A deteriorating cash flow for many Europe, Middle East and Africa (EMEA) engineering and construction (E&C) companies has been partly driven by their expansion into new international markets, particularly in the Middle East and Latin America, Fitch Ratings says.
The credit rating agency (CRA) adds that it has noted the decline in most of its portfolio of non-investment grade E&C companies in the EMEA region.
Contract disputes between the companies and local authorities have been the biggest factor, leaving some projects stranded and driving large working capital outflows. Other causes include companies’ weaker negotiating positions when entering new markets, the lack of advance payments in certain jurisdictions and the lack of access to short-term financial instruments such as factoring or confirming to soften the working capital cycle.
However, despite the increased risk Fitch still views international diversification, including the Middle East and Latin America, as positive for E&C companies, particularly those whose home markets have seen big drops in activity.
The CRA believes that risks can be reduced through exposure to a greater number of smaller construction contracts as well as the implementation of harder financial targets when bidding for contracts. This is reflected in the limited impact on the cash-flows of investment-grade E&C companies, which tend to be more diversified and less aggressive when bidding.
Among recent examples, Saudi Arabia’s transport minister last month urged a Spanish consortium to accelerate the construction of the Mecca-Medina high-speed train line, a €6.7bn contract. The Saudi Arabian authorities have demanded a plan to cover the project delays in two months’ time. Fitch believes that the consortium will need to reach an agreement with the local authorities to avoid further disputes. Spain’s OHL (formed by the merger of Obrascón, Huarte and Lain) is part of this consortium along with 11 other companies.
OHL has also been involved in contract disputes in Qatar and Algeria. For the last two contracts, the company is claiming a total of €288m, compared with its working capital outflows of €391m in the first nine months of 2014.
Italy’s Salini Impregilo was put on rating watch negative by Fitch last February due to a contract loss and difficulties in the Panama Canal extension project, although this was removed in June following a dispute resolution process. Another Italian group, Astaldi faced payment issues with the Venezuelan government during the first half of 2014 and started receiving payments in August. The outstanding amount to be collected (€290m as of September) is equivalent to almost its entire FY13 earnings before interest, tax, depreciation and amortization (EBITDA) of €302m.
Cash-flow based metrics now feature prominently alongside traditional revenue measures of business performance in the key figures or financial summary pages of any public company.
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