October 25, 2022
The consumer cyclical and non-cyclical sectors make up about one-third of the Bloomberg U.S. High Yield Bond Index. The changing investment landscape we’re seeing across consumer-centric industries should give active high-yield fixed income managers with deep credit analysis capabilities some opportunities to outperform.
Operating margins have been an overarching investment theme. Many consumer-centric industries have been generating record returns on sales due to strong pent-up demand and higher prices across the board. Some companies also used the pandemic shutdowns to test-drive cost cuts in business lines they may never have tried otherwise. For example, casinos have eliminated food buffets, which saved millions of dollars in loss-leader costs.
Operating margins, however, will likely narrow again as pandemic effects subside, but at higher levels. That could mean that valuations will eclipse those of previous cycles.
Our credit research draws some important distinctions among the relative attractiveness of some consumer-centric industries in high-yield credit.
Gambling casinos are seeing more traffic across their regional footprints and a strong Las Vegas market.
Hotel companies are experiencing high demand and strong room rates as consumers book more vacations and weekend getaways. Hotel room rates are now higher than in 2019 and lodging companies like Hilton and Wyndham are raising guidance for the rest of 2022. Wyndham expects strong demand to persist, given consumers’ willingness and ability to spend, even amid growing concerns about the health of the economy.
Grocery stores continue to see both high traffic and high sales, being buoyed by more permanent remote working options. A McKinsey survey found that 58% of U.S. job holders, or about 92 million people, can work from home at least once a week.1
The consumer seems to have cut back on e-commerce delivery from restaurants and fast casual due to the high cost of delivery, also to the benefit of grocers.
Consumers are feeling the bite of inflation and other financial pressures.
Lower-income consumers are pulling back on spending even amid the recent decline in gas prices. This is happening while retailers such as Macy’s, Kohl’s, Nordstrom, and Victoria’s Secret have high inventory levels.
Amid heightened uncertainty and stabilizing supply chains, we could see a very promotional fall season for retailers as they scale down inventory levels ahead of the end-of-year holiday season.
Weddings, special events, travel, and weekend gatherings are driving strong demand for high-end apparel and jewelry, but this trend may well ease by year end.
Housing is clearly slowing down, largely owing to the rise in mortgage rates and increased concern about the outlook for the economy.
That has led to reported declines in traffic, new orders, and cancellations as well as a ramp up in sales incentives.
As home starts come down, though, constraints from labor and building supplies should lessen.
The opportunity set within consumer high yield has shifted in tandem with developments in the macroeconomic backdrop. Our dedicated high-yield credit analysts work closely with portfolio managers and traders as a team to keep up with such shifts in order to be in what we see as the best risk-adjusted trades.
1 McKinsey & Company. (2022, June 27). Americans are embracing flexible work--and they want more of it. McKinsey & Company. Retrieved September 7, 2022, from https://www.mckinsey.com/industries/real-estate/our-insights/americans-are-embracing-flexible-work-and-they-want-more-of-it.
* Includes funds advised by Wellington Management Company LLP
Note: Data are as of September 30, 2022.
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