Industry Top Trends 2020

Capital Goods
Soft equipment-demand will weigh on sector performance in 2020
November 18, 2019
Authors
Tuomas Erik Ekholm, CFA
Frankfurt
+49 69 33999 123
tuomas.ekholm
@spglobal.com

Ana Lai, CFA

New York
+1 212 438 6895
[email protected]
What’s changed?
Synchronized economic slowdown. Trade tensions and dwindling growth continue Hiroki Shibata
to weaken the global economy and business confidence. We see a synchronized Tokyo
global slowdown affecting advanced and emerging economies alike. We do not +81 3 4550 8437
expect a sudden turnaround and foresee the cautious investment climate reducing hiroki.shibata
the sector's order intake, revenue, and profitability in 2020. @spglobal.com
Widening negative outlook bias. Currently, 16% of rated capital goods companies
have negative outlooks, with an additional 1% on CreditWatch negative. The Additional Contacts
negative outlook bias has widened throughout the year, with negative rating actions
exceeding positive actions by 2.5x. Nevertheless, 79% of outlooks are still stable, Makiko Yoshimura
Tokyo
reflecting headroom in the ratings. We expect negative rating actions to outweigh
makiko.yoshimura
positive actions again in 2020, particularly at the low end of the speculative-grade @spglobal.com
category, but we view large investment-grade issuers as in a good position to cope Svetlana Olsha, CFA
with the downturn. New York
svetlana.olsha
What to look for in the sector in 2020? @spglobal.com
Tobias Buechler, CFA
End-market performance and investment. We expect investment to remain weak Frankfurt
in the U.S. and Europe and to shrink in Asia-Pacific (excluding Japan). Multiple tobias.buechler
demand drivers--including autos and commodities--are stagnating or in decline, @spglobal.com
while construction has peaked. However, there are a few notable exceptions, Marta Bevilacqua
Milan
including aerospace and defense, health care, and e-commerce. We expect weaker
marta.bevilacqua
demand overall to curb operating expenditure and pressure prices and margins.
@spglobal.com
The trade dispute between the U.S. and China trade is a swing factor in our Maria Vinokur
forecast, as a resolution would likely encourage higher industrial investment and Madrid
spending. maria.vinokur
@spglobal.com
William Buck
What are the key medium-term credit drivers? London
Mergers and acquisitions and fast-paced technological change. We expect M&A [email protected]
and deconglomeration to continue among major industry players--but at a slower Pierre-Henri Giraud
pace. This will be boosted by low interest rates, ample funding, and companies Paris
Pierre-Henri.Giraud
seeking to expand in higher growth, margins, and high-technology business areas.
@spglobal.com
We expect capital allocation to the development of capabilities in advanced
automation to continue incl. digitalization, software and artificial intelligence.

S&P Global Ratings 1

Industry Top Trends 2020: Capital Goods

Ratings trends and outlook

Global Capital Goods
Chart 1 Chart 2
Ratings distribution Ratings distribution by region

Chart 3 Chart 4
Ratings outlooks Ratings outlooks by region

Chart 5 Chart 6
Ratings outlook net bias Ratings net outlook bias by region
Net Outlook Capital Goods
Bias (%)
5
0
-5
-10
-15
-20
-25
13 14 15 16 17 18 19

Source: S&P Global Ratings. Ratings data measured at quarter end. Data for Q4 2019 is end October, 2019

The rating trend for the sector in 2019 has been negative. Of the 218 issuers, we have had
70 downgrades in the year to date, most of which were of speculative-grade companies,
and 28 upgrades. Despite this, the negative outlook bias has widened, with 16% of the
portfolio on negative outlook and 1% on CreditWatch Negative, versus 3% of on a positive
outlook. This reflects our expectation of 2020 being more difficult for the sector than
2019, as we see weakening economic fundamentals and slowing demand already denting
order intake and operational performance. Most investment-grade issuers are better
placed to cope with the economic slowdown than speculative-grade issuers, as the latter
have more volatile cash flows and weaker credit metrics to start with.

S&P Global Ratings November 18, 2019 2

Industry Top Trends 2020: Capital Goods

Capital Goods
Key assumptions

1. Investments and orders are down due to the weakening economy

The global capital expenditure (capex) boom ended in early 2019, and the economy is
cooling faster than we expected. Trade tensions--particularly the tariff dispute between
the U.S. and China--are casting a shadow on the global economy and financing
conditions in all regions. This has already weakened order intake since the start of 2019
and is likely to continue dampen both industrial production volumes and investments in
capacity. We therefore expect 2020 to be a more difficult year for capital goods
companies than 2019, which was supported by higher orders carried forward.

2. Key end-market demand does not support material growth

We expect weaker demand for equipment and services in several key end markets to
persist in 2020. In particular, we believe that companies exposed to short-cycle demand
will continue to see a deceleration in activity, as the industrial slowdown causes
customers to defer near-term purchases. For instance, we expect to see a continued
slowdown in maintenance, repair, and operations activity, as well as in the general
industrial, automotive, and semi-conductor markets, which have shorter lead times.
Capital goods companies with longer lead-time backlogs, for instance in the aerospace
and defense, construction, or infrastructure markets, should have better near-term
growth prospects.

3. Flat topline, margins and credit metrics

Our global sector forecast sees overall revenue growth of about 1% and EBITDA margins
of 16% in 2020, slightly higher than in 2019 due our expectation that a few large global
players--for example, General Electric Co.--will improve their margins. Overall we expect
pressure on margins to increase, and margins in many cases to weaken. We expect a
modest strengthening in weighted credit metrics over the next 12 months, related to a
few large players expected to reduce their leverage, and forecast weighted average funds
from operations (FFO) to debt of 23% and debt to EBITDA of 3.2x in 2020, versus our
expectations of 22% and 3.4x in 2019.

The economic climate is impinging on production volumes, orders, and

industrial investment
Global business and investment activity is weak, and sentiment is gloomy. Central bank
firepower, including the resumption of an unconventional stimulus, should prevent a
global downturn, but the odds of recession are rising for some markets, including the U.S.
No corner of the world is free from geopolitical uncertainty, whether it be the U.S.-China
trade dispute across the Pacific, renewed conflict in the Middle East, the Brexit saga in
Europe, or political uncertainty in Latin America. These tensions are undermining
confidence. Against this backdrop, real wages are holding up in most major economies,
and employment conditions are steady. Consumer spending and housing remain key
supports. At the same time, tepid corporate earnings and a higher ratio of speculative-
grade to investment-grade borrowers pose risks to investors and incidences of market
illiquidity could see defaults rise within one-to-two years.
Capital goods sector issuers face the following risks in 2020:
– Purchasing manager indexes are sinking below 50 in many markets, a sign of
manufacturing contraction.

S&P Global Ratings November 18, 2019 3

Industry Top Trends 2020: Capital Goods

– The U.S. is facing a one-in-three chance of recession in late 2020.

– U.K. and Germany are in near-recessions.
– Growth in China continues to slow down.
These factors are already influencing the capital goods sector. Despite issuers'
significant share of revenue and profit from recurring services and aftersales, the sector
is sensitive to industrial investment levels and overall business confidence. The recent
growth in industrial production in the eurozone and Japan peaked at the start of 2018
and turned negative at the start of 2019. In the U.S., industrial production is still growing,
but at an ever slower rate. More importantly for the capital goods sector, new industrial
orders are contracting both in the eurozone and the U.S., which is weakening sector order
books and likely to dent revenues and profits in 2020.
Chart 7
Industrial Production excl. Construction (% Change)

Source: Datastream, ECB, S&P Global

Chart 8
New Manufacturing Orders

Source: Datastream, ECB, S&P Global

S&P Global Ratings November 18, 2019 4

Industry Top Trends 2020: Capital Goods

We expect industrial investment to remain weak in the U.S. and Europe, and to shrink in
Asia-Pacific (excluding Japan). Multiple demand drivers--including autos and
commodities--are either stagnating or in decline. End markets that are still growing are
aerospace and defense (excluding the supply chain impact of the grounding of the Boeing
737 MAX), health care, renewable energies, and e-commerce. Construction sector
demand is still growing, but slowing down.
Our capex analysis--based on aggregated forecasts of individual rated entities by sector-
-foresees weak capex in many end markets. Investments in most sectors will grow
moderately over the next two years compared to the latest actual numbers from 2018,
and develop negatively compared to our expectation for 2019 peak levels. Notable
positive exceptions are technology, aerospace and defense, and engineering and
construction, where our aggregated forecast still sees growth in investment.
Overall, we forecast declining investment over the next few years, and we expect this to
reduce capital goods companies' new equipment sales. An improving economic outlook
would likely reverse this development, as rated industrial companies are holding back
capex due to uncertainties in their operating environment.
Chart 9
Forecast Capital Expenditure for Key Industrial End Markets

Source: S&P Global Ratings. Bloomberg

S&P Global Ratings November 18, 2019 5

Industry Top Trends 2020: Capital Goods

Chart 10
Forecast Capital Expenditure Compound Annual Growth Rate (2018-2021)

Source: S&P Global Ratings. Bloomberg

End-market demand does not support growth in 2020

Automotive: Negative short term impact due to weak demand

Global light vehicles sales as of September YTD were down by 5.6% compared to previous Mitsubishi Electric,
year with China down by 10.3%. The prospects of a fast market recovery for the KUKA, Emerson,
remainder of 2019 and 2020 are weak due to softer market conditions in Europe and the
lack of a substantial turnaround in China after what we expect to be a dip of 7%-9% in Rockwell, 3M,
full-year 2019. The sector is reducing capacity to match actual utilization rates, and the Hitachi, ABB,
main industry players are refocusing their businesses and product offerings to withstand Siemens, Cummins,
a situation of no-economic growth. Toyota Industries
Capital goods issuers exposed to the auto production industry are seeing declining
revenues and margin pressure, and we expect this to continue in 2020. Uncertainty
around the transition to e-mobility and alternative propulsion has led original equipment
manufacturers to adopt more cautious investment behavior to avoid potential stranded
investments and to protect their cash flows. Over the longer term, a shift to e-mobility is
likely to increase model variety and the degree of automation, supporting the capex
spent.

Aerospace and defense: Expected growth caveated by 737MAX grounding Mitsubishi Heavy
We expect military spending in the US to grow at the rate of inflation after fiscal 2021 due
Industries, GE,
to competing fiscal priorities and other political issues. However, total spending is still Honeywell
very high and lags in the appropriation process will likely result in growing revenues for
most defense contractors for a few years after spending levels off. The long term demand
for commercial aircraft is still solid, despite weak new orders, somewhat slower air traffic
growth, and an uptick in order cancellations. Rising global wealth and GDP, even at a
slower pace, will keep air traffic growing. Airlines also need to refresh their fleets with
more fuel efficient aircraft.

Overall we expect healthy aerospace and defense spending to fuel capex on production
equipment and automation, as well as software. We also expect manufacturers of
components for the aerospace and defense sector to benefit from increasing production
volumes on large-scale aerospace and defense programs.

S&P Global Ratings November 18, 2019 6

Industry Top Trends 2020: Capital Goods

However, the grounding of Boeing’s 737MAX has gone on longer than we expected and
could be further delayed. If any delay is likely to go much into 2020, Boeing could decide
to further cut or even suspend MAX production temporarily. This could result in lower
revenues, earnings and cash flow for many suppliers, weakening the already fragile
supply chain.

Agriculture: Continuous weak demand due to low farm output prices CNH, Deere, AGCO
We expect tepid demand in the global agricultural industry in 2020, as soft commodity
prices remain relatively low and uncertainty from the U.S.-China trade dispute weighs on
farmers' confidence, particularly in North America. While farm aid should contribute to
modestly higher incomes for U.S. farmers in 2019, weather- and trade-related
uncertainties could still cause customers to defer equipment purchases over the next 12
months.
Still, we believe that the underlying need for global replacement equipment persists as
farmers seek to update aging fleets with more efficient and technologically advanced
equipment. We expect market conditions in Europe to be relatively flat due to continued
dry weather that has resulted in mixed harvest results and has moderated dairy prices.
Market fundamentals in Latin America are poised to benefit from increased demand for
agricultural exports as trade routes shift in the near term, although volatility in the
availability of financing and geopolitical conditions in the region could dampen this
improvement.

Chemicals: Moderately negative due to weak chemicals prices ABB, Honeywell,

We expect demand for virtually all commodity chemicals and many specialty chemicals to Siemens, Rockwell
remain weak in 2020 due to softness in industrial production. For many chemicals the
global demand has declined already in 2019, and we do not expect a recovery for the sector
overall in 2020.
With global chemicals companies facing uncertainty of demand and risk of low earnings,
we expect them to preserve cash and not engage in meaningful growth initiatives. We
therefore expect their capex spending to be moderate over the next two years and to
affect capital goods companies that provide process equipment and automated solutions
to the chemicals sector. Spending on operations and maintenance correlates with
production volumes, and we expect it to suffer less than spending on new projects and
capacity expansion.

Construction: Still positive, but with slower market growth rate Schneider, Siemens
The construction market is traditionally linked to global growth. We expect some
ABB, Caterpillar
headwinds in the second part of 2019 and in 2020, with softer market dynamics driven by Deere, Sandvik
lower new-build activity. Weakness stems mainly from Asia-Pacific, with some slowdown Komatsu, Hitachi,
in Europe and the U.S. Thyssenkrupp,
Emerson, Eaton
We have already witnessed the order intake softening, leading to a potential drop in
companies' toplines in the next 12 months, as current infrastructure projects come to an
end. We see more favorable conditions for companies whose projects are linked to
renewable energy integration, data centers, and storage and distribution warehouses.

We have not seen a notable change so far in low-voltage electrification, but we expect
activity to slow down along with overall construction. We expect elevators to fare well due
to the long-term contractual nature of the business, and rental companies to post
healthy credit ratios as they will cut investment in a downturn. Manufacturers of heavy
construction equipment are likely to feel the greatest impact from a slowdown.

S&P Global Ratings November 18, 2019 7

Industry Top Trends 2020: Capital Goods

Health care equipment: Stable modest market growth expected to continue

Siemens, GE
The health care end-market does not generally follow general economic cycles. Smiths, Heraeus
Therefore, we expect a relatively stable performance from health care equipment Ceramtec, 3M
manufacturers and suppliers of related components and materials, supported by the
following favorable trends: aging populations, penetration into emerging markets, the
rise of home-based health care, and the need for innovation and digital applications.

However, we view that the equipment markets are mature and competitive, and that with
pressure on healthcare budgets in most developed countries, sales growth through
upgrades or expansion will be limited. The most important market for the equipment, in
particular high end solutions and related software, remains the U.S.

Logistics and e-commerce: High growth rate due to rapid market expansion KION, KUKA
We see the positive trend in e-commerce as a key support for capital goods companies
ABB, Schneider
exposed to logistics end markets. We expect retailers and logistics companies to Honeywell
continue to respond to increased volumes of online orders by investing in fast shipping,
efficiency, and reliability, which are key elements of successful competition in the e-
commerce and logistics markets. Increasing automation and digitalization in warehouses
is also supportive, but depends to some extent on regional factors like land restriction
and labor costs. We continue to believe that logistics integrators are likely to show
weaker margins than component providers, as they carry the project execution risk and
face more pricing pressure as the direct suppliers of large logistics, retail, and e-
commerce customers.

Metals and mining: No expansionary capex expected due to low commodity prices Weir Group, Metso
We expect commodity prices to decrease slightly from 2019 levels over the next two
Epiroc, Sandvik
years, and reduce investment by global miners. For instance, we see the price of nickel Caterpillar,
decreasing in 2020 to $15,000 per ton (/ton) versus our expectation of $17,000/ton in Komatsu, Emerson
2019, and the price of iron ore decreasing to $80 per dry metric ton (/dmt) from $90 Rockwell, ABB
per/dmt. Siemens
The trend for global mining companies over the past few years has been strengthening
financial flexibility and improving profitability and cash conversion. We see capex focused
on maintenance, driven by replacement cycles instead of new projects. The lack of new
greenfield projects suggests that miners will not undertake expansionary capex in the
foreseeable future. Therefore, the demand for original equipment will be subdued, while
the share of aftermarket services in the revenues of capital goods companies serving the
mining sector will increase.

We expect efforts to increase efficiency and production on brownfield sites to sustain and
support the order intakes of capital goods companies exposed to this sector. Overall, we
do not expect any revenue growth for these companies due to miners' cautious
investment behavior, but performance in 2020 should be supported by a healthy order
backlog.

S&P Global Ratings November 18, 2019 8

Industry Top Trends 2020: Capital Goods

Oil and Gas: Stagnating volumes and prices will limit spending Weir Group, Smiths
Oil and gas markets are prone to volatile pricing, with production volumes likely
Group, Caterpillar
stagnating as the softer global economy affects demand. With prices remaining weak, we Gardner Denver,
expect oil majors' capex to remain roughly stable, around the 2018 level of $560 billion, Emerson,
over the next two years. The rig count is half that in 2014, and oil and gas majors focus on Rockwell,
maximizing production from existing wells at a lower cost. ABB,
For capital goods companies exposed to the oil and gas sector, we expect revenue and
Siemens,
margin pressure, with a negative impact on the ratings on companies with material Honeywell
exposure. As we do not expect expansionary investment over the next two years,
companies with exposure to upstream oil and gas will need to be able to offer
technological solutions to increase efficiency at existing fields. Overall, we expect
companies with high exposure to aftermarket sales to be better able to sustain their
credit metrics than those exposed to the development of new wells.

Utilities: Renewables positive, conventional negative, grids with long-term demand ABB, Siemens
In the utilities sector, trends vary substantially among different regions and subsectors.
GE, Hitachi
Demand for conventional large power plant equipment in most developed countries in Voith, Siemens-
Europe and the U.S. remains weak and is also softening in developing countries and Gamesa, Goldwind
China. This has led both to notable overcapacity in the market for equipment, for Emerson, Rockwell,
example, large gas turbines, and to a need for cost-cutting among original equipment Mitsubishi Heavy
manufacturers. With tougher regulation on carbon dioxide emissions, modifications to
increase the energy efficiency of existing plants remains positive performance drive for
Industries, Toshiba
the sector.

More favorably, we expect investment in renewable energy to grow significantly over the
coming years, which is particularly positive for wind turbine manufacturers. However, the
move to competitive auction-based systems as a global industry standard, as well as the
fragmented market structure, keep the profitability of this subsector under pressure.
Consequently, we forecast further industry consolidation, either through market exits or
M&A, over the next two-to-three years.

Investments in power and gas infrastructure remain positive globally. These investments
are to replace aged transmission and distribution networks and transform existing grids
into decentralized power generators. We view this market segment, particularly large
transmission projects, as highly competitive, and expect profitability to remain below the
sector average.

S&P Global Ratings November 18, 2019 9

Industry Top Trends 2020: Capital Goods

Key risks and opportunities

1. M&A will continue, but at a slower pace

We expect divestments and acquisitions to continue as large U.S, European, and

Japanese capital goods companies seek to simplify their structures and invest in higher-
growth technologies. We saw a number of transactions take place in 2019, and there is a
notable pipeline of acquisitions, divestments, and IPOs due to close in 2020. We expect
large players to shield their balance sheets in the current economic environment, and
therefore expect the pace of large M&A to slow down. However, most large players have
the means to engage in strategic bolt-on acquisitions, and favorable financing conditions
and the divestment of noncore activities will continue to provide opportunities for
financial investors.

2. Large sector players well-positioned to manage the downturn

We expect large capital goods companies to be able to withstand the downturn well. Of
the 13 tier 1 issuers that we rate in the 'A-' category or above, three (3M Co., ABB Ltd., and
Mitsubishi Heavy Industries), have negative outlooks, but overall, we see ample
headroom in the ratings. For companies rated in the 'A' category, we forecast average
FFO to debt of 52% and debt to EBITDA of 1.3x in 2019, and average FFO to debt of 50%
and debt to EBITDA of 1.4x in 2020.

3. Trouble for companies in the lowest rating categories

We expect to see negative rating transitions and a potential increase in defaults in the
lowest 'B' and 'CCC' rating categories--where we have already seen significant downward
movement and weakening credit ratios in 2019 as a result of slowing demand in
combination with highly geared balance sheets. Our outlook distribution in the 'B' and
'CCC' categories has a heavy negative bias, with 25% of the ratings on a negative outlook.
In 2020 we expect companies with less favorable business models, weaker operational
capabilities, and more concentrated market or product exposure to experience more
operational and financial challenges, including access to liquidity and feasible
refinancing options.

M&A is set to continue among the large sector players, but at a slower pace
While capital goods issuers continued to pursue strategic M&A and divestitures in 2019,
we expect the pace to slow in 2020 due to the global economic slowdown.
Deconglomeration and strategic M&A continue to transform the industry, and 2019 was a
busy year, with the announcement and completion of a number of notable transactions.
The ratings implications of acquisitions have been largely negative. We lowered the issuer
credit rating on Parker Hannifin to 'A-' from 'A' following the acquisitions of LORD and
Exotic Materials. While these acquisitions enhanced Parker Hannifin's competitive
position and scale in the engineered materials and aerospace industries, they were
largely debt-funded, resulting in a meaningful deterioration in leverage metrics. Similarly,
we revised the outlook on 3M to negative and affirmed the 'AA-' issuer credit rating due to
the debt-funded acquisition of medical technology company Acelity Inc. for $6.7 billion.
This, combined with weaker operating performance in 2019 than we expected, led to
weak credit metrics for the rating.
The ratings implications of divestitures and spinoffs have been largely neutral. We
affirmed the ratings on Johnson Controls International PLC (JCI) following the divestiture
of its Power Solutions unit to private equity. JCI used $3.4 billion from the $11.6 billion
sale proceeds to reduce debt, demonstrating a commitment to its financial policy.

S&P Global Ratings November 18, 2019 10

Industry Top Trends 2020: Capital Goods

While we expect the pace of acquisitions and divestitures to slow in 2020, there are a
number of relatively large transactions that have been announced and that we expect to
complete in 2020. General Electric announced the sale of the biopharmaceuticals portion
of its health care business to Danaher Corp. for about $20 billion in cash. We view this as
largely credit-positive given the balance between the cash proceeds that General Electric
expects and its retention of the majority of the EBITDA from its health care segment. In
addition, United Technologies announced in late 2018 its intention to separate its
commercial businesses Otis and Carrier into independent entities. Siemens announced
that it would undertake an IPO of its energy-related businesses in September 2020,
which will reduce the group's consolidated topline by around €30 billion. thyssenkrupp
announced an IPO or sale of its elevator technology business during the first half of 2020
after the group's steel merger with Tata Steel Europe was blocked by the EU. We expect
that ABB, which has a negative outlook after depleting its ratings headroom, will close the
disposal of its power grids division to Hitachi by mid-year 2020 for a cash consideration
of around $6.8 billion.
Large industrial issuers' balance sheets remain strong, as their cash flow has recovered
from the 2016 industrial downturn and most groups enjoyed two years of solid profitable
growth. We expect most investment-grade issuers to maintain conservative financial
policies to preserve credit quality in anticipation of an economic slowdown. We expect
most acquisitions to be bolt-on and modest in size. We believe that issuers will continue
to focus on running leaner, more profitable, and faster-growing businesses, and that this
will drive further portfolio realignment. One factor that hinders acquisitions in the sector
is the high valuations of potential companies, particularly those with more favorable
growth prospects such as in the technology, health care, or consumer-related end
markets.

Large capital goods companies can withstand the downturn, but highly
leveraged issuers' default risk will increase
We expect most large capital goods companies to maintain strong credit metrics in 2019
and 2020. For large capital goods companies rated in the 'A' category, we forecast
average FFO to debt of 52% and debt to EBITDA of 1.3x in 2019, and average FFO to debt
of 50% and debt to EBITDA of 1.4x in 2020. Most of these issuers have significant
headroom in the ratings, despite the weakening operating environment. The majority
have stable outlooks, as we expect they will be able to continue generating significant
free operating cash flow to cover shareholder distributions and M&A without their key
credit metrics breaching our downgrade thresholds.

S&P Global Ratings November 18, 2019 11

Industry Top Trends 2020: Capital Goods

Industry forecasts
Global Capital Goods – Large-Capitalization Rated Issuers
Chart 11 Chart 12
Revenue growth (local currency) EBITDA margin (adjusted)

Debt / EBITDA (adjusted) FFO / Debt (adjusted)

Source: S&P Global Ratings. Revenue growth shows local currency growth weighted by prior-year common-currency revenue-share. All other figures
are converted into U.S. Dollars using historic exchange rates. Forecasts are converted at the last financial year-end spot rate. FFO--Funds from
operations.

Sample: 3M Co. CNH Industrial N.V, General Electric Co., thyssenkrupp AG., Toshiba Corp., Caterpillar Inc., Deere & Co., Emerson Electric Co., Hitachi,
Ltd., Komatsu Ltd., Siemens AG, Honeywell International Inc., Atlas Copco AB, Schneider Electric S.E., ABB Ltd., Mitsubishi Heavy Industries, Ltd.,
CRRC Corporation Limited

For speculative-grade issuers, particularly issuers in the 'B' category and below, the
situation is different, and we expect ratings to continue to transition downward. In 2019,
the global capital goods sector had six defaults, all from the 'CCC' category. Of the six
defaults this year, four were from Europe, one was from India, and one was from the U.S.
Defaults were caused by continuous weak performance and a cash squeeze due to a high
interest burden and working capital outflows, leading to an unsustainable capital
structure or an inability to service debt.
In the global capital goods portfolio of 218 issuers, we had 70 downgrades in the year to
date, of which 5 were in the ‘B+’, 15 were in the 'B', 7 in the 'B-', and 6 in the 'CCC+'
categories. Compared to the end of 2018, the number of issuers rated in the 'B-' category
has increased by 50% or 10, and in the 'CCC' category by 10% or 1. Debt to EBITDA for our
'B' rated issuers stands at 5.7x, for our 'B-' rated issuers at 8.2x, and those rated 'CCC+'
at 8.5x, and has steadily increased over the past two years.
Therefore, in our lowest rating categories, we see a risk of a further material weakening of
credit quality over the next two years, and a potential increase in defaults due to issuers'
tightening liquidity and inability to achieve EBITDA growth. Additionally, in the likely
scenario of an economic downturn, we see weak credit metrics, together with a potential
repricing of financial risk by banks and investors, restricting the lowest-rated issuers'
access to sustainable financing. This could heighten refinancing risk in 2020 and 2021.

S&P Global Ratings November 18, 2019 12

Industry Top Trends 2020: Capital Goods

Related Research
– Caterpillar Inc., Nov 12, 2019
– Large Capital Goods Companies Can Withstand An Economic Slowdown In 2020,
Nov. 4, 2019
– Rising Orders At Wind Turbine Manufacturer Siemens Gamesa Buck Industry
Trend, Nov 05, 2019
– ABB Outlook To Negative On Weaker Cash Generation; 'A' Rating Affirmed, Nov
01, 2019
– General Electric Co. Demonstrates Better-Than-Expected Turnaround
Performance; No Change To Ratings, Oct 31, 2019
– Schneider Electric Retains Significant Ratings Headroom Despite Weakening
Economic Fundamentals, Oct 24, 2019
– Mitsubishi Heavy Industries Ltd., Oct 18, 2019
– KUKA AG Outlook Revised To Negative From Stable Following Revised Guidance
Oct 01, 2019
– thyssenkrupp AG, Sep 06, 2019
– CNH Industrial N.V.'s Plans To Spin Off Commercial Vehicle And Power Train
Operations Is Currently Credit Neutral, Sep 03, 2019
– ESG Industry Report Card: Capital Goods, Jun 03, 2019

This report does not constitute a rating action.

S&P Global Ratings November 18, 2019 13

Industry Top Trends 2020: Capital Goods

Industry forecasts
Global Capital Goods
Chart 15 Chart 16
Revenue growth (local currency) EBITDA margin (adjusted)
N.America W.Europe
Asia-Pacific Global
Forecast
20%
18%
16%
14%
12%
10%
8%
6%
4%
2%
0%
2016 2017 2018 2019 2020 2021

Chart 17 Chart 18
Debt / EBITDA (adjusted) FFO / Debt (adjusted)

Source: S&P Global Ratings. Revenue growth shows local currency growth weighted by prior-year common-currency revenue-share. All other figures
are converted into U.S. Dollars using historic exchange rates. Forecasts are converted at the last financial year-end spot rate. FFO--Funds from
operations.

S&P Global Ratings November 18, 2019 14

Industry Top Trends 2020: Capital Goods

Cash, debt, and returns

Global Capital Goods
Chart 19 Chart 20
Cash flow and primary uses Return on capital employed

Chart 21 Chart 22
Fixed versus variable rate exposure Long term debt term structure

Chart 23 Chart 24
Cash and equivalents / Total assets Total debt / Total assets

Source: S&P Global Market Intelligence, S&P Global Ratings calculations

S&P Global Ratings November 18, 2019 15

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