Defensive Spending Tactics Expected for EMEA Corporates

Corporate issuers in Europe, the Middle East and Africa (EMEA) will focus on measures to limit cash erosion in 2013 as challenging market conditions continue, says Fitch Ratings.

According to the credit ratings agency (CRA) defensive tactics will include limiting spending on expansionary capital expenditure (capex), dividends and mergers and acquisitions (M&A), with issuers primarily concentrating on cost and efficiency improvements to cope with weak demand. Those companies that do increase capex will mainly do so to protect market share, or offset home market weakness. A risk to this scenario, although Fitch regards it as an overstated one, is that sentiment towards M&A and buybacks could flip relatively quickly, possibly threatening credit quality.

Despite moderate expansionary investment over the last two years compared with 2008 highs (7.52% capex/revenue), Fitch-rated corporates have not significantly underinvested. Companies have the firepower, through high balance sheet cash and strong borrowing capacity, to resume capex once market conditions improve. Fitch expects nominal investment to slow slightly to US$485.5bn in 2013 (6.3% of revenue) from US$503.6bn in 2012 (6.7% of revenue). This remains closely linked to annual depreciation and amortisation (1.39x cover, from 1.52x in 2008).

Despite this scenario, Fitch says that some industries are likely to increase investment. Growing emerging markets and a need to catch up on underinvestment in 2008-2010 will lead most automotive manufacturers to increase capacity outside mature markets. This is intended to help them weather a further drop in sales in western Europe and lingering uncertainty about the future of the eurozone. An exception is Fiat – rated BB/negative – which Fitch expects to invest in its domestic Italian and European markets.

Higher telecoms capex will be driven by consumer demand and intense competition, forcing incumbent operators to increase spending on long-term evolution (LTE) spectrum auctions and fibre upgrades, especially where cable competition is severe. Continued regulatory and competitive pressure means telcos will have to remain disciplined on shareholder remuneration to keep leverage under control.

There will also be capacity additions in the drinks sector, driven by continuing strong end-user demand, while the CRA expects integrated and network utilities in emerging markets to increase capex closer to normal levels after a decline in 2011. Fitch estimates that non-food retailers’ total capex and capex as a percentage of sales in 2013 will be the highest since 2008. Investment in multi-channel platforms, continued store refurbishment and improvement in service and offers will become the norm as these retailers attempt to defend their market share.

However, capex/revenue is expected to slightly decline across the pharmaceutical, food retailing, and industrial sectors in 2013. Large diversified miners are likely to have marginally lower capex budgets than in 2013, while Fitch forecasts aggregate planned capex across the mining industry to be higher year on year. However, the start of many projects may be delayed as the year progresses.

Similarly, the CRA expects dividend payments to remain moderate across EMEA corporates in 2013, after a reduction in 2012. Rebased dividends will be maintained in food retail (with some use of scrip issues), while M&A activity will mainly be limited to strategic assets across the EMEA corporate portfolio. However, this remains largely sentiment driven, and large cash outlays may erode issuers’ credit profiles in the current low-growth environment


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