CORPORATE INDUSTRY CREDIT RESEARCH December 9, 21 Industry Top Trends 216 Engineering And Construction Credit Analysts Robyn P Shapiro New York +1 212 438 7224 robyn.shapiro@ Renato Panichi Milan, +39 272 11121 renato.panichi@ Dionisio Luiz London +44 2 7176 36 dionisio.luiz@ Renata Lotfi Sao Paulo + 11 339 9724 renata.lotfi@ Hiroki Shibata Tokyo +81 3 4 8437 hiroki.shibata@ 1 THE GLOBAL ENGINEERING AND CONSTRUCTION SECTOR REMAINS STABLE DESPITE WEAK COMMODITY PRICES Ratings Outlook. Our outlook on the engineering and construction (E&C) sector remains stable as Standard & Poor's Ratings Services currently has stable outlooks on 78% of the companies that we rate in the industry. Many E&C companies entered 21 with generally healthy order backlogs and cash balances. Operating Performance. In the face of low global oil prices, oil and gas exploration and production (E&P) companies are cutting back on capital spending as they try to control their costs and conserve their cash flow and liquidity. This could negatively impact the backlogs of contractors with exposure to the upstream oil and gas end market. However, companies with diversified backlogs that span across several end markets will likely only experience a moderate impact, in our view. Credit Metrics. Many E&C companies have strong credit measures that provide them with a cushion under our current ratings, given the volatility in their industry and the uncertain economic outlook. The solid credit metrics of these E&C companies should provide them with some cushion against occasional cost overruns and declining demand for new projects in their weaker end markets and regions. Risks. See below. Industry Trends. In many regions, we see the demand for infrastructure offsetting the weakness in the energy and commodities end markets. Under Standard & Poor's policies, only a Rating Committee can determine a Credit Rating Action (including a Credit Rating change, affirmation or withdrawal, Rating Outlook change, or CreditWatch action). This commentary and its subject matter have not been the subject of Rating Committee action and should not be interpreted as a change to, or affirmation of, a Credit Rating or Rating Outlook. STANDARD & POOR'S RATINGS SERVICES
Industry Top Trends 216: Engineering And Construction December 9, 21 RATINGS TRENDS AND OUTLOOK GLOBAL ENGINEERING AND CONSTRUCTION RATINGS DISTRIBUTION AND OUTLOOK CHART 1 RATINGS DISTRIBUTION CHART 2 RATINGS DISTRIBUTION BY REGION 2 1 1 Engineering & Construction North America Latin America 2 1 1 AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C SD D AAA AA+ AA AA- A+ A A- BBB+ BBB BBB- BB+ BB BB- B+ B B- CCC+ CCC CCC- CC C SD D CHART 3 RATINGS OUTLOOKS CHART 4 RATINGS OUTLOOK BY REGION Positive 3% Negative 16% WatchNeg 3% Negative WatchNeg Stable WatchPos Positive 1% 8% 6% Stable 78% 4% 2% % APAC LatAm W.Eur CHART RATINGS OUTLOOK NET BIAS Net Outlook Engineering & Construction Bias (%) - -1-1 -2-2 -3 13 14 1 CHART 6 RATINGS NET OUTLOOK BIAS BY REGION Net Outlook Bias (%) 2-2 -4-6 -8 Latin America 13 14 1 Source: S&P Ratings 2 STANDARD & POOR'S RATINGS SERVICES
Industry Top Trends 216: Engineering And Construction December 9, 21 FORECASTS KEY INDUSTRY FORECASTS CHART 7 REVENUE GROWTH (ADJUSTED) CHART 8 EBITDA MARGIN (ADJUSTED) 1% Global Forecast 16% Global Forecast 1% % 14% 12% 1% % 8% -% -1% 6% 4% 2% -1% 212 213 214 21 216 217 % 212 213 214 21 216 217 CHART 9 DEBT / EBITDA (MEDIAN, ADJUSTED) CHART 1 FFO / DEBT (MEDIAN, ADJUSTED).x 4.x 4.x 3.x 3.x 2.x 2.x 1.x 1.x.x.x Global Forecast 212 213 214 21 216 217 3% 2% 2% 1% 1% % % Global Forecast 212 213 214 21 216 217 Source: S&P Ratings. All figures are converted into U.S. Dollars using historic exchange rates. Forecasts are converted at the last financial year end spot rate. 3 STANDARD & POOR'S RATINGS SERVICES
Industry Top Trends 216: Engineering And Construction December 9, 21 ASSUMPTIONS KEY INDUSTRY ASSUMPTIONS NORTH AMERICA 1 Modest U.S. GDP Growth 2 Low Commodity Prices 3 Financial Policy: Typically Debt-Light Balance Sheets Our baseline forecast for U.S. GDP growth is 2.% for 21 and 2.8% for 216. We view this level of modest growth in overall economic activity as supportive of the conditions in the E&C industry. Additionally, we forecast that U.S. nonresidential construction (which includes industrial and commercial construction, such as energy-related construction) will be flat this year before increasing by about 6% in 216. EMEA 1 GDP: Revenue Growth Slightly Above GDP We expect that revenue in the European construction sector will increase at levels that are slightly above our expectations for the region's GDP growth during 216-217. We expect that the main contributor to this growth will be the civil engineering construction subsector. We expect that the growth rates in Eastern Europe will be comparatively higher than those in the rest of the region, particularly in Poland, the largest market in that geographical area. In Western Europe, we expect that the economic recovery will be more noticeable in those countries where the construction market was hit especially hard in recent years, including Spain, Italy, and Ireland. LATIN AMERICA 1 Financial Policy: Debt-Light Balance Sheets The large, pure E&C companies tend to hold sizable cash cushions to protect against any volatile working capital requirements. Their perceived financial stability is also an important factor in their ability to secure new projects. Many of these companies also maintain good liquidity positions and low debt- leverage to assure their clients of their financial stability. A number of the E&C companies that we rate are exposed to the energy-related construction and services market. We believe that the current slump in oil prices has caused the demand for these E&C companies' services to decline and has contributed to increased pricing pressure in this segment. In addition, U.S. oil and gas E&P companies are cutting back on capital spending as they try to control their costs and conserve their cash flow and liquidity. This could negatively impact the backlogs of contractors with exposure to the U.S. upstream oil and gas end market. 2 Low Commodity Prices: Capex Cut In Oil And Gas To Put Pressure We believe that the current, grim industry conditions for E&C companies involved in the oil services sector will persist until at least the end of 216. We also believe that the energy companies that these E&C companies serve will focus on cutting unnecessary capital and operating expenditures. Therefore, we expect that these challenging and competitive market conditions will continue as oil companies reduce the number of contracts they tender and become more cautious, which may cause some new projects to be delayed or cancelled altogether. 2 Low Commodity Prices: More Challenging Backlog Replenishing Oil companies and metal producers are cutting back on their capital expenditures (capex) to help weather the current, more challenging business environment, which has made it more difficult for them to replenish their backlogs. Weaker fiscal conditions in the major Latin American countries have also led to declines in public spending and the volume of new infrastructure projects. The large, pure E&C companies tend to hold sizable cash cushions to protect against any volatile working capital requirements. Their perceived financial stability is also an important factor in their ability to secure new projects. Many of these companies also maintain good liquidity positions and low debt- leverage to assure their clients of their financial stability. 3 Robust Backlogs Improve Revenue Visibility The current healthy backlogs of many E&C companies in Europe, the Middle East, and Africa (EMEA) provide them with decent short-term revenue visibility and some level of protection against potential slowdowns or cancellations. In particular, we have observed a moderately positive trend in the backlog-to-revenue ratios of the E&C companies that we rate in the EMEA region. 3 Solid Project Execution We expect that Latin American E&C companies will be able to sustain their solid project execution even if inflation increases and the region's currencies continue to decline. We believe that the largest Latin American E&C companies will be able to maintain relatively sound margins because they typically have the ability to pass-through increased costs in the bulk of their contracts. 4 STANDARD & POOR'S RATINGS SERVICES
Industry Top Trends 216: Engineering And Construction December 9, 21 ASIA PACIFIC 1 Slowdown In China Is Dragging Down All Of Southeast Asia The large, pure E&C companies tend to hold sizable cash cushions to protect against any volatile working capital requirements. Their perceived financial stability is also an important factor in their ability to secure new projects. Many of these companies also maintain good liquidity positions and low debt- leverage to assure their clients of their financial stability. 2 Weakness In Commodity Markets Will Pressure Companies Oil companies and metal producers are cutting back on their capital expenditures (capex) to help weather the current, more challenging business environment, which has made it more difficult for them to replenish their backlogs. Weaker fiscal conditions in the major Latin American countries have also led to declines in public spending and the volume of new infrastructure projects. 3 Moderate Backlogs And Conservative Financial Policies We expect that Latin American E&C companies will be able to sustain their solid project execution even if inflation increases and the region's currencies continue to decline. We believe that the largest Latin American E&C companies will be able to maintain relatively sound margins because they typically have the ability to pass-through increased costs in the bulk of their contracts. STANDARD & POOR'S RATINGS SERVICES
Industry Top Trends 216: Engineering And Construction December 9, 21 RISKS AND OPPORTUNITIES KEY INDUSTRY RISKS AND OPPORTUNITIES NORTH AMERICA 1 Infrastructure Demand 2 Project Execution 3 Margin Erosion In the last few years we have witnessed an increase in the number of bidders per project in certain end markets. This can lead to more competitive pricing for new projects. EMEA 1 Infrastructure: Large Infrastructure Pipeline In Europe Europe has an ambitious infrastructure spending project with its 31 billion "Juncker Plan" to rejuvenate the eurozone economy, which should support the European construction markets over the next three years. There is, in general, a robust pipeline of projects in place and additional demand is still coming from a number of end markets, namely the transportation (roads and rail) and energy sectors. However, we believe that funding those projects could be somewhat challenging--particularly due to the fact that some European governments still carry large debt burdens and have had difficulties expunging their deficits--thus some projects would likely require private sources of funding. LATIN AMERICA We expect that most E&C companies will experience occasional cost overruns because of the intrinsically risky nature of contract work in their industry. However, if individual companies experience abnormally large cost overruns due to project execution issues, it could cause their operating performance to decline. 2 Possible Slowdown In Emerging Markets Some Europe-based construction companies have significant exposures to emerging markets in the Americas, Africa, and Asia. We believe that the risks embedded in projects in those areas are much higher, which may lead to unfavorable working capital requirements for these companies. Furthermore, the current low oil price environment could translate into delays or cancellations for some of the projects in countries where oil is a significant source of government income. Despite the continued low oil prices, we forecast that the volume of U.S. nonresidential construction will remain flat in 21. This reflects our belief that increased construction demand in other markets will offset the weakness in the energy-related markets (which typically have higher margin work). 3 Margin Erosion In Europe May Continue Over the last few years, we have observed that the level of competition throughout Europe has increased, leading to significant margin erosion for most of the European E&C companies. This means that the smaller players in the industry will continue to face difficulties when bidding for large multi-national projects. Overall, we expect that this margin pressure will ease at a relatively moderate pace for several countries because a number of regions still have a significant overcapacity of bidders per project. 1 Weak Credit Conditions 2 Corruption Investigation In Brazil 3 Infrastructure: High Infrastructure Gap Weaker-than-expected levels of economic activity have prompted us to lower our forecast for Latin American GDP growth. In Brazil, declines in the level of household spending and fixed investment have been the main causes of the country's weak GDP, and these factors are unlikely to improve significantly over the next year. In Mexico, expectations for lower oilrelated fiscal revenue prompted the government to announce significant cuts to public investment earlier this year, and consistently low crude prices could encourage further spending cuts in the future. The fallout from the corruption scandal at the Brazilian state-owned oil company Petroleo Brasileiro S.A. (Petrobras) has led the company to cut back on its capex plans across several sectors. Furthermore, many E&C companies in the region are also being investigated by the Brazilian authorities for allegedly making bribery payments and forming a cartel to control the awarding of Petrobras contracts. Although the potential contingent liabilities related to the investigation that E&C companies in the country could face remain unclear, they could include fines, payments, and sanctions that prevent them bidding for public works projects. Historically, Latin American and Caribbean countries have invested around 19%-2% of their GDP on gross fixed capital formation, which comprises their resident producers' net investments in fixed assets. This rate is much lower than the 32.% average for the BRIC countries (Brazil, Russia, India, and China; according to World Bank data). Even though most of the countries in the region have a significant need to develop and improve their infrastructure, their weaker GDP growth prospects and the lower commodity prices have delayed some necessary investments. 6 STANDARD & POOR'S RATINGS SERVICES
Industry Top Trends 216: Engineering And Construction December 9, 21 ASIA PACIFIC 1 The Need For Infrastructure In APAC Is Robust A huge amount of new infrastructure construction will be needed in Asia over the next five to 1 years as the region's population continues to increase, its people increasingly move to urban areas, and its living standards improve. There is, in general, a robust pipeline of infrastructure projects already in place and we are still seeing demand coming from the power plant, railroad, and energy sectors. However, we believe that the region's weaker GDP growth prospects and the depressed commodity prices have delayed some necessary investments, though some governments will likely provide funding for certain projects. 2 A Further Slowdown In The Chinese Markets A further slowdown in China's macro economy will very likely to lead further declines in commodity prices. These lower commodity prices would, in turn, weaken the economies of emerging Southeast Asian countries and India. Consistently low crude prices could also encourage governments to further cut their spending in those countries. Furthermore, the current low oil price environment could translate into delays or cancellations of some projects in countries where oil and mining are a significant source of government income. 3 Improved Efficiencies Mitigate Weakening Profitability We expect that most APAC E&C companies will maintain relatively stable profitability and cash flow metrics-- backed by their moderate order backlogs-- and believe that they could retain adequate working capital without significant failures in their project management given occasional cost overruns and the declining demand for new projects. The smaller E&C companies will likely face difficulties in competing for large multi-national projects. 7 STANDARD & POOR'S RATINGS SERVICES
Industry Top Trends 216: Engineering And Construction December 9, 21 GLOBAL ENGINEERING AND CONSTRUCTION: CASH, DEBT AND RETURNS CHART 11 CASH & EQUIVALENTS / TOTAL ASSETS Global Engineering & Construction - Cash & Equivalents/Total Assets (%) CHART 12 TOTAL DEBT / TOTAL ASSETS Global Engineering & Construction - Total Debt / Total Assets (%) 2 18 16 14 12 1 8 6 4 2 2 27 29 211 213 LTM 3 2 2 1 1 2 27 29 211 213 LTM CHART 13 FIXED VS VARIABLE RATE EXPOSURE CHART 14 LONG TERM DEBT TERM-STRUCTURE 1% 9% 8% 7% 6% % 4% 3% 2% 1% % Variable Rate Debt (% of Identifiable Total) Fixed Rate Debt (% of Identifiable Total) 2 27 29 211 213 21 LT Debt Due 1 Yr LT Debt Due 3 Yr LT Debt Due Yr Nominal Due In 1 Yr $ Bn 14 12 1 8 6 4 2 LT Debt Due 2 Yr LT Debt Due 4 Yr LT Debt Due + Yr 2 27 29 211 213 4 3 3 2 2 1 1 CHART 1 CASH FLOW AND PRIMARY USES CHART 16 RETURN ON CAPITAL EMPLOYED $ Bn 4 3 2 1-1 Capex Dividends Net Acquisitions Share Buybacks Operating CF 2 27 29 211 213 21 9 8 7 6 4 3 2 1 Global Engineering & Construction - Return On Capital (%) 2 27 29 211 213 21 Source: S&P Capital IQ, S&P Ratings calculations 8 STANDARD & POOR'S RATINGS SERVICES
Industry Top Trends 216: Engineering And Construction December 9, 21 RELATED RESEARCH The Outlook For The Global Engineering And Construction Sector Remains Stable Despite Weak Commodity Prices, Oct. 1,-21 No content (including ratings, credit-related analyses and data, valuations, model, software or other application or output therefrom) or any part thereof (Content) may be modified, reverse engineered, reproduced or distributed in any form by any means, or stored in a database or retrieval system, without the prior written permission of Standard & Poor s Financial Services LLC or its affiliates (collectively, S&P). The Content shall not be used for any unlawful or unauthorized purposes. S&P and any third-party providers, as well as their directors, officers, shareholders, employees or agents (collectively S&P Parties) do not guarantee the accuracy, completeness, timeliness or availability of the Content. S&P Parties are not responsible for any errors or omissions (negligent or otherwise), regardless of the cause, for the results obtained from the use of the Content, or for the security or maintenance of any data input by the user. The Content is provided on an as is basis. S&P PARTIES DISCLAIM ANY AND ALL EXPRESS OR IMPLIED WARRANTIES, INCLUDING, BUT NOT LIMITED TO, ANY WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE, FREEDOM FROM BUGS, SOFTWARE ERRORS OR DEFECTS, THAT THE CONTENT S FUNCTIONING WILL BE UNINTERRUPTED OR THAT THE CONTENT WILL OPERATE WITH ANY SOFTWARE OR HARDWARE CONFIGURATION. In no event shall S&P Parties be liable to any party for any direct, indirect, incidental, exemplary, compensatory, punitive, special or consequential damages, costs, expenses, legal fees, or losses (including, without limitation, lost income or lost profits and opportunity costs or losses caused by negligence) in connection with any use of the Content even if advised of the possibility of such damages. Credit-related and other analyses, including ratings, and statements in the Content are statements of opinion as of the date they are expressed and not statements of fact. S&P s opinions, analyses and rating acknowledgment decisions (described below) are not recommendations to purchase, hold, or sell any securities or to make any investment decisions, and do not address the suitability of any security. S&P assumes no obligation to update the Content following publication in any form or format. The Content should not be relied on and is not a substitute for the skill, judgment and experience of the user, its management, employees, advisors and/or clients when making investment and other business decisions. S&P does not act as a fiduciary or an investment advisor except where registered as such. While S&P has obtained information from sources it believes to be reliable, S&P does not perform an audit and undertakes no duty of due diligence or independent verification of any information it receives. To the extent that regulatory authorities allow a rating agency to acknowledge in one jurisdiction a rating issued in another jurisdiction for certain regulatory purposes, S&P reserves the right to assign, withdraw or suspend such acknowledgment at any time and in its sole discretion. S&P Parties disclaim any duty whatsoever arising out of the assignment, withdrawal or suspension of an acknowledgment as well as any liability for any damage alleged to have been suffered on account thereof. S&P keeps certain activities of its business units separate from each other in order to preserve the independence and objectivity of their respective activities. As a result, certain business units of S&P may have information that is not available to other S&P business units. S&P has established policies and procedures to maintain the confidentiality of certain non-public information received in connection with each analytical process. S&P may receive compensation for its ratings and certain analyses, normally from issuers or underwriters of securities or from obligors. S&P reserves the right to disseminate its opinions and analyses. S&P's public ratings and analyses are made available on its Web sites, www. (free of charge), and www.ratingsdirect.com and www.globalcreditportal.com (subscription), and may be distributed through other means, including via S&P publications and third-party redistributors. Additional information about our ratings fees is available at www./usratingsfees. Australia Standard & Poor's (Australia) Pty. Ltd. holds Australian financial services license number 3376 under the Corporations Act 21. Standard & Poor s credit ratings and related research are not intended for and must not be distributed to any person in Australia other than a wholesale client (as defined in Chapter 7 of the Corporations Act). Copyright 21 by Standard & Poor s Financial Services LLC. All rights reserved. STANDARD & POOR S, S&P and RATINGSDIRECT are registered trademarks of Standard & Poor s Financial Services LLC. www.spratings.com 9 STANDARD & POOR'S RATINGS SERVICES