Fitch Sees Deflation as Key Risk for EMEA Corporates

Gradually improving margins and cash generation should lead to greater ratings headroom for companies in Europe, the Middle East and Africa (EMEA) in 2015, supporting a stable outlook for the region, Fitch Ratings says.

However, the credit ratings agency (CRA) adds that significant risks remain in geopolitical tension and the possibility of deflation. Strategic merger and acquisition (M&A) activity is also likely to accelerate, which could increase leverage if debt funded.

Fitch expects market conditions to improve further in 2015, continuing a gradual recovery that began in mid-2013. This should result in slightly stronger revenue growth and improving profitability, with cyclical industries such as capital goods, manufacturing, construction and automotive benefitting most.

The CRA also thinks that peripheral eurozone corporates will have the greatest improvement in rating headroom in the near term, albeit from a low base, as gross domestic product (GDP) growth across the region becomes sustainably positive.

Deflation remains a meaningful risk, although not Fitch’s base case, and would lead to subdued demand, falling asset values and increased real debt burdens, all of which would be negative. Adverse effects would be exacerbated for the growing number of highly leveraged issuers in the ‘B’ rating category.

The CRA adds that flagging growth increases the likelihood of risk events, and the gap between investor expectations for fundamental credit and spreads reflects this dilemma. Many investors are holding positions for fear of losing out on a potential European Central Bank (ECB) quantitative easing (QE) rally, but may remain exposed to developing refinancing risks over the medium term.

The turmoil in Ukraine has also added to geopolitical risks, while currency depreciation has reduced emerging-market growth expectations.

Expansion into higher-growth emerging markets was a focus for many EMEA corporates looking to boost anaemic revenue growth in recent years. With this option looking less attractive, the CRA believes that local bolt-on acquisitions may become more frequent, especially in telecoms, media and technology, pharmaceutical, oil and gas and capital goods.

Wide-ranging cost-cutting since 2008 has left many corporates with higher cash stockpiles and therefore more financial flexibility, but any rise in M&A is likely to be gradual, accelerating over the medium term if the recovery is sustained.

Weaker oil prices should drive worse-than-expected full-year results for major oil and gas producers. How these companies choose to rethink capital expenditure (capex), operating expense (opex) and shareholder remuneration plans in response to falling prices is likely to be the key rating consideration in 2015, says Fitch.

In contrast, the operating environment for western European telecoms should improve in 2015 as consolidation reduces competitive pressures and demand for high-speed fixed and mobile broadband accelerates.

Fitch’s just-published
‘2015 Outlook: EMEA Corporates’
offers a sector-by-sector analysis of the prospects for EMEA companies in the coming year.

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