- Stable and improving margin and leverage trends exhibited by most Irish-incorporated corporates in 2019 will be eroded in 2020 due to increased pressure on operating performance as the impact of the pandemic unfolds.
- Negative rating outlooks and CreditWatch placements have risen sharply by 33% to 39% to date in 2020, primarily because of the impact of COVID-19. However, downgrades have been limited and largely weighted toward more vulnerable sectors such as the transport-related industry.
- We expect average revenue to decline about 10% in 2020, fueling weaker credit metrics, and we expect that the recovery may be slow and protracted for many issuers.
- Mergers, acquisitions, and shareholder-friendly actions are likely to decline in the near term as some issuers postpone share buybacks, dividends, and business development to preserve and prioritize liquidity to support medium-term growth.
In this report, S&P Global Ratings takes an in-depth look at the performance of and outlook for publicly rated Irish corporate issuers either incorporated or headquartered in Ireland. Irish corporates displayed improved credit trends in 2019; however, over the next year, we expect greater challenges due to the current macro environment, which has been affected by the pandemic.
Our credit metrics relate to 2019 annual financial results with current projections based on the average S&P Global Ratings' forecast as of August 2020. We have adopted a portfolio approach to highlight overall portfolio trends, and we acknowledge that individual issuer's and industry's performance may vary.
S&P Global Ratings acknowledges a high degree of uncertainty about the evolution of the coronavirus pandemic. The consensus among health experts is that the pandemic may now be at, or near, its peak in some regions, but will remain a threat until a vaccine or effective treatment is widely available, which may not occur until the second half of 2021. We are using this assumption in assessing the economic and credit implications associated with the pandemic (see our research here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.
GDP Contractions Will Affect Earnings And Be Sector-Specific
Ireland has produced above average GDP growth since the global financial crisis. However, consistent with our view for a global contraction this year, we expect the COVID-19 pandemic will drive a 10.5% real GDP contraction in Ireland in 2020, following 5.5% growth last year. When GDP slows, corporate earnings typically follow, and the global contraction is increasingly creating a more challenging environment for many Irish corporate issuers.
The expected duration and severity of COVID-19's effects will differ materially across sectors. According to S&P Global Ratings' sector level impact and recovery predictions for Europe, the Middle East, and Africa (EMEA), the greatest and most sustained impact will likely be in sectors such as nonessential retail and commercial aerospace, while some sectors such as pharmaceuticals are expected to be largely unaffected (see chart 3). As a result, we expect a mixed impact for rated Irish corporates given that health care and transport-related issuers represent the two largest sectors.
Ratings Have Shown Resilience, Despite Increase In Negative Outlooks
Data set: Publicly rated Irish-incorporated or headquartered corporate issuers are split across 13 industries. We added one new issuer to our data set since our last report in September 2019, and following the acquisition of one rated Irish health care issuer, the number of Irish-incorporated or headquartered nonfinancial corporate and infrastructure companies remains at 36.
Irish issuers maintain their stronger rating distribution
Irish issuers have exhibited a stronger rating profile than the overall EMEA average (see chart 5). The majority are rated investment grade, while the overall EMEA portfolio is weighted toward speculative-grade issuers. One of the primary reasons for this is that close to 80% of Irish issuers are publicly or state owned, whereas in EMEA a higher proportion are owned by private equity firms following leveraged buyouts. This largely reflects the greater number of issuers rated in the single 'B' categories within the EMEA portfolio.
Most rating actions taken over the past year were a result of COVID-19
As of Aug. 31, 2020, Irish-incorporated or headquartered issuers have experienced a total of 16 rating actions since our prior report card in September 2019, and all but one of these actions have occurred since the start of 2020. These changes have been predominately in the 'BBB' and 'B' categories.
COVID-19 and the decline in oil prices accounted for 12 of these rating actions, with the remaining four arising from weaker-than-expected performance before the pandemic, improving business and financial risk profiles, and ongoing litigation settlements. In reviewing rating actions related to the impact of COVID-19 and oil prices to date, we found that the number of rating actions across both the EMEA and Irish portfolios are broadly consistent in terms of volume with approximately 30% of issuers experiencing a rating action. However, 57% of the actions across the overall EMEA portfolio comprised downgrades compared to only 33% for the Irish portfolio.
This differentiation can be explained by a number of factors, including:
- Irish corporates exhibit a stronger rating profile with 58% of issuers assigned an investment-grade rating compared to 40% for EMEA issuers. Almost 80% of the COVID-19 downgrades in EMEA to date affected speculative-grade issuers.
- While industry composition is similar between Ireland and EMEA, the greater mix of speculative-grade issuers within more vulnerable industries is leading to a higher level of downgrades across the wider EMEA portfolio.
- Irish corporate issuers exhibit a stronger business risk profile, which we determined based on factors including competitive advantage, geographical scale, and operating profitability.
Two-thirds of the COVID-19 rating actions to date relate solely to a change in outlook or CreditWatch placement. The significant increase in negative outlooks and negative CreditWatch placements reflect the heightened risk of further downgrades in the short to medium term, which is primarily driven by the challenging macro-economic environment and tightening credit metrics projected over the coming years.
Performance Gains In 2019 Will Be Eroded By COVID-19's Impact
Margins to recover faster than revenue after sharp 2020 fall
Almost 60% of rated Irish issuers experienced margin expansion in 2019, increasing average margins for Irish corporates in this period by 20 basis points. The increase was primarily a result of cost efficiency measures, improving product mix, and the realization of synergies from recent mergers and acquisitions. However, we expect revenue to decline about 10% and margins to drop about 70 basis points in 2020 because of COVID-19. Our projections to date show that the recovery will be slow, with revenue only rebounding 5% in 2021, but we expect to see a faster recovery in margins as companies continue cost-restructuring efforts following the operational disruption from COVID-19.
Leverage to rise as cash flows tighten
Irish issuers' improved financial metrics in 2019 were driven by higher EBITDA, coupled with a marginal decline in debt levels, which resulted in deleveraging to 2.2x from 2.5x and funds from operations (FFO) to debt rising to 36.6% from 31% the year before. However, given our macroeconomic forecast, we expect these gains to be eroded in 2020 as credit metrics tighten. We expect debt to EBITDA to increase to 2.6x and FFO to debt to drop to around 30.4%. For the purposes of comparability, we have excluded aircraft leasing companies in chart 8, which we analyze primarily using EBIT rather than EBITDA margins in our credit metric assumptions.
Controlled capex as issuers retain financial flexibility
In 2019, Irish issuers' capital expenditure (capex) fell by 50 basis points to 9.1% of revenue, though remaining above the five-year average of 8.4%. As companies try to maintain financial flexibility through the current cycle, we expect a more pronounced decline to approximately 8% in 2020, below the current five-year average. In 2021, we estimate capex levels will revert to those seen in 2019. Excluding aircraft lessors and transport-related companies, average capex would be a more modest 4.8%.
Shareholder-friendly focus likely to subside as issuers prioritize liquidity
Irish issuers continued their shareholder-friendly actions in 2019, with 50% of companies executing acquisitions, about 70% providing dividend distributions, and about 60% engaged in share buybacks. Over a third of our issuers engaged in all three actions, with over 80% of these issuers rated investment grade and over two-thirds holding a liquidity score of strong or exceptional, indicating strong financial flexibility.
Liquidity remains a key priority during the pandemic and remains a large consideration in our rating computation. We expect reduced shareholder-friendly and capital expenditure activity in 2020 as companies try to preserve liquidity to support their business. At present, we have only seen about 12% of Irish issuers publicly defer or cancel their dividend, and most issuers are looking at alternative ways to preserve liquidity. These strategies include postponing share buybacks, reducing capex, refinancing and extending debt maturities, availing of government support measures such as furlough schemes, and implementing cost-cutting measures. Given that many of our Irish issuers are rated investment grade, we would expect them to continue to have strong market access to additional liquidity.
Post-Brexit Negotiations Continue Amid COVID-19 Challenges
The resolution of post-Brexit negotiations has become less certain since early September. The looming end of the transition period on Dec. 31, amid the global pandemic and signs that material issues remain, represents a challenge for both the EU and U.K. to agree upon a tariff-free and quota-free trade agreement in goods. This objective looks even more elusive as the U.K. government has signaled its intent to retain the right to override sections of the Withdrawal Agreement to protect the U.K.'s sovereignty. While the likelihood of no agreement is rising, we believe that it remains in the best interest of both the U.K. and the EU to reach a limited agreement.
Despite the rising risks, most rated Irish corporates have global rather than regional business models. At present, we believe they retain the operational and financial flexibility to mitigate any near-term disruption. The longer-term impact will depend on the timing and scope of future trading arrangements between the EU and the U.K.
This report does not constitute a rating action.
- Global Credit Conditions: The Shape Of Recovery: Uneven, Unequal, Uncharted, July 1, 2020
- Credit Conditions Europe: Curve Flattens, Recovery Unlocks, June 30, 2020
- COVID-19 Heat Map: Post-Crisis Credit Recovery Could Take To 2022 And Beyond For Some Sectors, June 24, 2020
- Ireland 'AA-/A-1+' Ratings Affirmed; Outlook Stable, May, 29, 2020
- Industry Report Card: Irish Corporates' Strong Momentum Shows Signs Of Slowing, Sept. 26, 2019
|Primary Credit Analysts:||Amy O Martin, Dublin + 353 (0)1 568 0606;|
|Daniel OLoughlin, Dublin + 353 (0)1 568 0620;|
|Secondary Contact:||Patrick Drury Byrne, Dublin (00353) 1 568 0605;|
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