Key Credit Factors For The Consumer Durables Industry

Transcription

1 Criteria Corporates Industrials: Key Credit Factors For The Consumer Durables Industry Primary Credit Analysts: Diane M Shand, New York (1) ; diane.shand@spglobal.com Maxime Puget, London (44) ; maxime.puget@spglobal.com Criteria Officers: Peter Kernan, London (44) ; peter.kernan@spglobal.com Sarah E Wyeth, New York (1) ; sarah.wyeth@spglobal.com Table Of Contents SCOPE OF THE CRITERIA SUMMARY OF CRITERIA UPDATE METHODOLOGY Part I--Business Risk Analysis Part II--Financial Risk Analysis Part III--Rating Modifiers REVISIONS AND UPDATES RELATED CRITERIA AND RESEARCH DECEMBER 12,

2 Criteria Corporates Industrials: Key Credit Factors For The Consumer Durables Industry (Editor's Note: We're republishing this article following our periodic review completed on Nov. 9, See the "Revisions And Updates" section for details.) 1. Standard & Poor's Ratings Services has refined and adapted its methodology and assumptions for the consumer durables industry. This article is related to our global corporate criteria (see Corporate Methodology, published Nov. 19, 2013) and to our criteria article "Principles Of Credit Ratings," which we published on Feb. 16, SCOPE OF THE CRITERIA 2. These criteria apply to companies in the global consumer durable products industry. The consumer durables industry includes companies that derive revenue from the manufacture and marketing of diversified and miscellaneous consumer products, including home appliances, furniture, home improvement products and fixtures, small appliances, sporting equipment and other durable goods. SUMMARY OF CRITERIA UPDATE 3. This article reflects Standard & Poor's global criteria for analyzing consumer durables companies, applying its global corporate criteria. 4. We view consumer durables as an "intermediate risk" industry under our criteria, given its "intermediate" cyclicality risk and "intermediate" degree of competitive risk and growth. In assessing the competitive position of a consumer durables company, we put particular emphasis on: market position, growth prospects for market segments, geographic footprint, operating efficiency, and sensitivity to raw material prices. Given the extent to which working capital requirements can fluctuate seasonally and over the course of the business cycle, working capital management and its effect on cash flow coverage ratios is a key consideration in our assessment of financial risk. METHODOLOGY Part I--Business Risk Analysis Industry risk 5. Within the framework of our corporate methodology for assessing industry risk, we view consumer durables as an intermediate risk industry (category 3). Our industry risk assessment for consumer durables is derived from our view of the segment's intermediate (category 3) cyclicality, and our assessment that the industry warrants an intermediate risk (category 3) competitive risk and growth assessment. DECEMBER 12,

3 6. Key economic indicators tend to drive cyclicality in the consumer durable products industry. Key drivers include consumer confidence, consumer spending and saving patterns, unemployment rates and employment growth trends, household formation and net worth, interest rates, availability of consumer credit, and government incentives. 7. In our opinion, the discretionary nature of many consumer durable products increases the cyclicality of demand for these companies relative to other, lower-risk industries and sectors, such as consumer nondurables. During periods of economic weakness it is common to see consumer spending decline, with consumers trading down to lower-priced products or deferring purchases altogether. However, favorable secular long-term growth trends (like population growth, rising household disposable income in emerging markets, and increasing penetration of many durable products in emerging markets) tend to offset volume declines in developed markets during weak economic periods. 8. Price competition is moderate overall, and intensity can vary depending on the specific durable products category. Price competition may manifest itself in multiple forms, including reduction of list prices, promotions, discounts, and other customer incentives, and is often more pronounced in mature retail markets and on mid-price-range products. Additionally, pricing competition can increase during industry downturns, which can compound the cyclical decline in revenues. We believe that manufacturers with greater product innovation and/or a broad range of products at various price points are somewhat less sensitive to price competition. Cyclicality in profitability tends to be moderate. Although there is variability by category, durable consumer products in general are relatively discretionary in nature. Durable companies can be sensitive to rises in input and raw material costs, which can be volatile. Periods of lower consumer demand and commodity price inflation can lower margins, as companies can experience negative operating leverage from reduced volumes for a period of time. Cyclicality 9. We assess cyclicality for the consumer durable products industry as intermediate risk (category 3). The industry has demonstrated moderate cyclicality--relative to other industries--in both revenue and profitability, which are two key measures used to derive an industry's cyclicality assessment (see "Methodology: Industry Risk," published Nov. 19, 2013). Based on our analysis of global Compustat data, consumer durable products companies experienced an average peak-to-trough (PTT) decline in EBITDA margin of about 10% during recessionary periods since In addition, in five of the recessionary periods, the EBITDA margin decline was equal to or greater than 10%, with the steepest being about 18% during the and downturns. Since 1952, consumer durables companies experienced an average PTT decline in revenues of about 7.4% during recessionary periods, with PTT revenue declines materially exceeding the average in four of the nine periods. The largest PTT drop in revenues totaled 18.5%, and occurred in the most recent recession ( ). 10. With an average drop in profitability of 10% and an average revenue decline of more than 7%, consumer durable products' cyclicality assessment calibrates to "intermediate risk" (category 3). We generally consider that the higher the level of profitability cyclicality in an industry, the higher the credit risk of entities operating in that industry. However, the overall effect of cyclicality on an industry's risk profile may be mitigated or exacerbated by an industry's competitive risk and growth environment. DECEMBER 12,

4 Competitive risk and growth 11. We view consumer durable products as warranting an intermediate (category 3) competitive risk and growth assessment. To assess competitive risk and growth, we assess four subfactors as low, medium, or high risk. These subfactors are: Effectiveness of industry barriers to entry; Level and trend of industry profit margins; Risk of secular change and substitution by products, services, and technologies; and Risk in growth trends. Effectiveness of the consumer durable products industry's barriers to entry--medium Risk 12. Barriers to entry in the consumer durable products industry are moderate. While new players can enter the market, they can experience disadvantages relative to more established industry participants. For example, smaller companies may have some difficulty competing against larger, global industry leaders that have not only established brands, but also greater financial flexibility to advertise and market these brands; established distribution networks, and economies of scale. Factors such as manufacturing expertise, product technology, customer relationships, access to distribution channels, capital intensity, and ability to service an installed base, are typically the most prevalent barriers to entry in the industry. Less frequently, transportation costs and government regulation may also constitute barriers to entry. 13. Access to capital can be an important differentiator during difficult market conditions, favoring larger and more financially sound players. Having a lower cost of capital provides larger consumer durables companies greater opportunity and flexibility to quickly build out and expand infrastructure and distribution networks internationally, particularly in higher-growth emerging markets. Lack of capital market access can become more pronounced during weak global economic conditions if third-party capital is unavailable or too costly for smaller, private industry players. Small companies are often forced to rely on factoring, which can be a relatively expensive and restrictive form of asset-based lending. Level and trend of consumer durable products industry profit margins--medium Risk 14. Since the last global economic downturn, consumer durable products companies have generally managed to improve their profit margins through successful restructuring actions, productivity gains, the broad application of lean manufacturing techniques, pricing discipline, and the benefit of a period of generally benign input cost inflation. Although these benefits could be partly sustainable, profit levels will continue to vary both with the demand cycle and with segment-specific competitive dynamics. 15. Degree of seasonality varies by category within durable consumer products, as certain subcategories are more sensitive to seasonality (e.g., lawn and garden durable products). Therefore, certain factors, such as weather conditions may have meaningful short-term effects in such subsectors. However, many larger industry players have fairly diverse product portfolios as well as geographic diversification that mitigate the impact of seasonality on profitability and may be less impacted. 16. Durable products companies have some exposure to weaker consumer spending and consumer trade-down to lower price-point products. However, ongoing innovation, product development, and brand support by branded durable products companies have historically helped to blunt the negative impact of such trends. DECEMBER 12,

5 17. Consumer durable products companies are exposed to changes in input costs, including raw materials (such as steel and other metals, resins, packaging), fuel and other energy-related, electronic or sourced components, and labor costs. The ability of consumer durable products companies to offset the impact of higher input costs via higher selling prices varies depending on such factors as contractual provisions, market structure, flexibility of the footprint and workforce profile, and the intensity of competition; where this ability is limited, consumer durables companies need to offset cost increases through productivity gains and other cost savings. The degree of vertical integration and outsourcing also affects trends in profit margins in the industry: manufacturers integrated into material processing or component manufacturing typically exhibit higher fixed costs and capital spending than those focused on product design and assembly, and are often subject to greater variation in profit margins over the business cycle. Working capital requirements are typically moderate but may exhibit some seasonality. Risk of secular change and substitution by products, services and technologies--low Risk 18. We view the risk of secular change and substitution by products, services, and technologies as low because of the ubiquitous nature of the multiple products that come under the consumer durable products industry. 19. There are durable product categories that the consumer perceives as more commodity-like (such as some small appliance categories and home improvement products such as lighting fixtures), thus offering less perceived value-add; such products are more exposed to increases in private-label penetration, because these products primarily compete on price. 20. The need for continuous innovation is important to differentiate from private-label alternatives, maintain strong brand equity, and achieve pricing power. A company's ability to introduce new products or to launch product extensions is key to addressing such risks and preserving market share and profitability. Risk in consumer durable products industry growth trends--medium Risk 21. Growth trends in the consumer durable products industry are generally tied to economic conditions prevalent both in mature low-growth markets and in newer faster-growing markets. Durables revenue growth is generally expected to exceed GDP growth in emerging markets, although economic slowdowns will dampen consumer demand and growth prospects. 22. Demand for durable products tends to grow faster than GDP during periods of economic expansion, at a rate below GDP when growth is subdued, and to contract more than GDP during recessions. As such, ongoing economic contraction or subdued growth in mature markets, and slowing growth in emerging markets represent significant near-term risk to growth for the consumer durable products industry. 23. Positive secular growth trends in emerging markets seem likely to persist for an extended period of time. Demographic trends supportive of long-term demand include population growth, a rising middle class, and increased household penetration of durable consumer products. However, there are certain risks with entering emerging markets such as currency devaluation and local trade policy changes that somewhat temper the growth rates in these markets. Still, the growth trends seem likely to persist for an extended time period given most companies' limited market penetration in these emerging markets. 24. Growth trends are less favorable in developed markets. Durables are generally discretionary in nature, and some shifts DECEMBER 12,

6 do occur during difficult economic environments--including from premium products to value-oriented branded and private-label (or store-branded products). Moreover, shifts from traditional retail to alternative channels are occurring--and consumer durables companies face the challenge of adapting to such new distribution channels--especially internet retailing. They also may need to restructure, rationalize, or streamline production capacities to maintain profitability under the new modes of distribution. Country risk 25. Country risk plays a critical role in determining all ratings on companies in a given country. Country-related risk factors can have a substantial effect on company creditworthiness, both directly and indirectly. In assessing country risk for a consumer durable goods company, our analysis uses the same methodology as with other corporate issuers (see "Corporate Methodology"). A key factor in our business risk analysis for corporate issuers is the country risk assessment, which includes the broad range of economic, institutional, financial market and legal risks that arise from doing business in a specific country. 26. We generally determine exposure to country risk using revenues, as this information is consistently available. However this may not capture country risks beyond those affecting demand potential. Therefore if country exposure by EBITDA or assets is available and indicative of a materially different country exposure profile, we may instead use EBITDA or assets. Competitive position (including profitability) 27. Under our global corporate criteria, a company's competitive position is assessed as (1) excellent, (2) strong, (3) satisfactory, (4) fair, (5) weak, or (6) vulnerable. In assessing the competitive position for consumer products issuers we review an individual company's Competitive advantage; Scale, scope, and diversity; Operating efficiency; and Profitability. 28. The first three subfactors are independently assessed as either (1) strong, (2) strong/adequate, (3) adequate, (4) adequate/weak, or (5) weak. Profitability is assessed through the combination of two components, the level of profitability and the volatility of profitability. 29. After evaluating separately competitive advantage, scale scope and diversity, and operating efficiency, we determine the preliminary competitive position assessment by ascribing a specific weight to each component. The applicable weightings will depend on the company's Competitive Position Group Profile (CPGP). The CPGP assigned to the majority of consumer durables issuers is "Services and Product Focus," whereby we weigh the first three subfactors of competitive position as follows: competitive advantage (45%); scale, scope, and diversity (30%); and operating efficiency (25%). 30. We may assign the "Capital or Asset Focus" CPGP to consumer products companies that exhibit a sizable capital investment and asset outlays to sustain competitive position. Many consumer durables companies manufacture products that exhibit at least some degree of technical differentiation and require moderate capital investments to sustain their market position, but exposure to cyclical demand patterns often makes operating efficiency the most DECEMBER 12,

7 significant determinant of competitiveness for the more capital-intensive companies. The component weighting for companies assigned the "Capital or Asset Focus" CPGP is as follows: competitive advantage (30%); scale, scope, and diversity (30%); and operating efficiency (40%). Competitive advantage 31. In assessing the competitive advantage of a consumer durables company we consider its: Business strategy and global market positions; Extensiveness of presence in consumer markets and in channels of distribution; Product range and differentiation versus competition; Brand equity and underlying price power; Capital spending plans on production, innovation, sales and marketing; Strategy regarding balancing volume growth and margins. 32. In reviewing a company's business strategy, we assess the company's ability to establish leadership positions in the markets in which it competes, and at protecting or growing market shares in a profitable manner. Consumer durables companies need to adjust their strategy to evolving market conditions like demand growth prospects, industry supply capacities, and the level of promotional activity. If they are successful at defending or growing leading market shares, volumes should remain stable, thus protecting production costs. 33. We review the company's ability to access the largest possible number of customers for its products and look at its presence in the largest consumer markets around the world. We also consider the distribution strategy and the variety and sales growth prospects of its distribution channels and main retailers. Wide and fast-growing distribution channels reach more prospective customers for the manufacturers. The ability to participate in promotional activity can be a differentiating competitive advantage by effectively helping support sales growth. We also consider manufacturers' support of their key retail accounts through favorable payment terms. 34. We assess the number of product segments in which a company operates and the size of its product range in each of these segments. We review a company's track record in launching new and successful products from a sales perspective. We consider the degree of product uniqueness, customization, or specification against the competition. 35. Brand name recognition in the consumer durables industry is often associated with product quality, design, or ease of use. Consumer durables companies that are able to offer differentiated products or services or to capitalize on a strong brand name will generally benefit from greater pricing power, and often greater customer loyalty than those offering more commoditized products. 36. Manufacturers need to constantly reinvest cash flows in modernizing production capacities to improve productivity; in research and development to support product innovation and differentiation; in sales infrastructure to increase the presence in all distribution channels and to reach consumers; and in marketing to promote the brand and support the pricing power. 37. The consumer durables industry is characterized by its medium capital intensity: higher than consumer nondurable products but lower than large capital goods. Companies generally follow two strategies to maintain a competitive advantage on production costs. The large players focus on maintaining high capacity rates in their factories and DECEMBER 12,

8 generate higher profit with sales volume growth. The smaller players tend to outsource some or all of their production to protect their operating margins given their lower economies of scale. However, we think both large and smaller players are price-takers on raw materials sourcing, with limited ability to achieve procurement discounts. Strong brand equity can protect gross margin through the ability to raise prices without adversely affecting sales volumes. 38. A consumer durables company with a "strong" or "strong/adequate" competitive advantage assessment typically is characterized by a combination of: Global or regional leading market positions, and a business strategy that supports sales growth and profitability. A significant presence in the largest and in fast-growing consumer markets. Large product range and presence in the most dynamic product segments, and a superior track record of product development, innovation, and customer satisfaction. Strong brand equity that provides the product a clear price premium relative to its competitors. A demonstrated commitment and ability to reinvest in its asset base, as evidenced by a continuous pipeline of new products with a track record of successful product launches. Ability to maintain volume growth and strong pricing power. 39. A consumer durables company with a "weak" or "adequate/weak" assessment of its competitive advantage typically is characterized by a combination of: Business strategy that is inconsistent or not well adapted to marketplace conditions. The company is a small local manufacturer in a declining market. Most products are commoditized and could be replicated at lower cost by competitors. Weak brand power, no price premium relative to competing brands, and an inability to raise prices when raw materials prices rise without losing market share. Low level of investment on product innovation and production capacities. Scale, scope, and diversity 40. In assessing the scale, scope, and diversity of a consumer durables company, we consider: The size of its revenues and earnings base in the context of the size and growth potential of its geographical markets and product segments; The depth and breadth of its product offering; The geographical diversity of its sales and earnings; The level and localization of the production capacities and ability of the distribution network to meet demand; and The degree of supplier and customer concentration. 41. We generally assume that participation in a number of markets will make for greater stability of financial performance in market downturns, although some downturns are so extreme that all markets are severely weakened. The relative attractiveness of the markets (in terms of size, expected growth, cyclicality, barriers to entry, intensity of competition, etc.) and how the consumer durables company is positioned in those markets influence our assessments of scale, scope, diversity, and competitive advantage. 42. A large product offering in a particular segment and a presence in several product segments enables a company to support its market share in one or several product segments. Consumers are more likely to turn to a brand that provides a large range of options and alternatives to a need. Also the presence in several product segments often DECEMBER 12,

9 enables a company to offset a decline in sales in a particular segment. 43. We consider geographical diversity as important. A decline in consumer demand for durable goods in a particular region or country can often be offset by more positive market dynamics in another region or country. Hence a worldwide manufacturer is generally better positioned to cope with drops in demand in one or several specific markets compared to a national player facing the same prospects. 44. The size and location of production facilities will enable the company to meet demand levels. Usually companies have large production facilities near the large consumer markets. However they need to adapt their production capacities to demand trends. The size and global reach to consumers is also important and we assess whether products are widely distributed through major retailers or only available in certain outlets, and whether companies use online retailing or rely on more traditional retail distribution networks. 45. We see the concentration risk of suppliers and customer (generally retailers) as an important factor for a manufacturer. The default of a major supplier can severely disrupt the supply chain and lead to the stoppage of the production process. This in turn will mean lower volumes and problems supplying customers on time. The default of a major customer could lead to a large number of unsold products and, thus, loss of revenues and lower operating cash flow. To the extent the manufacturer can recover its merchandise, there would typically be additional inventory and transportation costs, and the products may ultimately be sold at a discount. 46. A consumer products company that warrants a "strong" or "strong/adequate" assessment of scale, scope, and diversity typically is characterized by a combination of: Industry leading market shares, large size of production capacities, and large EBITDA base. A comprehensive range of products or service offerings, or a large portfolio of well-known brands. Geographically diverse earnings in markets with favorable growth prospects. Large and geographically diverse manufacturing base as well as sourcing. Diverse customer and distribution channels with no large single-name concentration. 47. A consumer products company warranting a "weak" or "adequate/weak" assessment of scale, scope and diversity typically is characterized by a combination of: Low market share and penetration, small industrial size, or limited growth prospects of main markets. A single product or limited range of products. Sales in only a few markets. A small manufacturing base, or reliance on unique and/or declining distribution channel. Significant manufacturing and sourcing concentration, or high reliance on a single or few customers. Operating efficiency 48. In assessing operating efficiency for a consumer durables company, we consider its: Flexibility of its cost structure in absorbing demand declines or input cost pressures. Cost management and working capital management characteristics. Relative cost position versus industry peers. 49. In reviewing cost structure flexibility, we consider a consumer durables company's ability to limit margin deterioration DECEMBER 12,

10 in a down cycle through cost reduction, and to pass on increases in input costs. Indicators of cost flexibility may include: proportion of fixed versus variable costs, degree of operating leverage, productivity and capacity rates, raw materials and components cost exposure, labor and pension costs, and flexibility of labor contracts. 50. We consider a company's cost management by reviewing its record of cost reduction during good and bad times, the effectiveness of its restructuring programs and lean manufacturing programs in the different geographical regions, its track record at successfully integrating acquisitions, and its working capital management metrics, especially regarding inventory and transport costs. Companies exposed to significant seasonality and long cash conversion cycles may exhibit lower operating margins than those without. 51. To the extent a consumer durables company has a high degree of operating efficiency, it should be able to generate better profit margins than peers that compete in the same markets, whatever the nature of the prevailing market conditions. In reviewing the relative cost position of a consumer durables company compared to that of its peers, we primarily consider its EBITDA margin level, supplemented by various indicators of cost efficiency, such as gross margin, and/or selling, general, and administrative expenditures (SG&A) as percent of revenues. Both the overall cost and margin profile of a consumer durables company and that of its various reporting segments are important in our analysis. 52. A consumer durables company with a "strong" or "strong/adequate" operating efficiency assessment typically is characterized by a combination of: Large size and scale that yield strong purchasing power, which can provide discounts for higher volume purchases of key input costs; high productivity levels. Ability to rapidly adjust production and overhead costs (measured via SG&A as percent of revenues) to market demand levels. Lower fixed cost structure and better sourcing capacities than peers that supports profitability (measured by gross margin and EBITDA to revenues) that is better than industry peers, taking into account differences in sales mix and average selling prices. We also consider the sustainability of these cost structures and profitability levels. 53. A consumer durables company with a "weak" or "adequate/weak" assessment of its operating efficiency typically is characterized by a combination of: Inability to adequately source and hedge raw materials, which could be attributed to lack of size, bargaining power, or centralized procurement; low average capacity utilization of manufacturing facilities; high and rigid labor costs. Inability to control operating costs due to a rise in raw material prices and supply-chain deficiencies. Higher fixed cost structure than peers, leading to swings in profitability as soon as demand for the products drops. Profitability 54. The profitability assessment can confirm or modify the preliminary competitive position assessment. The profitability assessment consists of (1) the level of profitability, and (2) the volatility of profitability. The two components are combined into the final Profitability assessment using a matrix (see "Corporate Methodology"). Level of profitability 55. The level of profitability is determined on a three point scale: "above average," "average," and "below average." DECEMBER 12,

11 56. We use EBITDA margin as the primary indicator of the level of profitability for a consumer durables company, based on thresholds identified in table 1 below. We use return on capital (ROC) as a supplementary indicator to refine our assessment when EBITDA margin is close to the thresholds for "below average" or "above average" (see ROC thresholds in table 2). For instance, if a company's EBITDA margin is at the high end of the defined range for "average" but its return on capital is comfortably in the "above average" range, we may assess its level of profitability "above average." We could also use ROC if EBITDA is significantly distorted by currency-exchange fluctuations. In accordance with the global corporate criteria, for this assessment we typically determine the five-year average EBITDA margin and ROC using the last two years of historical data, our forecast for the current year, and our forecast for the following two years. We may put more emphasis on forecast years if historical data is not deemed representative or to take into account projected shifts in profitability levels. 57. We use two EBITDA margin thresholds to differentiate between diversified consumer durable companies that manufacture specific products for a local market versus home appliances manufacturers, which tend to be more global and standardized. In our current rated universe, the first group (diversified durables) has diverse businesses like outdoor equipment and home furnishings. The higher thresholds reflect the typically smaller scale and EBITDA base but higher average EBITDA margins. The second group of companies specifically includes home appliances manufacturers only. These companies are generally characterized by a larger scale and EBITDA base but a lower average EBITDA margin. We use the same ROC thresholds for all durables companies because ROC is based on a measure of operating earnings after depreciation, therefore capturing differences in depreciation (and to some degree capital expenditure) profiles. Table 1 Guideline Ranges Of EBITDA Margin By Subsector EBITDA margin Below average Average Above average Diversified durables Below 8% 8-14% Above 14% Home appliances Below 6% 6-9% Above 9% Table 2 Return On Capital Thresholds Return on capital Below average Average Above average All companies Below 9% 9%-15% Above 15% Volatility of profitability 58. The volatility of profitability is determined on a six point scale, from '1' (least volatile) to '6' (most volatile). 59. In accordance with our global corporate criteria, we generally determine the volatility of profitability using the standard error of regression (SER), subject to having at least seven years of historical annual data. We generally use nominal EBITDA as the metric to determine the SER for consumer durables companies, although we may also use EBITDA margin or ROC. In accordance with the global corporate criteria, we may --subject to certain conditions being met--adjust the SER assessment by up to two categories better (less volatile) or worse (more volatile). If we do not have sufficient historical information to determine the SER, we follow the global corporate criteria guidelines to determine the volatility of profitability assessment. DECEMBER 12,

12 Part II--Financial Risk Analysis Accounting and analytical adjustments 60. Our analysis of a company's financial statements begins with a review of the accounting to determine whether the statements accurately measure a company's performance and position relative to its peers and the larger universe of corporate entities. To allow for globally consistent and comparable financial analyses, our rating analysis may include quantitative adjustments to a company's reported results. These adjustments also enable better alignment of a company's reported figures with our view of underlying economic conditions. Moreover, they allow a more accurate portrayal of a company's ongoing business. Adjustments that pertain broadly to all corporate sectors, including this sector, are discussed in Corporate Methodology: Ratios And Adjustments. Cash flow/leverage analysis 61. In assessing the cash flow adequacy of a consumer durables issuer, our analysis uses the same methodology as with other corporate issuers (see "Corporate Methodology"). Cash flow/leverage is assessed on a scale of (1) minimal, (2) modest, (3) intermediate, (4) significant, (5) aggressive, and (6) highly leveraged, by aggregating the assessments of a range of credit ratios, predominantly cash flow based. Core ratios 62. For each company, we calculate two core debt payback ratios, funds from operations (FFO) to debt and debt to EBITDA, in accordance with our ratios and adjustments criteria. Supplemental ratios 63. In addition to our analysis of a company's core ratios, we also consider supplemental ratios in order to develop a fuller understanding of a company's credit risk profile and refine our cash flow analysis. We view free operating cash flow (FOCF) to debt as the preferred supplemental ratio. Working capital and capital spending cycles can significantly shape patterns of cash flow generation for consumer durables companies. In the early stages of a downturn, capital released from working capital has historically helped companies achieve FOCF to debt ratios that are stronger than FFO to debt, and we may adjust the cash flow and leverage assessment accordingly. Conversely, during a business upturn, increased working capital needs can depress the FOCF to debt ratio, suggesting a lower cash flow assessment than the core ratios, but we may choose not to use the supplementary ratio adjustment (negative) if the core ratios are on an improving trend. For companies that return a large portion of their FOCF to shareholders through dividends, we may consider discretionary cash flow (DCF) to debt as the most relevant supplemental ratio. 64. If the preliminary cash flow leverage assessment indicated by the core ratios is significant or weaker, then two coverage ratios, FFO plus interest to cash interest and EBITDA to interest, will be given greater importance as supplemental ratios. These ratios become more important ratios in our analysis of companies with highly seasonal businesses and resultant significant intrayear swings in working capital investment needs, such as lawn and garden equipment companies. The seasonal companies typically borrow to fund their increased working capital investment and the interest coverage ratios capture all annual interest costs. DECEMBER 12,

13 Volatility adjustment 65. In accordance with our global corporate criteria, we may adjust our cash flow leverage assessment based on the volatility adjustment. Given the inherent cyclicality in consumer durables, these ratios can change moderately over the course of an economic cycle. Cash flow volatility varies by company and subsector. We typically classify furniture manufacturers as either "volatile" or "highly volatile," depending on historical performance within various subsectors, and we generally classify high-growth companies as "highly volatile." Part III--Rating Modifiers Diversification/portfolio effect 66. In assessing the diversification/portfolio effect of a consumer durables companies, our analysis uses the same methodology as with other corporate issuers (see "Corporate Methodology"). Capital structure 67. In assessing the capital structure of a consumer durables company, our analysis uses the same methodology as with other corporate issuers (see "Corporate Methodology"). Liquidity 68. In assessing the liquidity of a consumer durable company, our analysis uses the same methodology as with other corporate issuers (see "Corporate Methodology"). Financial policy 69. In assessing financial policy on a consumer durables company, our analysis uses the same methodology as with other corporate issuers (see "Corporate Methodology"). Management and governance 70. In assessing management and governance on a consumer durables company, our analysis uses the same methodology as with other corporate issuers (see "Corporate Methodology"). Comparable ratings analysis 71. In assessing the comparable ratings analysis on a consumer durables company, our analysis uses the same methodology as with other corporate issuers (see "Corporate Methodology"). REVISIONS AND UPDATES This article was originally published on Dec. 12, These criteria became effective on Dec. 12, 2013, the date of publication. Changes introduced after original publication: Following our periodic review completed on Nov. 20, 2015, we updated the contact list and criteria references. In addition, we removed the "Impact On Outstanding Ratings" and "Effective Date And Transition" sections, which were related to the initial publication of the criteria and no longer relevant. Following our periodic review completed on Nov. 14, 2016, we updated the contact list. DECEMBER 12,

14 Following our periodic review completed on Nov. 9, 2017, we added the "Revisions And Updates" section. RELATED CRITERIA AND RESEARCH Related Criteria Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 Corporate Methodology, Nov. 19, 2013 Corporate Methodology: Ratios And Adjustments, Nov. 19, 2013 Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 Methodology: Industry Risk, Nov. 19, 2013 Methodology: Management And Governance Credit Factors For Corporate Entities And Insurers, Nov. 13, 2012 General Criteria: Principles Of Credit Ratings, Feb. 16, 2011 These criteria represent the specific application of fundamental principles that define credit risk and ratings opinions. Their use is determined by issuer- or issue-specific attributes as well as Standard & Poor's Ratings Services' assessment of the credit and, if applicable, structural risks for a given issuer or issue rating. Methodology and assumptions may change from time to time as a result of market and economic conditions, issuer- or issue-specific factors, or new empirical evidence that would affect our credit judgment. DECEMBER 12,

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