Consumer-Products Companies Cut Costs, but Woes Continue

As we enter the calendar fourth quarter, Standard & Poor's Ratings Services believes that the remainder of 2009 will constitute an ongoing challenge for most rated consumer-products companies. This will be especially true for issuers in the apparel, furniture, bedding, and appliance subsectors, since they have close ties to the retail environment and housing market, both of which remain weak.

We continue to believe ratings in the speculative-grade sector are more likely to suffer along with the weak economy. These companies tend to be smaller and highly leveraged, which results in less margin for error on operating shortfalls. Liquidity is a key rating concern for speculative-grade issuers, because many of these companies continue to have tight financial covenant cushions, making them more vulnerable to potential covenant violations.

As their higher ratings indicate, investment-grade companies should be better positioned to withstand the difficult operating environment. They're generally larger, more diversified, and benefit from purchasing and pricing power economies of scale. They generally also have stronger cash flows and more solid balance sheets, with easier and less costly access to the capital markets than their speculative-grade counterparts.

Downgrades Outnumber Upgrades The U.S. consumer-products companies that Standard & Poor's rates include an array of subsectors, including packaged food, alcoholic and nonalcoholic beverages, tobacco, household products, apparel, personal care, appliances, lawn care, home and office furniture, agriproducts, commodity foods, cosmetics, and service companies. About 32% of companies in the sector are in the more stable investment-grade category, with the remaining 68% in the more volatile speculative-grade category.

In 2008, downgrades outnumbered upgrades in the sector by just over 3-to-1, but the balance has tipped so far this year, with a ratio of 5-to-1 as of Sept. 24, 2009. About 33% of issuers in the sector have either a negative outlook or are on CreditWatch with negative implications. Only about 9% of sector issuers have either a positive outlook or are on CreditWatch with positive implications.

Roughly 44% of all consumer-products issuers fell into the B category as of Sept. 24, vs. about 27% at the end of 2002. In fact, B has replaced B+ as the primary rating in the B category (which ranges from B- to B+) for consumer-products companies. Ratings for about 6% of the consumer-products companies we rate are lower than B-, about the same as at year-end 2007, and slightly less than 4% of all consumer-products companies that we rate are in the CCC category.

Companies Trading Down So far in 2009, Standard & Poor's has lowered ratings on eight rated consumer companies to either D (default) or SD (selective default), and three of these eight companies (Merisant Worldwide, Spectrum Brands (SPEB), and Eurofresh) had filed for relief under Chapter 11 of the U.S. Bankruptcy Code. This represents twice as many changes to D or SD within the rated consumer sector as compared with those in the same period in 2008, when we lowered four rated consumer companies to D. Spectrum Brands (B-) emerged from bankruptcy on Aug. 28, and we assigned ratings on Sept. 16.

Many companies have taken steps to reduce costs and improve efficiencies during this recession, while some consumers have traded down to value brands and private label. Some companies have restructured their business, reduced headcount, and increased pricing, among other actions.

Commodity costs have abated to some extent from higher levels in 2008, but they're still higher than the historical levels. For example, the price of corn was about $3 per bushel as of Sept. 23, down from about $5 per bushel a year earlier, and still above 2006 monthly ranges of $2-$3 per bushel. Gasoline prices have been creeping up again, which may make it harder for consumers to spend their money on discretionary items. Oil is currently hovering around $70 per barrel, up from about $50 per barrel earlier this year, yet still down considerably from its July 2008 spike to close to $147 per barrel. We believe the additional dollars spent at the pump will likely have to come out of their budgets for other discretionary spending. Traffic at retail outlets is down, resulting in continued softness in sales for apparel, durable goods, and other discretionary consumer goods.

Furnishings Still Down Despite some recent pickup in housing sales, we believe the housing market remains in a downturn, which will continue to limit sales of housing-related items and furnishings. The weak economy and housing market recently led us to take a negative rating action on one company in the housing-related items and furnishings sector.

On Sept. 9, we placed our ratings on Mohawk Industries (MHK) (BB+), a floor covering manufacturer, on CreditWatch with negative implications, reflecting our concerns about the company's difficult operating environment, increased leverage, and our expectation for a further weakening in credit measures over the near term. Although the company has taken actions to reduce operating expenses and improve cash flow and liquidity, we believe it continues to be challenged by the recession and housing downturn, given that approximately 70% of its sales are from the residential market.

The domestic office furniture industry has been contending with the ever-increasing unemployment rate in the U.S. As a result, office furniture manufacturers continue to be hurt by declining demand. On Aug. 6, Standard & Poor's revised its outlook on Herman Miller (MLHR) (BBB) to negative from stable. The outlook revision is based on our expectation that operating performance will remain weak over the next year, given the weak economy and challenging global demand environment for office furnishings, and for some further deterioration in key credit measures.

Shoring Up Balance Sheets Investment-grade companies continue to tap the debt markets for refinancing of 2009 and 2010 maturities as the credit environment remains open for this sector. Recent debt issuance activity in the investment-grade sector has included Procter & Gamble's (PG) (AA-) and Procter & Gamble International Funding's combined $1.5 billion senior notes issuance, Colgate-Palmolive's (CL) (AA-) issuance of $300 million medium-term notes, Coca-Cola Enterprises' (CCE) (A) issuance of $250 million senior unsecured notes, and H.J. Heinz (BBB) subsidiary Heinz (H.J.) Finance's issuance of $250 million of senior unsecured notes.

In the speculative-grade sector, Smithfield Foods (SFD) (B-) issued $225 million of senior secured notes, and most recently, Dole Food (B-) issued $315 million junior-lien senior secured notes.

For many companies, we expect management to continue to scale back on debt-financed and quarterly dividends, as well as share repurchases in light of current difficult, albeit somewhat improved, credit markets and/or to conserve cash. We believe that credit access to finance aggressive shareholder dividends and leveraged buyouts for speculative-grade companies is scarce to nonexistent. In addition to potential financial buyers facing challenges to obtain debt financing to acquire these already highly leveraged companies, many of these companies may be working to shore up their balance sheets and avoid covenant defaults. We believe even some investment-grade-rated companies that had once been active in accelerated and/or large share repurchase programs continue to exercise more prudent financial policies.

Little Willingness to Increase Leverage Although mergers-and-acquisitions activity may be picking up, as demonstrated by Kraft Foods' (KFT) (A-) recent £10.2 billion unsolicited proposal to acquire Cadbury (CBY) (BBB) and combine the companies as part of a potential cash and share offer for the group, we still believe there will likely be fewer acquisitions in the consumer-products sector in the remainder of 2009. Those that do occur will probably be strategic and opportunistic, and more often characterized more by smaller bolt-on acquisitions rather than leveraged buyouts by private equity or other financial sponsors.

We also believe that it is likely that the larger opportunities will be at least partially equity financed, because many companies will likely be less willing to increase leverage to make acquisitions as they are more mindful of their balance sheets in the current credit environment. Increasing access to the credit markets for speculative-grade issuers continues to contribute to a more optimistic outlook for potential issuer refinancing of upcoming debt maturities.

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