High yield bond and leveraged loan issuance for consumer food and beverage companies in North America and Western and Southern Europe enjoyed a surge in activity in Q1 2020. Both values and volumes experienced an uptick quarter-on-quarter, with values jumping from US$9.7 billion in Q4 2019 to US$21.6 billion at the start of the year.
Despite strong first quarter issuance, the overall outlook for the rest of the year is uncertain. COVID-19 lockdowns may see some consumer food and beverage groups take a hit to earnings, which will feed through to credit quality and lender appetite, while many other brands have benefited from the sharp shift to online orders and from increased demand via supermarket channels.
At the same time, consumer food and beverage companies of all types and sizes may face long-term earnings pressure and uncertainty as extended lockdowns affect consumer spending.
While these concerns weigh heavily, the industry overall has proven more resilient than many other sectors. The S&P Food and Beverage Select index climbed by more than a quarter in the past two months, recovering almost all the losses suffered in the immediate aftermath of COVID-19’s initial spread. Moreover, food and beverage companies on both sides of the Atlantic have been able to raise finance after lockdowns were imposed.
Mixed fortunes for the sector
While issuance has held steady, some parts of the industry have faced more disruption than others. A clear divide has opened between companies supplying restaurants, schools and hotels, and those supplying supermarkets and consumers directly.
This is unsurprising given the impact of COVID-19 lockdowns. The UK’s Office for National Statistics reported a 31.1% contraction in the accommodation and food services industry between February and March. One effect of US lockdowns is suggested by credit rating agency S&P’s assumption that demand for meat in the US food services space could fall by as much as 50% this year.
Companies that supply supermarkets and sell direct to consumers have encountered much less weakness in product demand—and in some cases sharp spikes in demand—during the pandemic. For example, General Mills, which generates about 85% of its revenues from the consumer vertical, expects to exceed revenue forecasts for the financial year. Other food and beverage groups with similar customer profiles, including Nestlé and Mondelez, have also seen steady earnings growth through the pandemic.
The resilience of food and beverage companies with lower exposure to the food services segment has supported lender appetite. Food processor Cargill generates less than 10% of its sales from food services and was recently able to raise US$1.5 billion of financing at attractive pricing. Mondelez has issued bonds to a value of US$1.5 billion while beverage companies Diageo and Coca Cola have also enjoyed successful bond issues. Nestlé’s bond issue was so successful it was heavily oversubscribed, with the group raising €2 billion (US$2.2 billion) against €13 billion (US$14.3 billion) of demand.
Issuers across the industry have benefitted from the Federal Reserve’s support for capital markets and its program to buy up investment grade and “fallen angel” bonds. The fiscal support has injected much needed liquidity into the system and lenders have jumped at the opportunity to back solid credits in the sector.
Investors have also been willing to finance M&A that helps food and beverage groups pivot away from food services to consumer distribution. Lenders have provided additional capital to support companies pursuing deals that deliver this kind of diversification.
Squeezed supply chains
All companies in the sector, regardless of customer base, however, have encountered supply chain risk because of COVID-19.
The US Department of Agriculture has reported declines in beef and pork processing of 27% and 20% respectively, and meat companies including Smithfield Foods, Cargill, Specialty Foods Group and Tyson Foods have closed meatpacking facilities, at least temporarily, because of COVID-19. The impact on supply chains has already been felt, with fast food chain Wendy’s forced to remove burgers and other beef-based items from its menu in some restaurants and Costco limiting meat purchases.
Operators have been able to reopen some sites, but the possibility of ongoing disruption remains a risk to earnings, with implications for creditworthiness and the ability to turn to debt markets for liquidity. Credit Rating agency Fitch, for example, moved its rating outlook on Tyson Foods to negative because of the interruption to operations caused by COVID-19.
Despite the risk of supply chain disruption, food and beverage groups have generally been able to weather economic storms and access debt markets when necessary.
Bond markets are expected to remain the primary source of capital for the industry through the year.
Loan markets effectively shut down in the middle of Q1 2020. Loan prices are linked to interest rates, which have been pushed further down by the pandemic, and banks have been cautious about trying to syndicate loans to institutions in such an uncertain market. The term loan B market is expected to remain shut for now, with lenders focusing on bonds, amortizing term loan A debt and revolving credit facilities.
Leverage levels have always been fairly conservative in the industry, given its typically thin margins. Most companies in the space will have room to take on additional lending without pushing up against covenants.
Companies that have recently undertaken large acquisitions funded with debt may find it harder to source funding, as will those with large exposure to food services. Lenders will also be monitoring production concentration closely, given the impact of plant closures on some companies.
Lenders are, however, open to supporting deals that help companies diversify earnings away from food services and broaden processing plant portfolios. There is also optimism that, as lockdowns gradually ease and economies rebound, the pressure on food and beverage company earnings caused by restaurant, school and hotel closures, and supply chain issues will subside.