- The engineering and construction (E&C) industry has above-average exposure to governance issues due to the inherent complexity of projects, which exposes companies to contingent liabilities and litigation risks.
- The sector is also exposed to bribery, corruption, and anticompetitive practices because of the magnitude of contracts and the competitive process necessary to secure contracts with both private and public clients.
- Social exposures are significant, because of the high reliance on labor and the importance of safety. The ability to find and keep skilled labor, including at subcontractors, and particularly at expected cost levels, directly affects the profitability of construction projects. In addition, given the exposure to unions in some regions, E&C companies can face strikes, which increase the cost and time to complete projects.
- We consider environmental risks to be limited, as E&C companies are typically contractors executing projects on behalf of asset or project owners, where the residual environmental liabilities reside. We see risks weighted toward the exposure to increasing climate change risk, as extreme weather can cause major delays and project-cost overruns, beyond already factored contingency levels. Risk of remediation for land biodiversity or restitution can be more relevant for the construction of civil projects and industrial projects, even if environmental risks are often borne by the project company rather than the E&C contractor.
Environmental, social, and governance (ESG) risks and opportunities can affect an entity's capacity to meet its financial commitments in many ways. S&P Global Ratings incorporates these considerations into its ratings methodology and analytics, which enables analysts to factor in short-, medium-, and long-term impacts--both qualitative and quantitative--to multiple steps of their credit analysis. Strong ESG credentials do not necessarily indicate strong creditworthiness (see "The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis," published Sept. 12, 2019).
Our ESG report cards qualitatively explore the relative exposures (average, below, above average) of sectors to environmental and social credit factors over the short, medium, and long term. For environmental exposures, chart 1 shows a more granular listing of key sectors and (in some cases) subsectors reflecting the qualitative views of our analytical rating teams. This sector comparison is not an input to our credit ratings and not a component of our credit rating methodologies; it is based on our current qualitative, forward-looking opinion of credit risks across sectors.
In addition to our sector views, this report card lists ESG insights for individual companies, including how and why ESG factors may have had a more positive or negative influence on an entity's credit quality compared to sector peers or the broader sector. These comparative views of environmental and social risks are qualitative and established by analysts during industry portfolio discussions, with the goal of providing more insight and transparency.
Environmental risks we considered include greenhouse gas (GHG) emissions, including carbon dioxide, pollution, and waste, water and land usage, and natural conditions (physical climate, including extreme and changing weather conditions, though these tend to be more geographic/entity-specific than a sector feature). Social risks include human capital management, safety management, community impacts, and consumer-related impacts from customer service and changing behavior to the extent influenced by environmental, health, human rights, and privacy (but excluding changes resulting from broader demographic, technological, or other disruptive industry trends). Our views on governance are directly embedded in our rating methodology as part of the management and governance assessment score.
The list of entities covered in this report is not exhaustive. We may provide additional ESG insights in individual company analyses throughout the year as they change or develop, with companies expected to increasingly focus on ESG in their communication and strategy updates.
Social factors represent significant risk in the E&C sector, because the industry is labor-intensive and safety management is key to project execution.
The ability to find and keep skilled labor, including at subcontractors, and particularly at expected cost levels, directly affects the profitability of construction projects. In addition, given the exposure to unions in some regions, E&C companies can face strikes, which increase the cost and time to complete projects.
Safety management is another key risk, given the use of large and dangerous equipment. Companies in the sector track and manage incidents and typically have specific programs to educate their workforces. Community opposition to construction projects can also cause significant delays. Similarly, regulation and compliance requirements could become tougher for contractors, which could result in higher costs.
We consider environmental risk as limited, as E&C companies are contractors executing projects on behalf of asset or project owners, where the residual environmental liabilities reside. However, for companies that have exposure to end markets such as oil and gas or mining, we consider the company risk higher than average. We see risks weighted toward the exposure to increasing climate change as well as biodiversity and land use. Extreme weather can cause major delays and project-cost overruns, even if E&C companies factor in some level of weather-related delays to complete construction projects.
Risk of remediation for biodiversity or restitution for incorrect land use is usually low for the construction of high-rise buildings but can be more relevant for the construction of civil projects and industrial projects.
The construction industry has an above-average exposure to governance issues, in our view. The inherent complexity of projects exposes companies to contingent liabilities, and litigation risks grow in tandem with challenges to complete a project profitably and on time. These challenges include client cancellations and delays, change orders, and subcontractor risk. Among our rated companies, litigation is more common in emerging countries, where the legal framework is usually weaker; however, developed countries have similar but less pronounced risks.
The sector is also exposed to bribery, corruption, and anticompetitive practices because of the magnitude of the contracts and the competitive process necessary to secure contracts with both private and public clients. Ethical breaches typically result in investigations by public authorities; and large fines, settlement costs, and reputational damage can affect financial performance.
Furthermore, complex groups with a presence in high-risk countries can face limits on the ability to move cash flow within the group, thus limiting the potential benefit of project and geographic diversification. Transparency related to advance payments and working capital swings is another key area of our governance focus.
ESG Risks For E&C Companies
|Actividades de Construccion y Servicios S.A. (ACS)(BBB/Stable/A-2)|
|We see ACS' ESG related exposure as similar to that of the broader construction industry. We view the group's management and governance as satisfactory, in line with global peers. ACS' litigation risk is lower than the peer average, reflecting the group's smaller presence in emerging markets (less than 10% of total E&C business), where legal frameworks tend to be weaker. Based on year-end 2017 data, ACS had €1.58 billion of completed works under litigation, which represent a limited 1.3% of the construction activity performed in the period when those delays accumulated. Most of this relates to claims raised before the group introduced stricter project selection criteria in 2015. We do not adjust our debt figures for provisions on litigation because they mainly refer to claims by ACS to its clients. At the same time, governance has some areas of complexity, mainly due to ACS' significant minority stake in Hochtief, its main and fully consolidated subsidiary: ACS' share decreased to 50.1% from 72% following the agreement between Hochtief, ACS, and Atlantia to jointly acquire Abertis. ACS' governance structure has significantly improved in the past few years. In 2014, the group started a transformation process to reduce its corporate complexity, strengthen and standardize risk management across main subsidiaries Hochtief and CIMIC, increase group integration, and improve cash flow generation. As a result, it has sold several noncore assets and has introduced more disciplined working capital management and a stricter project selection process. ACS has a good safety record and no history of significant environmental accidents. Given that construction work is inherently dangerous, ACS' focus on safety is a competitive strength. The group's construction end markets are significantly diversified, which limits indirect exposure to environmental risk. ACS has a significant presence in the U.S. market, where exposure to unions is higher than other regions, but this has not resulted in significant problems for the group.||Renato Panichi|
|China Aluminum International Engineering Corp. Ltd. (Chalieco)(BB+/Negative/--)|
|We view Chalieco's ESG factors as comparable to that of the broader E&C industry. Seventy percent of its revenues are related to activities that are more environmental neutral, such as housing and transportation E&C. However, as the largest contractor for aluminum smelter plants and alumina refineries in China (30% of its revenues), Chalieco is indirectly exposed to environmental-related issues that affect the operation of its customers. Plant relocation related to environmental protection measures could increase demand for new plant construction. On the other hand, large-scale plant closure due to pollution concerns could hurt its topline. The exposure could be partially offset by Chalieco's advanced technologies and skills in plant design and chemical waste disposal, which could help aluminum producers to improve production efficiency and reduce emissions.||Yolanda Tan|
|China Metallurgical Group Corp. (CMGC)(BBB+/Stable/--)|
|We view environmental, social, and governance factors for CMGC and its core subsidiary, Metallurgical Corp. of China Ltd. (MCC), as comparable with that of the broader E&C industry. We believe the environmental factors are neutral for our credit analysis of CMGC/MCC as most of the company’s businesses (about 80%) are environmental neutral. However, being the largest construction contractor for metallurgical projects in China, CMGC and MCC are indirectly exposed to potential environmental-related issues that affect customers, such as steel mills. In addition, the environment concerns of the steel mills push up relocation demand to industrial parks and provide new revenue opportunities for the company. We assess CMGC/MCC's management and governance as fair, in line with domestic peers. That said, the company experienced heavy losses in overseas projects back in 2012 and since then it has been prudently managing its project execution and contract terms. As a result, the company demonstrated better working capital management and more disciplined capex spending compared with its peers, leading to deleveraging since 2013.||Yolanda Tan|
|CLISA-Compania Latinoamericana de Infraestructura & Servicios S.A. (CLISA)(CCC/Negative/--)|
|We assess CLISA’s management and governance as fair and see its credit quality as more negatively affected by governance than global peers due to a bribery case currently under investigation. The case implicates the company's ex-chairman and main stakeholder, Aldo Roggio (holding a 52% stake of CLISA through Roggio S.A). The company has implemented several compliance policies and initiatives to improve governance and transparency, and Mr. Roggio was removed from the company's board of directors. Despite these measures, the company’s recent track record remains too limited for us to determine the effectiveness of these initiatives. We believe CLISA remains exposed to further potential reputational damage. Under its waste management business division, environmental and social factors are important, but we do not see CLISA as more exposed than peers. Environmental risks are related to water and land contamination. Social risks are mainly associated with climate change and waste disposal.||Martin Frugone|
|Ferrovial S.A.(BBB/Watch Dev/A-2)|
|We see Ferrovial’s ESG-related exposure as similar to that of the broader construction industry. We view the group’s management and governance as strong, reflecting its management experience and expertise, and a proper balance of different stakeholders’ interests. However, the group is involved in some legal proceedings, mainly related to its construction and business service activities. Ferrovial’s financial disclosure has some unique features in that a major share of capital is locked up in infrastructure equity investments; the debt of which is not consolidated in our adjusted figures. The group is, however, transparent in regularly disclosing the underlying financials of these strategic key equity investments, such as stakes in ETR 407 and managed lanes in North America, and Heathrow, Aberdeen, Glasgow, and Southampton airports. Ferrovial’s most notable litigation is with the Birmingham City Council. On Feb. 22, 2018, the U.K. Court of Appeals found in favor of Birmingham City Council, agreeing the execution of the additional works that the client deemed necessary in relation to the Birmingham Highways private-finance initiative contract. The litigation was settled in June 2019 by reaching an agreement to terminate the contract, and with Ferrovial subsidiary Amey Plc paying £215 million and providing services up to March 31, 2020.||Gaetan Michel|
|We view Fluor's ESG factors as comparable to that of the broader E&C industry. We assess Fluor's management and governance as satisfactory, notwithstanding some sizable project losses over the last two years, including execution issues on energy-related projects. However, the company indicated it will have more scrutiny of its bid-pursuit criteria. The company plans to have more senior management involved in risk management, with a new board risk committee that will report directly to the company’s CEO. Similar to peers, Fluor can be exposed to labor shortages in certain regions, which can increase project costs. However, partially mitigating this risk, the company has engineering capabilities and operates fabrication yards in several regions globally, which can reduce onsite craft labor needs and shift work to safer and more controlled work environments. Given that employees often work on projects that are inherently dangerous, safety is critical and we view Fluor as having a good reputation and track record on project and safety performance. Similar to peers, Fluor's environmental risk relates to the extent that climate change causes increased severe weather conditions that could result in project delays and increased costs, such as a chemical project in Louisiana that experienced delays after Hurricane Harvey in 2017. We currently see Fluor’s strong liquidity position mitigating such risks. About 46% of Fluor’s backlog stems from energy and chemical related projects. Given the long-term and gradual energy transition and Fluor’s broad project capabilities, we believe the company is well-positioned should climate-change related legislation increase the pace of development of carbon capture and storage projects, alternative transportation, alternative energy facilities (such as wind farms), or incentivize increased implementation of clean fuel projects.||Robyn Shapiro|
|Infrastructure and Energy Alternatives Inc. (IEA)(B-/Negative/--)|
|We believe IEA is more favorably exposed to environmental trends than many of its peers due to its focus on construction of renewable energy infrastructure. The company generates about half of its revenue from onshore wind energy and, to a lesser extent, solar projects and coal ash remediation. We foresee growth in wind energy projects in the U.S., which should provide demand for IEA's services, although in 2018 the company saw lower-than-expected profitability on several projects. We assess IEA’s management and governance as fair, factoring in the company's significant levels of E&C experience, particularly in wind energy projects.||Grant Hofmeister|
|Power Construction Corp. of China (PCCC)(BBB+/Negative/--)|
|We view PCCC's ESG factors as comparable with those of the broader E&C industry. Although PCCC is the largest power project constructor in the world, with strong expertise in the construction of hydro and other clean energy power plants, it also engages in thermal power plant construction and operations, with gross profit contribution (13.7% of total) almost equal to that of clean energy power projects construction. We assess PCCC's management and governance as fair. The company has sufficient and in-depth management teams and there have been no material legal infractions in past years. PCCC expanded into the overseas market long ago but we expect project execution risk to be low, based on management’s sufficient experience. The company recently has actively participated in investment-linked general infrastructure construction backed by heavy upfront spending, resulting in elevated debt leverage.||Yolanda Tan|
|Salini Impregilo SpA(BB-/Positive/--)|
|We view the credit quality of Salini Impregilo as more negatively influenced than global peers by the group's numerous litigations and previous adverse court rulings that had a negative effect on the ratings on the company. We assess its management and governance as fair. On Dec. 13, 2018, we put our ratings on Salini Impregiloon on CreditWatch with negative implications, partly because Salini Impregilo's payment of €196 million following a court decision of the International Chamber of Commerce in Miami. The tribunal's ruling stems from a protracted dispute between the Panama Canal Authority and a construction consortium led by Spain's Sacyr (not rated) and Salini Impregilo. The dispute concerned cost overruns related to the construction of a third set of locks for the waterway, which was completed in 2016. In February 2019, Salini Impregilo paid an additional €100 million. We resolved the CreditWatch placement in March 2019, but believe that Salini Impregilo remains exposed to litigations and that it could have further impact on the ratings. In November 2019 Salini Impregilo completed a €600 million capital increase, of which €225 million will fund its acquisition of a 65% stake in Astaldi SpA, the second-largest E&C group in Italy. We see this as a key step in the company's program to consolidate the fragmented Italian construction market, which has been weakened by several defaults among the country's largest players. The capital increase resulted in the entry of new long-term shareholders, among which is Italian government-owned CDPE. We do not believe that the new board composition will have a material impact on the governance of Salini Impregilo. Furthermore, the presence of the state-owned CDPE could potentially support Salini Impregilo in its local operations. Following the capital increase, the Salini family retains 45% of the capital through Salini Costruttori, while CDPE’s stake reaches 18.7% and the rest is split between Italian banks and other investors. CDPE will appoint five members of the board out of 15 seats, and it will also designate the chairman. Salini Costruttori will appoint the remaining nine members, including CEO. The last director has to be independent and an expression of the minorities; if the minorities do not submit a minority list, he or she will be appointed by Salini Costruttori. A positive is that nine of the 15 board members are independent.||Pascal Seguier|
|Sarens Bestuur N.V.(B/Stable/--)|
|We view Sarens’ direct environmental exposure as comparable to that of the broader construction industry. However, given that the company generated about 45% of its sales from the oil and gas as well as mining end-market in 2018, Sarens is indirectly exposed to environmental-related issues that could affect the operation of its customers. We note that about half of sales from the oil and gas sector are related to one big project, the Tengizchevroil (TCO) project (expansion and construction of an oil refinery in Kazakhstan), which should come to end in about two years. The majority of remaining end-market exposure is related to activities that are more environmental neutral or friendly, such as wind energy, civil works, and industrial. We assess Sarens’ management and governance as fair. The rating trajectory over the past few years has been linked to the significant ramp up of the TCO project and the risks introduced by it. In the prior years, the ramp up led to negative free cash flow generation and used up considerable liquidity buffers due to high front-loaded investments in equipment and working capital. The board regarded extending the scope and scale of project deliverables as being in the best interest for the company over the long term while understanding that in the short to medium term, this would weigh on credit metrics and financial risks could increase.||Wen Li|
|SNC-Lavalin Group Inc. (BB+/Negative/--)|
|We view SNC's management and governance as fair only, and less supportive when compared to the broader E&C industry. This primarily reflects cost overruns on a project to construct sulfuric acid plants at a copper mine in Chile and two infrastructure projects in Canada that led to significant losses realized in the fourth quarter of 2018 and first half of 2019. In our opinion, the magnitude of these losses across multiple projects stems from risk mitigation procedures that were less effective than we had anticipated. It also adds some uncertainty in the company's ability to successfully execute on its backlog of fixed-price contracts. In early 2019, the company announced plans to no longer bid on lump-sum turnkey projects, which should reduce project execution and oversight risks over the next couple of years as the company works down the backlog remaining on such projects. Our view of SNC’s governance also reflects fraud and bribery charges laid on the company back in 2015 relating to alleged payments made by the company’s former employees to secure contracts in Libya from 2001-2011. However, we acknowledge that in response to the allegations, the company took appropriate steps that included sweeping changes to executives at the company (including a change in CEO) while instituting strong internal ethics reforms aimed at preventing corruption. In December 2019, SNC pleaded guilty to a single charge of fraud related to these activities, ending years of Canadian federal court proceedings and overhang on the rating. Most notably, as part of the settlement, SNC was absolved of a potentially more damaging bribery charge, allowing the company to continue bidding on Government of Canada-awarded contracts. A bribery conviction could have led to a ban of up to 10 years on federal contract work, and a potentially lasting impact on SNC's reputation in the E&C industry. The company will also pay a fine of C$280 million in equal installments over the next five years, which we do not expect will materially affect its financial risk profile or liquidity. SNC's social and environmental risk exposures are similar to those of industry peers. The company has a good safety record and a limited impact on the environment. From 2016 to 2018, the company’s injury and environmental incident frequencies per 200,000 hours were 0.17 and 0.50, respectively.||Alessio Di Francesco|
|Terra Millennium Corp. (TMC)(B/Negative/--)|
|We view TMC's ESG factors as largely in line with that of the broader E&C industry. However, as the largest industrial refractory installer in North America (about 10% of industry demand as the market remains very fragmented), TMC is exposed to potential environmental issues related to the materials it works with and the end-markets it serves, such as chemicals, refining, and power generation. Partially offsetting this exposure is the way in which projects are structured, so that once an inspection or construction work is complete, it is signed off by the facility owner, who assumes all liability thereafter. In addition, TMC is starting to grow its position in the renewable energy industry. As demand for more environmentally sustainable methods of power generation increases, we expect demand for TMC’s project management services for solar, wind, or thermal powered plants to increase. We believe this will help offset the decline in demand for refractory services in more traditional power generation facilities, such as coal or nuclear power. While TMC employs both unionized and nonunionized employees, which shift depending on the number of projects, the company has not experienced any issues or identifiable risks relative to peers. We believe TMC is focused on safety risks as illustrated by its industry safety recognition awards and below-average incident rate.||Nick Santoro|
|Ratings as of Feb. 11, 2020|
This report does not constitute a rating action.
|Primary Credit Analysts:||Robyn P Shapiro, New York (1) 212-438-7224;|
|Renato Panichi, Milan (39) 02-72111-215;|
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