Fitch: EMEA construction outlook weakens in West; remains strong in East

Western European issuers are likely to face increasingly challenging market conditions as macro-economic conditions deteriorate, coupled with continued pressure for debt-funded shareholder-friendly actions, i.e. M&A and buybacks. In contrast, issuers in eastern Europe and the Middle East should continue to experience strengthening credit quality, driven by strong, structural demand and increasing corporate sophistication.

Despite weakening economic conditions, and therefore reduced demand for residential and commercial construction, the outlook for western European construction remains stable. 'We expect the diversified nature of large construction issuers to allow sufficient cash flow to be generated by non-construction activities to offset any weakness in traditional construction activities,' says Monica Insoll, Managing Director in Fitch's Industrials team.

Fitch's outlook for western European housebuilding is negative, reflecting increased leverage and expected materially reduced earnings in 2008. Leverage (adjusted net debt-to-operating EBITDAR) increased across the sector during 2007 as companies became more aggressive in debt-funded M&A activity and share buybacks. This could prove problematic, given that earnings are likely to come under pressure in 2008 as housing markets weaken due to affordability issues, reduced mortgage lending and localised over-supply.

The outlook for construction in the CIS and Gulf Co-operation Council (GCC) regions is more positive than in western Europe. Supportive factors, such as strong GDP growth, rapid population growth and increasing mortgage availability, continue to underpin robust growth in areas such as Moscow, Dubai and Doha. These positive fundamentals, together with increasing corporate sophistication (such as improved corporate governance, increased scale, better geographical diversification and more refined risk-management procedures), should benefit credit profiles over the medium term.

Nevertheless, CIS and GIC issuers continue to face the risk of possible over-supply in certain localised markets should large development backlogs be inadequately phased. Concerns also persist regarding the relatively less mature, non-transparent and potentially volatile nature of some local construction markets, while issuers, generally speaking, still lag behind their western European peers in terms of corporate governance, risk management and access to back-up liquidity sources.