Construction order books have generally been declining over the course of 2009 - OHL SA's ('BB-'/Negative Outlook) short-term order book was down 9.5% y-o-y in the first nine months of 2009 while Bouygues SA's ('BBB+'/Negative Outlook) order book was down 8% over the same period. This decline is likely to manifest itself in weakening operational cash flows from 2010 and into 2011. There is a heightened risk that margins on new orders taken will erode due to intensified bidding competition as the overall volume of work shrinks, compounding negative cash flow pressure.
Fiscal stimulus packages in western Europe are a short-term positive, but Fitch is conscious that these will need to be reversed over the medium-term as they simply represent an acceleration of a finite amount of infrastructure spending. This risks adding to negative cash flow pressures for European civil-focused construction companies including Bouygues, OHL and Vinci SA ('BBB+'/Stable) from late 2010 and beyond.
Based on an expectation of a continuation of weakening order books, Fitch is forecasting an average 5% to 10% annual fall in construction revenues until 2011 and a shift in average construction EBITDAR margins to about 4% in 2010-2011 from 6% in 2008.
In Russia, the outlook is even more negative than western Europe. Over the course of 2009 the recession has led to a collapse in both real estate affordability and confidence, in turn severely affecting residential and commercial property selling prices and volumes. Residential selling prices dropped almost 40% from peak (August 2008) to trough (September 2009). As a result, operational cash generation (funds from operations) and working capital inflows due to pre-sales have come under significant pressure. This, combined with much reduced availability of external finance, has resulted in severe liquidity problems and weak trading prospects for the Russian construction sector.
Following two consecutive monthly gains in Russian residential selling prices of 0.3% in October 2009 and 2.3% in November 2009, Fitch is projecting flat selling prices in 2010 driven by a structural under-supply of housing and improving economic outlook in Russia. Fitch does not expect a significant increase in residential mortgage availability, which will be a constraining factor for sector recovery. The outlook is worse for commercial property construction where a reduction in rents of around 30% due to excess supply and reducing demand will impact selling prices negatively in 2010.
Although lending, including bond issuance, to the European construction sector will likely remain tightly rationed during 2010, refinancing risks remain relatively low for the majors given their good access to back-up liquidity, including cash and committed undrawn lines and continuing support from relationship banks. Nevertheless, if the rationing of credit persists into late 2010, this, in combination with an expected drop in construction cash generation, could increase pressure on ratings in the sector.
In Russia, the liquidity and funding outlook for many construction companies, including those rated by Fitch, is fragile. A combination of over-leveraged capital structures and significantly weakened trading (Sistema-Hals 9M09 revenues down 80% yoy and negative EBITDA) has meant that the refinancing of significant amounts of short-term debt reaching maturity is difficult. As a result, Fitch expects an increase in defaults for Russian construction companies in 2010. Those companies able to obtain financing from state-controlled banks or from supportive parent companies, such as Sistema-Hals, are likely to have a better chance of avoiding outright payment defaults and potential insolvency. Fitch notes that one company in its rated universe of Russian construction issuers, LSR Group, was explicitly included in the Russian government list of corporates qualifying for potential federal support.
