What Will '07 Bring for Key Sectors?

S&P Ratings sizes up prospects for industry groups in the coming year. Part 1 includes a look at consumer products, homebuilders, and high tech

From Standard & Poor's RatingsDirect

Standard & Poor's Ratings Services believes that in 2007 the biggest influence on U.S. corporate credit quality will continue to be corporate strategic and financial decisions rather than the economy's performance. S&P still expects efforts to enhance shareholder value, including leveraged buyouts, stock buybacks, and special cash dividends, as well as mergers and acquisitions—and the attendant execution issues—to drive rating activity. This dynamic should continue through next year, especially considering the anticipated continuing high activity of private equity firms and hedge funds.

Consumer spending, always an important part of the economy, should be relatively unaffected through the first part of 2007, despite a slumping housing market and higher interest rates. "Since the summer, lower energy prices have translated into solid sales performance for retailers. Money not spent at the gas pump goes straight to the shopping malls," says Standard & Poor's Managing Director John Bilardello. "But with a negative savings rate and higher levels of consumer debt, the momentum of consumer spending could slow in the latter part of the year, with negative implications for credit quality in some industries."

Further softening in the housing market could hurt building material manufacturers, specialty chemical companies, and forest product companies. A pullback in consumer spending could also temper expectations for higher profit margins in consumer-oriented sectors, as people become more realistic about their spending habits and curtail purchases of furniture, appliances, garden equipment, and other discretionary goods.

Of course, a return of energy prices to this year's record levels could affect the credit outlook of many industries for the worse. Energy prices could be volatile, thanks to the ongoing geopolitical uncertainties in the Middle East and Iraq. Standard & Poor's already expects a slower economy overall in 2007. "If energy prices were to surge in addition to an economic slowdown, corporate credit quality could end up markedly lower than we now expect," says Bilardello.

Following is the first of a two-part look at Standard & Poor's Ratings Services' outlooks for more than a dozen industries, ranging from chemicals and high tech to media and retailing. (The second part will be published on a subsequent date.)

Chemicals: Outlook still stable despite warning signs

Despite some indications that economic growth could moderate in 2007 and ongoing uncertainties over raw material costs, credit quality within the North American chemicals sector remains stable. Against the backdrop of favorable economic conditions in 2006, U.S. companies have reduced debt, bolstered liquidity, and strengthened credit quality to levels appropriate for the ratings.

"In terms of operating prospects, we remain cautiously optimistic on the outlook for 2007, with slower economic growth raising concerns somewhat. But the expectation for a satisfactory economic scenario continues to underpin a solid operating performance overall," says Standard & Poor's Managing Director Kyle Loughlin. "While favorable trends are likely to persist heading into 2007, it is becoming increasingly clear that the commodity petrochemical cycle is running its course and that the global supply and demand balance will begin to erode pricing power and profitability over the next couple of years."

In 2007, some specialty chemical companies could feel the pinch because of the softening housing market and difficult conditions for U.S. automakers, both of which drive demand for several key products including coatings, specialty plastics, adhesives, and resins used in building materials. Still, for the majority of specialty players, the outlook remains good, and we could see the benefits of lower energy costs in profit margins early in the year.

Consumer Products: A struggle with tough operating conditions

Although cost pressures have moderated somewhat in recent periods, S&P expects the U.S.