Fitch Ratings expects European corporates to face a combination of waning demand, increasing input costs and higher interest rates, compounded by sustained, albeit moderating, supply chain issues, and major uncertainty about macroeconomic developments in 2023. This could further impair credit profiles and increase risk of further downward earnings and cash flow revisions as challenges outweigh opportunities.
However, we also believe that corporate issuers have built some financial buffers after the pandemic and are in a better position to face these challenges in 2023. Favourable demand dynamics continue to support a few sectors, including travel-related industries, but the post-pandemic recovery driven by pent-up demand, which boosted revenue in the past 12 to 18 months, is gradually fading for most sectors.
This trend is exacerbated by weakening consumer spending, the energy crisis and higher interest rates, which are constraining disposable income and burdening consumer and corporate confidence.
Reduced demand will trigger renewed competition to capture remaining consumer interest and could rebalance bargaining power towards end-customers. For example, we expect sustained intense competition among grocers as they target value-seeking consumers, which in combination with material cost inflation will lead to weaker profitability in 2023.
The gradual normalisation of semiconductor availability will also alleviate pressure on supply chains and supply/demand balance, testing the ability of various industries, such as automotive, trucks and capital goods, to maintain high prices.
Further to the adverse effects from the operating environment, we believe that political interference beyond fiscal intervention as the region enters a potential recession will increasingly shape corporates’ strategic decisions. This could come in various fields, such as energy policies, where the implementation of energy price caps considered by the EU could disrupt the region’s supply of gas, or ESG considerations. For example, we expect emission regulations to be an important strategic driver for several corporate issuers, as climate change comes to the forefront of states, consumers and investors’ decisions.
Fitch expects pressure on profitability from the inflationary environment, including rising raw materials, labour and energy costs. We anticipate a modest deterioration of the aggregate EBITDA margin of our portfolio of European corporates in 2023, by just more than 0.5 percentage points. This deterioration is off a high base, with many sectors posting record margins in 2022 following the post-COVID recovery.
We forecast about half of our corporate sectors to improve their EBITDA margin in 2023 as several corporates have strengthened their cost structures in the post-pandemic environment. We also believe that some sectors may benefit from their sustained order books, at least in the first half of 2023. However, we believe that improvement could reverse in the second half of the year and further in 2024 as risks are skewed to the downside due to cost increases becoming more sticky and revenue growth waning.
Rising interest rates will be an additional burden on corporate issuers’ earnings and cashflows in 2023 as they gradually refinance maturing debt issued at more favourable conditions. This will be a particular concern for lower-rated companies, which typically have higher indebtedness and are more vulnerable to deteriorating conditions.
Free cashflow (FCF) generation should be slightly better, with deteriorating FCF margins in 2023 in only three sectors: aerospace and defence, natural resources, and real estate. This reflects stronger funds from operations (FFO) and some working capital-release, which offset lower EBITDA and moderate increase in capex and dividends, which we forecast in 2023.
Our conservative assumptions for investment and shareholder distribution give companies flexibility to protect cashflows in case of increasing pressure on FFO. However, capex reduction in some sectors would constrain other sectors’ revenue, such as capital goods or technology hardware, which depend on others’ investing plans.
We forecast leverage to increase across our EMEA portfolio in 2023, albeit only moderately, to 2.1x from 2.0x because of deteriorating EBITDA and a slight increase in debt between 2022 and 2023. We expect an increase in leverage for sectors including chemicals and natural resources as they will be hit by energy price movements. Excluding the energy sector, we project the aggregate leverage for EMEA corporates to be broadly stable in 2023, around 2.9x, and then to decrease slightly in 2024, to 2.8x. In particular, sectors whose leverage soared during the pandemic, such as transportation and lodging and leisure, will have a further reduction in leverage in 2023.
Liquidity remains healthy for most of our portfolio of corporate issuers, in particular for investment-grade issuers, which largely refinanced at the onset of the pandemic, on favourable terms. We do not anticipate any imminent maturity wall that would jeopardise credit profiles.
However, falling issuance in 2022 will leave several issuers in need of cash in the medium term and dependent on capital markets to rebuild cash buffers in 2023, at more expensive conditions. Green bonds could become an increasing part of new debt issuance as companies seek to boost their ESG credentials, diversify and enhance their investor base, and reduce their financing costs.
The proportion of Negative Outlooks in EMEA has increased modestly in 2022, to 15%, but it remains well below the high levels (above 20%) recorded between 2Q20 and 1Q21, during the worst phase of the pandemic. This share varies widely between EMEA developed markets (DMs) and emerging markets (EMs): it was 12% at the end of 2022 in DMs, broadly comparable to pre-pandemic levels, but it remains high in EMEA EMs, around 30%, primarily reflecting the several corporates linked to sovereigns with Negative Outlooks. Downgrades in EMs also outweighed those in DMs in 2022 because of the numerous rating actions in Russia and Ukraine, something that should not be repeated in 2023.
Emmanuel Bulle is senior director, head of research – Europe, Middle East & Africa Corporates, Fitch Ratings
