Part 2: What Will '07 Bring for Key Sectors?

(page 3 of 3)

From Standard & Poor's RatingsDirect

The bottlenecks that developed in parts of the system after last fall's hurricanes have been resolved. And refiners are simply getting less for their finished products, notably gasoline.

Packaging: A Downward Spiral?

The 2007 outlook for credit quality in the global packaging sector remains negative, owing to the continued impact of inflationary cost pressures arising from high and volatile raw material prices in the U.S. and Europe, as well as elevated energy costs. "For many packaging companies, 2007 will be a challenging year," says S&P Director Liley Mehta. "Various factors, including the movement in natural gas and oil prices, resin price trends, and the pace of consumer spending will determine the degree of pressure on several issuers."

Packaging demand is generally considered to be recession-resistant and is primarily derived from relatively stable end markets such as beverages, food, household cleaning products, personal care products, medical products, and other consumer goods. While most of the packaging companies S&P rates cater to these segments, nearly 30% of the 28 rated packaging companies in the U.S. have significant exposure to less stable markets such as industrial and protective packaging applications.

Retailers: Bracing for a Difficult Year

Looking ahead, 2007 is likely to be a more challenging year for retailers than 2006. There may be further pressure on ratings if consumer spending trends become less favorable than in the first half of 2006, energy prices go back to their record levels, and the housing market continues its slump.

While the overall credit outlook for the U.S. retail sector is negative, the department store sector is fairly healthy, with several positive rating actions this year. Among them, the assignment of a positive outlook to Saks (SKS). This is not the case for the restaurant and discount sectors, where customers appear to be pinched by energy prices. "Many negative rating actions in the retail sector reflect the impact of both discretionary actions like share repurchases and operating execution issues," says S&P Managing Director William Wetreich. "The trend is expected to remain in place heading into next year, based on the current outlook distribution."

Telecom & Cable: Things Are Heating Up

Like so many other industries, the U.S. telecom sector is facing increasing competition. A battle between the large incumbent cable and telephone companies is being waged. S&P believes that while the cable TV operators have the current advantage, it's not clear that they will be the long-term winners. Telephone providers have substantial resources to develop their own alternative video services and have committed to spending tens of billions of dollars to upgrade their networks, with Verizon Communications' (VZ) fiber-optic services carrying the largest price tag.

S&P expects that upon regulatory approval from the FCC for the merger of AT&T (T) and BellSouth (BLS), it will affirm the A rating with a negative outlook. The merger, which should close in the near future, will provide some benefits to the combined company in terms of increased scale to compete against the cable companies, despite any conditions imposed by the FCC during the approval process. Yet, the negative outlook will capture the risk associated with the increasingly challenging business environment facing the regional Bell operating companies in the wireline sector.

Standard & Poor's expects that the cable companies will continue to aggressively roll out telephony, increase the speed of their broadband product, and heavily market enhanced video features, such as HDTV and digital video recorders as well as video on demand, in an effort to create more robust, compelling bundling propositions.

Cablevision Systems (CVC) has been one of the most successful at this strategy with telephony penetration in excess of 30% of its video subscriber base. Yet, Cablevision's prospects remain constrained by an aggressive financial policy. The most recent example of this position was the Dolan family's leveraged buyout offer, which, if approved by the Cablevision board, would result in a material weakening of the company's financial profile. However, S&P notes that the company has material programming and other noncable assets that could be monetized to mitigate the financial effects of the buyout transaction.

We also anticipate further consolidation of the competitive local exchange carriers (CLECs). This will provide greater economies of scale to the larger CLECs and potentially benefit their long-term ratings. In addition, S&P expects some continued consolidation among the long-haul providers such as Level 3 Communications (LVLT). Mergers in these segments should provide some long-term price stability, as well as additional market diversity.

Standard & Poor's senior features editors Frank E. Benassi and Robert McNatt contributed to this report.