the possibility of another U.S. recession to be between 15% and 20%. Our pessimistic scenario includes the following assumptions: U.S. real GDP growth of 1.3% in 2013 and decelerates to 0.4% in 2014; An unemployment rate of 7.6% in 2013 and increases to 8.0 in 2014; Consumer sentiment of 80.1 in 2013 and declines to 76.1 in 2014 from 76.5 in 2012. Under the pessimistic scenario, we believe that most issuers' credit quality would hold up, given the financial cushions they have built, good inventory controls, and leaner operations since the previous recession. We could, however, revise our outlooks on some companies to stable from positive. Investment-grade companies (those rated 'BBB-' or higher) are better equipped to weather temporary weakness. The companies most at risk of downgrades would be those at the lower end of the speculative-grade scale, particularly those with negative outlooks. Additionally, we have seen a number of companies owned by private equity firms increase leverage through either a dividend, modest-sized acquisitions, or a sale to another sponsor. These companies could also be at risk if economic conditions weaken substantially.
Effects on ratings
Through the first nine months of the year, there were more downgrades than upgrades, with a ratio of 1.31 to 1 (see chart 4). This resulted from a slippage in credit quality tied to somewhat weaker-than-expected operating performance and increased debt issuance to fund acquisitions. In 2012, this ratio was almost even, with upgrades just slightly outpacing downgrades with a ratio of 1.03 to 1. Given that negative rating outlooks (15) exceed positive outlooks (5), prospects for rating changes over the next year suggest more downgrades than upgrades (see chart 3).
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
This would continue the longer-term trend of more downgrades than upgrades in the retail and restaurant sectors. Most downgrades will be a result of weaker operators losing market share as a result of intense industry competition or leveraged buyouts by financial sponsors. We do not expect the shutdown to have any immediate impact on our rated credits. Even for the U.S. military exchange retailers, a short-term shutdown is unlikely to affect credit profiles or outlooks given that these companies self-fund the bulk of their operations. (For more information, see our news comment, "The Government Shutdown Is Unlikely To Have Short-Term Effects On U.S. Military Exchange Retailers' Credit Profiles", published Oct. 1, 2013.)
Chart 3
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
Chart 4
We maintain ratings of 'CCC+' or lower on several of the companies we rate (see chart 5), which suggests vulnerability and the potential for additional defaults over the next year. During the first nine months, none of the publically rated retail companies defaulted.
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
Chart 5
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
dining, niche non-apparel stores, certain mid-tier department stores, and transportation. We believe that promotional activity could pressure margins during the balance of the year. However, off-price retailers, discounters, and dollar stores will continue to perform well thanks to the consumer's sharper focus on value. We expect share repurchase activity to continue at a fairly aggressive pace over the next year, especially for the large investment-grade companies and those at the higher end of the speculative-grade category with large amounts of cash. We have seen a number of companies refinance existing debt to take advantage of the low interest rate environment or to extend maturities. There have been some LBOs and a greater number of debt-financed dividends to financial sponsors. These transactions have either diminished credit quality or reduced potential for improved credit quality.
AA-/Negative/A-1+ 6/14/2013 AA-/Negative/A-1+ 6/14/2013 CCC-/Negative/-B-/Stable/-B/Stable/-B+/Stable/-NR B-/Stable/-BBB-/Negative/-6/17/2013 6/21/2013 6/21/2013 6/25/2013 7/9/2013 7/11/2013 7/16/2013
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
Contact Information
Contact Information
Credit analyst Robert Schulz, CFA Ana Lai, CFA David M. Kuntz Location New York New York New York Phone E-Mail
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Industry Economic And Ratings Outlook: U.S. Retail And Restaurant Ratings Will Be Stable With A Slight Negative Bias Amid Restrained Consumer Spending
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