Demand for industrial goods fell off a cliff in November, but global stimulus efforts could help offset that weakness. Still, it’s a good bet that capital goods producers won’t see a pickup in demand until late 2009 or 2010, meanwhile pension funding pressures could further strain the sector.
First, the good news. In its 2009 Outlook, Morgan Stanley points to massive fiscal stimulus plans in the U.S., Europe and China, with much of the spending aimed at infrastructure projects, as a significant plus.
Still, Morgan Stanley warns that the sector is in the early stages of a capital spending recession and cautions that oil and gas companies and mining companies that are dependent on commodity-related spending will be hard hit.
As this chart from Merrill Lynch shows, the global industrial economy is “falling like a stone” going into 2009, with the U.S. Institute for Supply Management Index diving to a 30-year low in November.
Merrill says investors should proceed with caution, as earnings in the sector will be under considerable pressure in 2009. The firm doesn’t expect a trough until later in 2009 and then only a weak recovery in 2010.
Amid weak demand and falling equity prices, Standard & Poor’s warns the capital goods sector will soon be contending with higher pension costs and funding needs that could further strain liquidity. The following chart shows the asset mix of capital goods companies covered by S & P, which remained heavily weighted toward equities through 2007.
New legislation signed by President Bush last week offers some temporary relaxation of pension funding requirements in the midst of the global credit crisis. Still, S&P is concerned.
We expect that many issuers rated by Standard & Poor’s Ratings Services will soon be confronting additional significant issues brought on by the market turmoil and broad stock market decline: higher pension costs, larger underfunded balances, and higher cash contribution levels that will place added pressure on their liquidity and other credit metrics.
For details, see “Pension Funding Levels Weigh Heavily on the U.S. Capital Goods Sector.”
Company executives have become markedly more pessimistic in the past month, according to a global survey conducted in early December by McKinsey & Co., with twice as many executives now saying they expect their companies’ profits to decline in 2009, compared with a month ago.
More executives said they expected to reduce the size of their workforces in the near term — 44 percent versus 39 percent previously. McKinsey said job reductions were aimed at raising cash rather than boosting profits, according to the executives.
Just over half expect deflation in the first quarter, and the economic downturn appears to have begun hitting developed markets harder over the month, with much higher proportions of executives in those countries saying conditions have gotten ’substantially worse.’
By region, Eurozone executives were least likely to say their companies have suffered lower profits as a result of the global economic turmoil, and Chinese executives more likely to say their companies have taken a hit.
Despite the gloom and doom in the corner office, McKinsey sees industry bright spots over the longer term in steel and high tech –specifically IT spending. The report, “Industry Trends in the Downturn,” is available free on The McKinsey Quarterly Web site.
Looking for some light reading while sitting by the yule log? The Capital Markets and Securities practice at Paul Weiss has just published a primer for the bailouts, a Reference Guide to the U.S. Rescue Efforts.
The 50+ page report has been updated to include events of the past week and is available for free download.
North American manufacturers face more stresses that will likely persist in 2009 and even possibly 2010, according to Moody’s Investors Service, due mainly to a worsening global recession that is now spreading from Europe to Asia.
Not surprisingly, manufacturers are trying to get in front of the downturn by cutting costs through restructuring or layoffs. Caterpillar Inc. (NYSE:CAT) was the latest to offer voluntary buyouts to managers and slash their pay by up to 50 percent next year.
Moody’s says similar cost-cutting measures have been announced recently at Danaher Corp. (NYSE:DHR), Carlisle Companies Inc. (NYSE:CSL), Rockwell Automation Inc. (NYSE:ROK) and Tyco International, (NYSE:TYC).
Lower business volumes will result in declining revenues and stress on operating margins. Restructuring actions and lower commodity costs could partially offset the effect of lower volumes.
Among manufacturers, some sectors will be hit harder than others in 2009 by crumbling demand, as illustrated by Moody’s in the following table:
For stronger manufacturers with healthy balance sheets and access to stable funding, the severe recession offers opportunities for strategic acquisitions, Moody’s points out.
For details, see “North American Diversified Manufacturers: Six Month Industry Update.”
Investors looking for a refuge from the global credit storm might consider telecommunications companies in the Asia Pacific region — minus Japan, of course.
Though negative pressures from the global economic recession could build during the coming year, Moody’s Investors Service still sees ample cash flow overriding the negatives, and has a “stable” outlook for the sector.
Compared to other regions, a disproportionately higher number of rated Asia Pacific telecom operators are investment grade. Liquidity for these investment grade issuers..tends to be relatively strong, as reflected by high cash balances and consistent cash flows, well-laddered debt maturities and manageable debt-servicing requirements.
The region will not be immune to the credit crisis and global recession, Moody’s says, with funding getting more expensive and households having less discretionary income. But the ratings agency expects that, just as happened in Japan during the “lost decade” of the 1990’s, households will still spend on telecom.
For example, Moody’s says that despite slowing economies in Australia and Hong Kong, consumers so far are not putting off cell phone upgrades. The local servicers, Telstra Corp.(TLSYY), PCCW Ltd (PCCWY) and City Telecom Ltd (CTEL), are still generating healthy growth.
For details, see “Snapshot: Asia Pacific (ex-Japan) Telecommunications Sector.”
Homebuilders have had a rough 2008, with revenues down nearly 40 percent in the first nine months of the year. Figures due out this week for November existing and new home sales are expected to show a further slide in the housing market.
And now, in a 15-page outlook report for 2009, Fitch Ratings says the tough times are far from over.
As weak as housing has been, it could deteriorate further, influenced in particular by job losses, fear of job loss, poor consumer confidence and lack of income growth or possibly income contraction…Fitch concludes that operational and financial pressures will persist and probably intensify for the public homebuilders during 2009.
The ratings agency has lowered its credit ratings for most of the homebuilders, including Beazer Homes USA (NYSE:BZH), Centex Corp. (NYSE:CTX), D.R. Horton Inc. (NYSE:DHI) , KB Home (NYSE:KBH), Lennar Corp. (NYSE:LEN) and Toll Brothers Inc. (NYSE:TOL).
Even with the promise of a housing stimulus program from Congress in early 2009 aimed at forestalling foreclosures, Fitch says any such actions would be unlikely to stabilize or boost housing demand until late 2009 or even later.
For details, see “U.S. Homebuilding 2009 Outlook: First Housing, Now the Economy: The Housing Downturn Extends into its Fourth Year.”
To no surprise, the troubles of Detroit were on readers’ minds during the past week. In the days leading up to the TARP-funded bailout of GM and Chrysler, two of the most well-read posts on Research Recap were our roundup on the troubles facing automotive suppliers and a related post that points out that labor issues are but a small part of the struggle that the Big Three face and explored the “truthiness” of the $73 per hour wage that is frequently bandied about.
Readers were also looking forward but were not necessarily pleased by what they saw. Analysis by CreditSights shows that the peak maturity profile for U.S. leveraged finance deals made in 2006 and 2007, the height of the credit craze, is from 2011 to 2014. The fact that much of that debt had weak terms and low coupons is compounded by the large amounts of leverage in those deals.
While December typically brings careful analysis of retail spending, Research Recap readers barely took notice of a CreditSights post on continued pain for retailers, tech and media due to weak consumer demand and decimated margins. It seems we’ve already become immune to reports of weak holiday sales.
The week closed with news that S&P had downgraded a dozen US and European financial institutions. While investors are no doubt anxious to bring 2008 to a close, there’s little to suggest that the start of 2009 will bring substantive change to the global economy.
Posting will be light this week and next due to the holidays.
The Research Recap team wish you a happy and healthy Christmas, Chanukkah, Kwanzaa, winter solstice or your favorite non-denominational winter-themed holiday. And, of course, a prosperous new year. Or a bailout, if that doesn’t happen.
Apparently, Standard & Poor’s Credit Research didn’t get the memo. U.S. Treasury Secretary Henry Paulson told CNBC earlier this week that he doesn’t foresee another major financial institution failure, seemingly giving the U.S. banking system the all clear.
The ratings agency made big news on Wall Street with its downgrades of 12 U.S. and European financial firms. Less publicized was S&P’s downgrade of the U.S. and U.K. financial systems by lowering their Banking Industry Country Risk Assessment, or BICRA, ratings by a notch.
The BICRA downgrades primarily reflect our opinion of the banking systems’ ongoing credit deterioration, the need for banks to rebalance their funding profiles, and macroeconomic weakness, among other factors.
The following chart accompanied S & P’s downgrades of major U.S. and European companies:
The downgrades and revised outlooks reflect our view of the significant pressure on large complex financial institutions’ future performance due to increasing bank industry risk and the deepening global economic slowdown.
So how bad is it?
Some on the blogosphere were trying to read something into the news that JPMorgan Chase CEO Jamie Dimon is reportedly not requesting a bonus this year. Dealbreaker queried whether Dimon made the move preemptively:
Could J.P. Morgan be sitting on some assets that, when they go bad, people will question why in the hell Dimon took his bonus if he knew this was coming?
Meanwhile, Treasury’s Paulson said he would be asking Congress for the release of the remaining $350 billion in funds meant for bank and housing industry bailouts. Some of the money is needed for the $17.4 billion pledged to the auto industry.
For details on S & P’s ratings moves, see “Research Update: JPMorgan Chase & Co…JPMorgan Chase Bank N.A. Downgraded to ‘AA-’” among others.
It hasn’t been a good week for investment-banks-turned-bank-holding-companies Goldman Sachs Group (NYSE:GS) and Morgan Stanley (NYSE:MS).
Both reported their first quarterly losses as public companies this week. And Moody’s Investors Service cut both companies’ ratings on non-FDIC-insured debt one notch to “A1” from “Aa3” for Goldman and to “A2” from “A1” for Morgan Stanley.
Moody’s is maintaining a negative outlook on the companies, meaning that more ratings cuts could come in 2009.
The Financial Times reports that Goldman’s rank and file got to share in the bad news this week after they were notified that their 2008 bonuses were slashed by 80 percent.
Today, Moody’s released a special comment elaborating on its downgrades and pointing to what it called the outperformance “by a wide margin” of Goldman’s core business when compared to Morgan Stanley’s.
This analysis demonstrates that Goldman Sachs outperformed Morgan Stanley by a wide margin, as the latter’s core franchise earnings were overwhelmed by asset write-downs during the year. This was an important factor in our ratings discussion and the rating outcome for the two firms relative to each other.
The Wall Street Journal online pointed out that Morgan Stanley’s quarterly results were boosted by the firm’s buyback of more than $2 billion of its own debt. But as the WSJ graphic below shows, the firms’ credit default swap spreads reflect greater market skepticism about Morgan.
Regardless of where Goldman and Morgan stack up vis-à-vis one another, Moody’s points to the biggest factor clouding the outlook at both companies: the global recession and “hostile capital market conditions in 2009 and possibly beyond.”
For details, see “2008 Operating Performance – A Factor in the Ratings Actions on Goldman Sachs and Morgan Stanley.”