Eight Industries That Will Lag Behind Economic Recovery

by: Rick Newman

Sooner or later, the economy's going to turn a corner. Some think it won't be until 2010 or even 2011, since unemployment seems certain to rise for the foreseeable future and fall only slowly after it finally peaks. Others are more optimistic, pointing to evidence of an imminent turnaround. Merrill Lynch, for instance, declared in a recent research note that "the recession is over."

Whenever it happens, a recovery is likely to be sporadic and uneven. Industries that have held up over the last 18 months, like healthcare, education, pharmaceuticals, energy, telecom, and some high-tech sectors, should remain stable places to work. A few industries that have been battered during the recession may actually be poised for a bit of growth, since failed companies and consolidation have left openings that healthy companies can exploit. Some smaller regional banks, for instance, could nab credit-card business from wounded giants like Citigroup (NYSE:C) and Bank of America (NYSE:BAC). And while billions in government bailouts once signaled the fragility of the financial and insurance industries, they've also helped contain the damage, which could bring back some jobs over the next couple of years.

But other industries are mired in a world of hurt, with weak prospects for improvement any time soon. To determine which parts of the economy will struggle the most over the next couple of years, we analyzed data from Moody's (NYSE:MCO), the rating agency, which predicts the likelihood of defaults on corporate debt in most sectors of the U.S. economy. We focused on two important measures: industries with the highest projected default rates, and the percentage of companies in a given industry for which Moody's has a negative outlook. Then we singled out the industries that rank below the median on both of those lists.

These are industries where the majority of companies will remain under pressure to cut costs and revive cash flow, mainly because of lower demand and long-term changes in their slice of the economy. Some companies in these industries are still at risk of failing, often because of debt taken on in recent years to fund mergers or expansion. Jobs are likely to be scarce. And as the economy gradually gets healthier, these industries will be the laggards that turn around last.

Airlines. They're no longer gagging on the sky-high fuel prices of 2008, but double-digit cutbacks in fliers and revenue mean another money-losing year for this long-ailing industry. Sharp declines in high-revenue business travel have been the toughest blow, and that's likely to continue well into 2010. Swine flu could keep even more people home if there's a fresh outbreak this fall, as some experts expect. Most airlines have cut capacity, but that alone isn't enough to keep carriers in the black. After several rounds of bankruptcy over the last several years, more are possible, with American (NASDAQ:AMR), United (UAUA), and US Airways (LCC) currently the lowest-rated major carriers, according to Moody's.

Hotels and cruise lines. With both business and leisure travelers staying home, hotel occupancy has plunged. That has led to deep discounting at chains like Marriott (NYSE:MAR), Westin, Sheraton, and Wyndham (NYSE:WYN), and that has hammered profitability. A pickup depends on improving business conditions and a better jobs picture, which seem a year away at best. Cruise lines are almost entirely dependent on leisure travelers, who have been scarce because of falling home values and a dramatic reduction in Americans' net worth. Theme parks, sports arenas, and other leisure venues are suffering from the same woes.

Casinos. If there's any good news, it's that laid-off Americans don't seem to be betting their savings at the blackjack table. But they're not gambling with their disposable income, either. That's bad news for Las Vegas, where visits are down nearly 10 percent this year and the local economy has been battered. Even if traffic bounces back, several new casinos that are scheduled to open next year will deepen a gap between supply and demand. Other gambling states like New Jersey, Connecticut, and Illinois are feeling the pinch, too, and gaming companies like Harrah's (HET) and MGM Mirage (NYSE:MGM) are struggling to generate the cash flow required to make interest payments on debt and cover expenses. Gambling usually rises and falls with consumer spending, but this time, analysts aren't so sure that shell shocked consumers will return to the casinos once their incomes improve.

Automotive. The General Motors and Chrysler bankruptcies may have been the start, not the end, of a dramatic reordering of the nation's automotive industry. Car sales have picked up a bit, but global sales are still likely to be down by more than 10 percent in 2009, which affects every carmaker operating in the United States. Government bailouts in the United States and Europe may have saved jobs and prevented a catastrophic collapse, but they also kept in place excess capacity that will keep profits low. A worldwide emphasis on smaller cars—which have smaller profit margins—will add to the financial stress. And there's still the possibility that GM or Chrysler could fail. The pressure will extend to thousands of suppliers, dealerships, car-rental agencies, and other firms dependent on the carmakers.

Media. It's hard to imagine what else could go wrong for traditional print and broadcast media companies. Even without a recession, newspapers, magazines, and TV and radio broadcasters have been losing their audience to the Internet. At the same time, a crushing downturn in the retail, automotive, and financial industries has led to double-digit cuts in advertising, the biggest source of revenue for many media companies. And there's no historic election, accompanied by millions in political advertising, slated anytime soon to help pick up the slack, as there was in 2008. Many newspapers are in such bad shape that investors have virtually no interest in buying them, at any price, according to Moody's. Magazines are doing so poorly that McGraw-Hill (MHP) is struggling to find a buyer for BusinessWeek, one of the most venerable titles on the market. TV networks have the ability to boost ad revenue from entertainment programming and deals with cable companies—but only if they can deliver viewers, who are more elusive than ever.

Real estate and construction. Everybody knows about the dismal housing market, which is likely to stay depressed well into 2010 because of rising foreclosures and ongoing job losses. And by the time home prices bottom out—perhaps midway through 2010—a commercial real estate bust may be fully underway, with acute drops likely in construction of retail, office, government, and manufacturing complexes. The real estate doldrums will continue to plague a huge swath of the U.S. economy, including home builders, mall operators, cement companies, pickup truck manufacturers, and thousands of small businesses that cater to contractors and construction firms.

Metals. Demand for steel, rebar, aluminum, copper, and other metals is linked closely to two industries that are depressed: Cars and construction. The global car market seems likely to sag for well over a year, and a commercial real estate bust is coming right behind the meltdown in housing. Strong demand in developing markets like China and India drove many metals prices to record highs in early 2008. But demand has now collapsed, with prices of some products approaching 10-year lows. With no rebound on the horizon, big producers like Alcoa, US Steel, and AK Steel will be in a holding pattern, at best.

Retail. A trip to the mall says it all: There are fewer shoppers, and they're spending less. Bankrupt chains like Circuit City, Steve & Barry's, and KB Toys have left behind acres of vacant storefronts. Two major factors are likely to prolong the pain: rising unemployment, which leaves consumers with less income and more job worries, and a severe decline in household wealth, thanks to the housing bust. Over the next year, Moody's predicts that the most vulnerable retailers will be specialty stores that cater to a small subset of consumers or specialize in discretionary products people can live without. Also vulnerable are department stores, which were losing sales before the recession even started and have slashed prices and closed stores to survive the last two years. The lowest-rated firms on Moody's list include Brookstone, Claire's (CLE), Finlay Fine Jewelry, Oriental Trading Co., Bon-Ton (NASDAQ:BONT), and Neiman Marcus (NMG). The only possible bright spots are low-margin discounters like Wal-Mart (NYSE:WMT), supermarkets, and drugstores. For the foreseeable future, a utilitarian economy may be the best we can muster.

Disclosure: no positions