U.S. Consumer: Spending in the Age of Covid

Winnie Cisar - Global Head of Strategy
James Dunn - Senior Consumer Analyst
James Goldstein, CFA - Senior Retail & Gaming Analyst
Matt Woodruff, CFA - Senior Aerospace and Defense, Transportation Analyst
David Bussey, CFA - Senior Gaming, Lodging, and Leisure Analyst
Ben Morgan - Senior US Consumer Analyst
Noah Schucking - Senior US Retail Analyst

EXECUTIVE SUMMARY
  • Persistent inflation has become the driving force of corporate credit market valuations and performance. In this report we provide sector level analysis of the latest inflationary drivers, looking at how companies are dealing with the headwinds and where higher costs are driving deterioration in credit metrics.
  • At the consumer level, while we have seen a marked shift in consumption patterns (away from durable goods categories and in favor of more experience and service based categories…and the goods that support those activities), we still have a generally positive view of the spending outlook, with consumption supported by strong employment metrics and healthy consumer balance sheets. However, with inflation continuing to march higher, we are starting to see signs of price elasticity. In this context, investment considerations have become more nuanced, requiring a company by company analysis rather than a broad sector allocation approach.
  • Elevated inventories, and the repercussions of challenging supply chain dynamics came home to roost for certain retailers this quarter, leading some to lower guidance in expectation of clearance activity to move through newly out-of-favor goods.
  • Notably, we have continued to see robust demand for leisure travel despite higher gasoline prices. Given the level of pent-up demand, we expect travel spending to remain strong throughout the year, and think that travel demand can be sustained at healthy levels for so long as the employment picture holds.
RELATIVE VALUE

Persistent inflation has become the driving force of corporate credit market valuations and performance. A combination of policy tightening, nagging supply chain disruptions and inventory challenges weigh on borrowing costs, liquidity and operations for a wide range of IG and HY consumer-aligned issuers. At the same time, heightened uncertainty around the ability of US consumers to remain resilient in the face of rampant price acceleration has raised questions around the durability of the reopening trade and the potential magnitude for a deceleration (or contraction) in goods demand. These factors have resulted in meaningful spread dispersion across issuers and sectors, a trend we also observe across the consumer cohort.

In the IG market, Leisure, a relatively small sector, has posted outsized spread widening versus the broader market, while consumer goods and retailers (heavily dominated by bellwether names like WMT, HD, etc) have fared somewhat better. Similarly, in the HY market, a handful of consumer sectors, including Leisure and Food & Beverage, have seen spreads gap wider, while others (Restaurants, Theaters, Gaming and Hotels) have been somewhat more durable. Consumer valuations, relative to the IG and HY indices, are mixed, offering opportunities to pick up yield and spread or shed risk in credits that have offered somewhat more stability. Across the consumer sectors, we recommend a nuanced approach to credit selection that generally favors credit risk over duration risk and focuses on company specific catalysts, which are more likely to drive market performance in the coming months.

Inflationary concerns have made their way into our investment considerations within the Consumer Goods space. For some companies, the impact to margin has resulted in deteriorating leverage metrics. We do not think this merits a risk off approach for the sector, but rather a more selective company specific approach. Certain categories have demonstrated more resilient pricing power than others, which has helped with margin preservation (e.g. beverages, protein), but even in challenged categories we have seen a spectrum of margin results. This bifurcation has so far played out the most among mid- to low-BBB F&B companies. Here, we have taken a more cautious approach to names like ConAgra Brands where significant cost headwinds have driven severe margin erosion and pushed net leverage into the mid-4x range and introduced fallen angel risk into the name. Instead, we favor exposure to Kraft-Heinz, where we do not think the market is giving KHC credit for its performance to-date as KHC spreads trade in-line with CAG despite the company having maintained margins and leverage metrics much more successfully (MRQ net leverage was 3.3x at KHC vs. 4.5x at CAG). In home and personal care, Clorox Co has already seen one ratings downgrade materialize from inflationary pressures in resin and broad-based supply disruptions, and we are still taking a cautious approach to the credit on our expectations for a prolonged margin recovery and elevated trade down risk across its portfolio.

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