Fitch: Europe’s Companies Face Negative Free Cash Flow in 2013

European companies will in aggregate generate negative free cash flow in 2013 as persistent economic weakness across the region weighs on operations, while the need to keep investing pushes up capital expenditure (capex) in some sectors, according to Fitch Ratings’ latest forecasts.

In its report, entitled
‘EMEA Corporate Forecast Evolution’
, the credit ratings agency (CRA) expects Fitch-rated European corporates to report negative free cash flow (FCF) of around US$9bn in 2013, while this time last year it had expected positive aggregate 2013 FCF of nearly US$27bn. The lowered forecast results from negative nominal flows for utilities and transport, which Fitch no longer expects to be fully offset by other sectors.

The change in its forecasts for earnings before interest, taxes, depreciation and amortisation (EBITDA) was spread more evenly across sectors, with improving prospects for natural resources and consumer and healthcare companies offsetting lower expectations for the industrial, telecoms and utilities sectors. Meanwhile capex expectations have risen in most sectors.

On a through-the-cycle basis, FCF is both a key indicator of financial strength and a measure of a company’s ability to manage periods of volatility without eroding credit quality. Persistent negative flows significantly lessen flexibility, for example by preventing a company reducing its debt. The CRA’s latest forecast indicates that some companies have reached the limit of their ability to minimise capex while remaining competitive or are facing significant investor opposition to dividend cuts. But in the medium term Fitch expects FCF to improve as the European economy slowly returns to sustainable growth, and it believes further cuts to capex and dividends could still be found if conditions rapidly deteriorated.

Fitch’s forecasts for telecom, media and technology companies have weakened due to the impact of rising competition and worse-than-expected austerity cuts on peripheral incumbents such as Portugal Telecom and Telecom Italia. Intense competition in the sector and the ever-growing data needs of customers also mean that telecom companies need to invest heavily – which has pushed the CRA’s capex forecasts for 2013 and 2014 slightly higher.

Fitch has lowered its forecasts for utilities due to weaker gas and electricity demand combined with continued higher gas import prices, which are hurting earnings among generators. Structural changes from the growth in renewables and higher taxes in some parts of the eurozone are also adding to the pressure. But the prospects for the pharmaceuticals sector look better than they did a year ago, thanks to receding concerns about patent expiries and an improving drug pipeline. These factors have helped lift the agency’s 2014 EBITDA forecast for healthcare companies by around 10%.

The directional changes are more interesting for their root causes than their ultimate impact. The change in forecasts reflects a relatively minor shift in revenue base for the selected corporates of over US$5,989.2bn, and a netting of negative FCF of US$48.4bn in the traditionally cash-thirsty utilities and transport sectors, compared with positive FCF of US$38.9bn in the rest.


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