Gradually improving economic conditions across much of Europe should help strengthen cash flows and modestly reduce leverage among the region’s corporate issuers in 2015, according to Fitch Ratings.
However, the credit ratings agency (CRA) cautions that macro risks remain significant and any delay in economic recovery could hit lower-rated corporates hard, especially as many companies have already cut costs to the bone.
Fitch expects the diversified manufacturing and automotive sectors to experience the strongest improvement in cash generation in 2015, while oil and gas and utility companies will face pressure from weak oil and energy prices.
Overall, the CRA expects higher funds from operations to lead to slight deleveraging across Europe, Middle East and Africa (EMEA) corporates and help strengthen interest and fixed-charge cover in conjunction with falling debt funding costs.
However, the extent of the impact on credit profiles will depend on how companies decide to use their cash. Fitch expects capex to remain fairly stable in 2015, while strategic mergers and acquisitions (M&As) could increase further, especially as corporate funding costs remain historically low.
The telecom, media and technology (TMT), capital goods, building materials and pharmaceutical sectors could all undergo further significant M&A. The rating impact could be greater in some sectors than others. For example, Fitch’s negative rating outlook on the pharma sector reflects a trend for strategically riskier deals and pressure for higher shareholder returns. But recent deals in TMT have used equity and equity-linked instruments to minimise the impact on balance sheets, or have included a pledge to reduce dividends to increase the pace of deleveraging.
The main macro risks for 2015 include slower growth and foreign exchange volatility in emerging markets, and the potential for prolonged eurozone deflation. Turkish corporates would be most at risk in an FX stress scenario because of their relatively high FX borrowing and lack of hedging, but overall Fitch believes widespread financial distress in emerging markets remains unlikely thanks to an improvement in credit fundamentals over the last decade.
Quantitative easing (QE) has reduced the risk of prolonged deflation, but were this to occur corporates would face a combination of weaker demand, higher real interest rates and rising real debt burdens.
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