Industry Top Trends 2016 Capital Goods

Transcription

1 CORPORATE INDUSTRY CREDIT RESEARCH December 9, 215 Industry Top Trends 216 Capital Goods WEAK COMMODITIES COULD OVERWHELM POCKETS OF STRENGTH Credit Analysts Sarah Wyeth New York standardandpoors.com Ratings Outlook. Although 8% of Standard & Poor's Ratings Services' ratings on companies in the capital goods sector have stable outlooks, the majority of recent rating actions have been negative and there is a clear negative bias among the companies that do not have stable outlooks. Depressed Commodity Prices. Weak demand for products and services used in the commodity markets has had a considerable impact on the capital goods sector, which will likely persist in 216. Vincent Gusdorf Paris vincent.gusdorf@ standardandpoors.com China Slowdown. The slowing pace of economic growth in China will likely continue to weigh on investment in the region (APAC), especially investment related to construction equipment and factory automation, and increased headwinds for commodity prices. Hiroki Shibata Tokyo hiroki.shibata@ standardandpoors.com Auto Production Remains Supportive. The strong growth of global auto sales and the increased level of regulatory scrutiny in the sector should support healthy capital expenditure (capex) spending by the original equipment manufacturers (OEMs). Solid U.S. Construction Activity. Companies with exposure to U.S. construction activity that is not tied to the oil and gas industry should benefit from solid growth. In addition, while the industrial economy as a whole has weakened, pockets of stability--if not growth-remain. 1 Softening Appetite For Capex Offset By Increasingly Aggressive Financial Policies. As the level of uncertainty in their end markets increases, capital goods issuers have decreased their capex; however, this has been offset by increased shareholder rewards as companies bow to investor pressure to return more of their cash. STANDARD & POOR'S RATINGS SERVICES

2 Industry Top Trends 216: Capital Goods December 9, 215 RATINGS TRENDS AND OUTLOOK GLOBAL CAPITAL GOODS RATINGS DISTRIBUTION AND OUTLOOK CHART 1 RATINGS DISTRIBUTION CHART 2 RATINGS DISTRIBUTION BY REGION Capital Goods AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C SD D North America Latin America AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C SD D CHART 3 RATINGS OUTLOOKS WatchPosPositive 1% 1% Negative 15% WatchNeg 2% CHART 4 RATINGS OUTLOOK BY REGION Negative WatchNeg Stable WatchPos Positive 1% 8% 6% 4% Stable 81% 2% % APAC LatAm W.Eur CHART 5 RATINGS OUTLOOK NET BIAS Net Outlook Capital Goods Bias (%) CHART 6 RATINGS NET OUTLOOK BIAS BY REGION Net Outlook Bias (%) Latin America Source: S&P Ratings 2 STANDARD & POOR'S RATINGS SERVICES

3 Industry Top Trends 216: Capital Goods December 9, 215 FORECASTS KEY INDUSTRY FORECASTS CHART 7 REVENUE GROWTH (ADJUSTED) CHART 8 EBITDA MARGIN (ADJUSTED) 1% 5% % -5% -1% -15% Global Forecast % 18% 16% 14% 12% 1% 8% 6% 4% 2% % Global Forecast CHART 9 DEBT / EBITDA (MEDIAN, ADJUSTED) CHART 1 FFO / DEBT (MEDIAN, ADJUSTED) 6.x Global Forecast 35% Global Forecast 5.x 3% 4.x 3.x 2.x 25% 2% 15% 1% 1.x 5%.x % Source: S&P Ratings. All figures are converted into U.S. Dollars using historic exchange rates. Forecasts are converted at the last financial year end spot rate. 3 STANDARD & POOR'S RATINGS SERVICES

4 Industry Top Trends 216: Capital Goods December 9, 215 ASSUMPTIONS KEY INDUSTRY ASSUMPTIONS 1 Weak Commodity Markets 2 Slowing Growth In China 3 Increasing Auto Production We expect that commodity prices will remain weak in 216. We believe that the price of oil (West Texas Intermediate) will bottom out at $45 per barrel in 215 before improving slightly to $5 a barrel in 216. The slow recovery reflects our view that the supply and demand dynamic in this sector will likely remain imbalanced because oil production has not meaningfully declined. We also maintain a similarly weak outlook for other commodities. The slowdown in the Chinese macro economy could negatively affect the capital goods industry, particularly by further reducing demand for construction machinery and factory automation products for technology businesses, including smartphone makers. The economic weakness in China, linked to weak commodity prices, could also lead to further declines in the flow of investment to the emerging countries in the Asia- Pacific region. We expect that the volume of global auto sales will increase by about 2% in 215 and by about 3% in 216 as global light-vehicle sales hover above 9 million units. This growth will vary across regions, but we expect that Europe will lead the way followed by the U.S. and then the emerging markets. 1. Weak Commodity Markets We expect that commodity prices will remain weak in 216. We believe that the price of oil (West Texas Intermediate) will bottom out at $45 per barrel in 215 before improving slightly to $5 a barrel in 216. The slower-than-expected recovery reflects our view that the supply and demand dynamic in this sector will likely remain imbalanced because oil production has not meaningfully declined. This will likely weedout the weaker exploration and production (E&P) companies, many of whom are customers of capital goods companies. However, we believe that the 3%-4% cuts in capital spending on upstream equipment investment, specifically in fracking, so far in 215 represents the worst of the cuts that we will see. Although demand will likely remain weak, and possibly even contract further, we do not expect that any future contractions will be as severe as what we saw this year. However, the demand for products with longer lead times, especially those used in large projects, will likely decline significantly in 216. We believe that companies' healthy backlogs supported demand for these products in 215, but that their declining orders and backlogs point to difficult conditions during the next year. Prices in other commodity markets will also likely remain weak as China now accounts for 4%-5% of the global demand for raw materials and concerns over slowing growth in that country will likely prevent any meaningful recovery in prices in 216. We therefore expect that the prices for most base metals will remain low in 216. Coal prices will also likely remain weak given the uncertainty regarding the future pace of China s growth. Furthermore, the current regulatory environment and the trend to use renewable energy in developed economies will likely limit the demand for coal, further pressuring prices. 2. Slowing Growth In China We forecast that GDP will increase by around 5.5% over the next two years, which includes the weaker-than-expected trade data and financial turbulence in China. China's economic slowdown is directly and indirectly affecting commodity prices, currencies, capital flows, business and consumer confidence, and the level of future capex in APAC. We don't expect that the level of capex in APAC will increase significantly in 216, given the sluggish commodity prices and the slowing Chinese economy. However, consistent infrastructure and government spending should still support modest construction demand during the next two years. 4 STANDARD & POOR'S RATINGS SERVICES

5 Industry Top Trends 216: Capital Goods December 9, Increasing Auto Production The Chinese car market, the main source of growth for the global auto industry in recent years, is now experiencing a change of fortune. Since June 215, monthly passenger car sales have recorded year-on-year declines, although the declines have been less pronounced in recent months. We now believe that low-single digit sales growth of between 2% and 5% a year will be the new normal for the Chinese auto market in 215 and 216. In our base-case scenario, we expect that China's auto industry will continue to grow in the coming years for three reasons. First, there is the large fundamental demand from the growing Chinese middle-class family segment. Second, various auto financing services are becoming more widely available to consumers and some sales taxes are being lifted on smaller vehicles. Third, we see potential for a delay or loosening of new car registration rules for large cities and the continued penetration of cars into China's tier 3 and 4 cities. 4. Good U.S. Nonresidential Construction Activity Returns In 216 CHART 11 U.S. NON RESIDENTIAL CONSTRUCTION GROEWTH Growth Rate (%) e 216e 217e Source: U.S. Census Bureau, S&P Ratings Our forecast for U.S. nonresidential construction activity includes construction related to the oil and gas industry. In 215, we expect that the overall level of U.S. nonresidential construction activity will remain flat. In 216 and 217, we expect that the level of nonresidential construction activity will increase by about 6% and 9%, respectively, demonstrating that construction activity that is not related to the oil and gas markets will likely be robust in the coming years. 5 STANDARD & POOR'S RATINGS SERVICES

6 Industry Top Trends 216: Capital Goods December 9, 215 RISKS AND OPPORTUNITIES KEY INDUSTRY RISKS AND OPPORTUNITIES 1 Further Declines In Commodity Prices 2 Exposure To China 3 Increased Automation In Auto Production Although we believe that the most dramatic declines in commodity prices are already behind us, the prolonged pressure that these low prices placed on manufacturers who serve these markets could cause their credit quality to weaken. We believe that the biggest risk for these companies, especially U.S.-based capital goods issuers, is that the price of oil may decline further. A reduction in Chinese investment, for example in natural resources, would significantly affect the capital goods industry, particularly the construction and industrial machinery subsectors. The declining growth rate of the domestic Chinese macro economy, as well as the country's sluggish real estate and equity markets, will likely cause the level of machinery orders to weaken. This will affect overall investor sentiment in the region. We expect that capex spending in the automotive sector will remain healthy as carmakers increase their presence in the emerging markets, invest in technology related to emissions regulations, and address technological changes such as automation and connectivity. On the downside, the slowdown in the Chinese economy may lead some automakers to reduce their capex in this market. 1. Further Declines In Commodity Prices, Especially For Oil, Could Weaken The Credit Quality Of Some Capital Goods Companies Although we believe that the most dramatic declines in commodity prices are already behind us, the prolonged weakness of these commodities could pressure the credit quality of manufacturers that make equipment for the mining and other commoditydriven markets. We believe that the biggest risk, especially for U.S.-based capital goods issuers, is further declines in the price of oil. This would not only affect issuers that have direct exposure to the oil and gas markets, but could also hurt companies in ancillary markets such as construction and infrastructure. We expect that additional oil price declines would hurt broader business confidence and lead managers to be more conservative when considering investments. Many capital goods issuers benefitted from the commodities boom and are now navigating the bust. Coal and metal miners have faced challenging market conditions since 213, partly because of the commodity super cycle, which led many miners to increase their capacity. These miners still have excess capacity, which should allow them to postpone replacement and maintenance spending. We believe that if commodity prices remain pressured and the mining industry continues to contract, some issuers could be challenged to maintain their current credit quality. 2. Construction Equipment And Industrial Machinery Manufacturers Could Be Pressured In China A reduction in Chinese investment, for example in natural resources, would significantly affect the capital goods industry, particularly the construction and industrial machinery subsectors. In addition, the declining growth rate of the domestic Chinese macro economy, as well as the country's sluggish real estate and equity markets, will likely cause the level of machinery orders to weaken. If the Chinese government chooses to scale back its expenditures on infrastructure, this downside pressure will likely increase even further. Additionally, the knock-on effect on the emerging countries in Southeast Asia could cause the level of investment by developed countries in the region to decline. While the slowdown of the Chinese economy seems to be a rather negative event, every cloud has a silver lining. Spare capacity will lead to more competitive labor costs and some bottlenecks that are currently holding back the economy could be removed. 6 STANDARD & POOR'S RATINGS SERVICES

7 Industry Top Trends 216: Capital Goods December 9, 215 Furthermore, the Chinese government will likely invest a significant amount to mitigate this downward trend, which could stimulate the region s economy. 3. The Increased Level Of Automation In Auto Manufacturing Should Support Growth Expertise in automation should benefit companies that are exposed to the automotive industry. We continue to see substantial growth opportunities in the discrete automation (the manufacturing and assembly of parts and components to a finished product) of auto production as the level of robot penetration in this sector remains low in our view, especially in the U.S. In addition, we believe that competitive intensity will remain moderate in the near term. This should benefit companies such as Siemens (the market leader in discrete automation), ABB, Rockwell Automation, and Emerson Electric, among others. 4. The U.S. Construction And Certain Manufacturing Activity Could Partly Offset The Headwinds From Oil And Gas Capital goods issuers that have exposures to U.S. construction and certain manufacturing activity should be able to weather the challenges caused by the weak commodity markets. In particular, general equipment rental providers are positioned to benefit from the healthy growth of U.S. commercial construction activity. Those with broad geographic coverage and the operational wherewithal to efficiently move equipment between regions should be able to capitalize on the cyclical upswing that we expect to see over the next two years. In addition, some pockets of the North American industrial economy should continue to support issuers in this region, in particular, aviation, and factory automation. FINANCIAL POLICY Despite an uncertain economic outlook for the capital goods sector, investors have pressured companies to increase their shareholder returns, especially in the form of share buybacks. Management teams have had to walk a fine line between managing their balance sheets through difficult times and keeping their shareholders happy to the extent that they do not attract activist investors. In some regions, particularly North America, we see little to no reason why investors would ease up in 216, so we believe that more aggressive financial policies will continue to drive many of the rating actions in the sector. The tendency for capital goods issuers to reduce their capex, which we expect they will do in 216, modestly offsets their less conservative financial policies. 7 STANDARD & POOR'S RATINGS SERVICES

8 Industry Top Trends 216: Capital Goods December 9, 215 GLOBAL CAPITAL GOODS: CASH, DEBT AND RETURNS CHART 12 CASH & EQUIVALENTS / TOTAL ASSETS CHART 13 TOTAL DEBT / TOTAL ASSETS Global Capital Goods - Cash & Equivalents/Total Assets (%) LTM Global Capital Goods - Total Debt / Total Assets (%) LTM CHART 14 FIXED VS VARIABLE RATE EXPOSURE CHART 15 LONG TERM DEBT TERM-STRUCTURE 1% 9% 8% 7% 6% 5% 4% 3% 2% 1% % Variable Rate Debt (% of Identifiable Total) Fixed Rate Debt (% of Identifiable Total) LTM LT Debt Due 1 Yr LT Debt Due 3 Yr LT Debt Due 5 Yr Nominal Due In 1 Yr $ Bn 1,2 1, LT Debt Due 2 Yr LT Debt Due 4 Yr LT Debt Due 5+ Yr CHART 16 CASH FLOW AND PRIMARY USES CHART 17 RETURN ON CAPITAL EMPLOYED $ Bn 3 25 Capex Net Acquisitions Operating CF Dividends Share Buybacks 7 6 Global Capital Goods - Return On Capital (%) Source: S&P Capital IQ, S&P Ratings calculations 8 STANDARD & POOR'S RATINGS SERVICES

9 Industry Top Trends 216: Capital Goods December 9, 215 Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook. No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an as is basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, (free of charge), and and (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at Australia Standard & Poor's (Australia) Pty. Ltd. holds Australian financial services license number under the Corporations Act 21. Standard & Poor s credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act). Copyright 215 by Standard & Poor s Financial Services LLC. All rights reserved. STANDARD & POOR S, S&P and RATINGSDIRECT are registered trademarks of Standard & Poor s Financial Services LLC. 9 STANDARD & POOR'S RATINGS SERVICES