Consolidation in the U.S. regulated utility sector will continue at a moderate pace over the next several years, according to a new Fitch Ratings report. The industry’s fragmented structure and the potential to realize meaningful economies of scale will drive further M&A activity, continuing the trends seen in 2010-11.
Capital market conditions are favorable for utilities, with low interest rate and attractive equity valuations providing a favorable backdrop for merger activity.
Fitch believes financial buyers may be more interested in smaller utilities operating primarily in a single state, while strategic buyers pursue larger utility holding companies.
MidAmerican Energy Holdings (MEHC), Xcel Energy (XEL), and NextEra, among others are potential industry consolidators. MEHC, a wholly owned subsidiary of Berkshire Hathaway, operates in multiple jurisdictions with a proven track record in M&A.
Companies with market capitalization of $5 billion and under and book multiples less than 1.3x represent better financing opportunities are more likely acquisition targets. In its report, Fitch has identified 11 regulated utilities that meet these requirements.
For details, see the full report U.S. Regulated Utilities M&A
In a new report, S&P’s Capital IQ Global Markets Intelligence group takes a look at the rising cash hoards held by US companies.
Among quarterly results posted by 68 of the 419 nonfinancial S&P 500 companies, total cash and short-term investments on the balance sheet at year-end 2011 totaled $440.4 billion, up 23.7% from those same companies’ collective year-end 2010 total of $356.1 billion, according to S&P Capital IQ data.
Among companies reporting financial results so far this season, the 10 companies with the largest holdings include General Electric Co., with $131.9 billion on its balance sheet at the close of 2011, followed by Microsoft Corp. ($50.7 billion) and Google Inc. ($44.6 billion). Of the top 10, Intel Corp. was the only company to experience a drop in its year-end 2011 total from year-end 2010, after the company reported $14.8 billon for year-end 2011, off 32.2% from the prior-year period.
Although less than one-quarter of the 71 companies in the information technology sector have reported results, the sector currently ranks first in terms of cash holdings, with more than $181.3 billion, representing a 13.4% increase from those same reporting companies’ cash totals for year-end 2010.
(The report was prepared before Apple Inc. reported cash on hand of $97.6 billion, up 20% over the last quarter and more than double the year earlier level.)
For details see Cross-Market Commentary: An Early Look At Corporate Cash Holdings
Fitch Ratings expects 2012 to be a year of significant retrenchment for the largest European airlines, as a poor demand environment and persistent cost pressures threaten to drive operating losses higher.
This month’s roll out of a major cost and capacity restructuring plan by Air France-KLM may signal broader industry rationalization later in the year, particularly for carriers facing bloated cost structures and heavy exposure to quickly softening short-haul air travel demand across Europe.
Despite slowing global economic growth, energy cost pressure is not abating, with Brent crude prices remaining near $110 per barrel and jet fuel costs for European carriers still substantially higher than a year ago. Persistent fuel cost pressure in 2012 will continue to erode the profitability of short-haul flights where unit fuel costs are significantly higher. As a group, European airlines will likely pay nearly 30% of total operating expenses for jet fuel in 2012.
Unlike the U.S., where industry consolidation and a multiyear restructuring wave has kept a lid on fleet and capacity expansion, the European industry still faces a difficult adjustment period as fleet capex is curtailed, unprofitable routes are abandoned, and employment levels are reduced in response to the more difficult operating environment.
The AEA’s December forecast of €1 billion to €2 billion in industry operating losses for 2012 may ultimately be tested as traffic and yields come under increasing pressure.
Against a back drop of macroeconomic weakness and unrelenting fuel cost pressure, Fitch expects European network carriers to remain focused on free cash flow improvement and liquidity preservation this year, with growth clearly taking a back seat.
Excerpted from European Airline Cuts Reflect Tough Demand, Cost Outlook
The ongoing sovereign debt crisis in Europe, coupled with a weak economic outlook for the U.S., means growth in two important markets for European business services companies will likely be lackluster in 2012, according to a report published by Standard & Poor’s Ratings Services.
A new Industry Report Card Why European Business Services Companies Should Hold Up Through Economic Uncertainty points out that many of the larger business services issuers rated by Standard & Poor’s are turning the attention to emerging markets such as Brazil, India, China, and Australia in their quest for growth. In 2012, we expect these companies to accelerate their investments in these countries because operating margins tend to be higher than in developed markets.
S&P’s view is that credit metrics will remain broadly stable and that current ratings reflect the forecast economic conditions.
However, the report does highlight several risks facing the business services
sector in 2012, namely:
- An unexpected increase in debt-financed acquisition activity;
- A more severe economic downturn than we currently anticipate; and
- A build-up of cash on balance sheets, which could lead to shareholder
pressure for extraordinary dividends or share buyback programs.
Several trends are currently weakening the credit profiles of many rated banks globally, according to Moody’s.
These trends include:
(i) deteriorating sovereign creditworthiness, particularly in the euro area;
(ii) elevated economic uncertainty; and
(iii) elevated funding spreads and reduced market access at a time when many banks face large debt maturities.
In advanced economies, these factors are expected to lead to many banks experiencing downward migration of their standalone credit assessments and their debt and deposit ratings in 2012.
In the short-term, these pressures will primarily affect the ratings of global capital markets intermediaries (the largest firms trading securities and derivatives) and, in Europe, other banks exposed to financial market disruption. Moody’s expects to place the ratings of a number of these banks under review for downgrade during first-quarter 2012, in order to assess the effect of these trends on bank credit profiles.
Although Moody’s also notes positive factors — such as the accommodative stance of central banks in advanced countries and the strengthened regulation designed to make banks safer — the positive trends are overshadowed by the aforementioned negative credit factors, in Moody’s opinion.
A free expanded report is available at the Alacra Store.
Fitch Ratings has updated how it derives its Fitch Core Capital measure used to assess a bank’s capitalization.
In calculating FCC the agency’s objective is to arrive at a figure, comparable across countries, measuring a bank’s highest-quality, “going-concern” capital. FCC is broadly similar both to Basel III’s Common Equity Tier 1 measure and Common Capital Tier 1 used in the US but it is not dictated by regulatory capital considerations and may differ from these.
FCC comprises loss-absorbing, “going-concern” capital instruments. FCC starts with equity reported in the bank’s financial statements and deducts items that Fitch does not consider to be readily available to absorb losses in a stress scenario. This may be because they are not fungible, failed to perform as loss-absorbing instruments in the past and are difficult to monetize or where inclusion introduces an element of double-counting.
FCC excludes all hybrid capital instruments. Nevertheless, good-quality hybrid capital is still captured in an ancillary capital ratio, the Fitch Eligible Capital (FEC) ratio. FEC adds a bank’s hybrid securities to FCC to the extent that they receive “equity credit”. FEC represents a secondary measure of bank capitalization for Fitch.
For the detailed description, see Fitch Core Capital: The Primary Measure of Bank Capitalisation
Uncertainties about sovereign debt as well as scarce and expensive debt financing could drive the European corporate default rate above 6% or even higher over the coming quarters, says Standard & Poor’s Ratings Services.
Standard & Poor’s base-case European speculative-grade default forecast of
6.1% for the full year would equate to 41 rated companies defaulting by the end of the year, up from 4.8% at the end of 2011.
However, in a downside scenario, the default rate may climb to 8.4% or even higher if the economic and financing environment deteriorates further due to a deeper or more protracted recession in Europe.
The base-case scenario represents a modest upward revision to S&P’s previous
forecast of 5.5%-7.5% at the start of 2010. However, prospective defaults
would remain well below the peaks reached in the third quarter of 2009, when
the trailing 12-month default rate hit 14.7% in Europe.
S&P says that publicly rated investment-grade and higher rated speculative-grade European corporates in most sectors are better positioned to cope with a technical recession than they were in the fourth quarter of 2009, having adopted more conservative financial policies to reduce leverage following the 2008/2009 financial crisis.
“We believe that companies that sell goods and services globally should be better insulated from the turbulence engulfing the eurozone, irrespective of industry-specific cycles that usually prevail over credit developments, because they’ll be able to rely on continued relatively strong growth in emerging markets and other commodity-producing countries.”
“Nonetheless, country risks will likely weigh on the credit fortunes of more
domestic-oriented European companies, especially those with significant exposure to economies that are hardest hit by the sovereign debt crisis, Greece, Italy, Ireland, Portugal, and Spain.”
For details, see the S&P reports Eurozone Risks Will Weigh On Corporates If They Can’t Find Growth Globally and European Corporate Defaults Likely To Rise In 2012 On Gloomy Business And Financing Prospects
Developing countries should prepare for further downside risks, as Euro Area debt problems and weakening growth in several big emerging economies are dimming global growth prospects, says the World Bank in the newly-released Global Economic Prospects (GEP) 2012.
The Bank has lowered its growth forecast for 2012 to 5.4 percent for developing countries and 1.4 percent for high-income countries (-0.3 percent for the Euro Area), down from its June estimates of 6.2 and 2.7 percent (1.8 percent for the Euro Area), respectively. Global growth is now projected at 2.5 and 3.1  percent for 2012 and 2013, respectively. More Report Highlights »
Standard & Poor’s Ratings Services expects the current positive rating change bias in the global technology sector to continue to moderate, reflecting the ongoing slowdown in IT spending which began in the second half of last year, a weak global economy and ongoing M&A activity.
Our expectation for global 2012 IT spending is for low- to mid-single-digit growth overall, with semiconductor firms likely to record the weakest full-year revenue performance, at flat to low-single-digit growth.
Our expected outlook for the semiconductor sector is for flat to low-single-digit growth in 2012, following similar growth rates in 2011. Sequential declines in semiconductor revenue in the second half of 2011 will carry over with resulting weakness in the first half of 2012 and a modest pickup likely in the back half of the year. We expect memory, which showed revenue declines in 2011, to remain a weak subsector within semiconductors for 2012.
Hardware growth will decelerate, with strength still to be found in storage, tablets, and Smartphones, albeit likely at lower levels. The flooding in Thailand will continue to affect the supply chain for hard-drive supplies through at least the first quarter of 2012. In turn, this will have a negative impact on PC and set-top box volumes until supplies return to normal levels later in the year.
Stable revenues from recurring maintenance and long-term service contracts supported software and services through the downturn. Until recently, contract signings were tepid, reflecting extended sales cycles and delayed corporate buying decisions. We expect services growth will likely be in the low-single digits and software growth in the mid-single digits for 2012. Still, governments are a significant market, particularly for service providers, and remain an area of concern.
Excerpted from Industry Economic And Ratings Outlook: Slow Global IT Spending Growth Is Likely To Continue Into 2012
Most covered bond investors intend to increase their holdings, despite growing concerns over sovereign debt risk, according to a new survey from Fitch Ratings.
One year on from its previous investor survey, Fitch says that sovereign risk still constitutes the main challenge facing the covered bonds market, according to 59% of covered bond investors polled by the agency at year-end 2011, up from 37% a year earlier. Regardless, 88% of respondents are planning to either increase their current holdings or maintain them, up from 83% in the previous survey.
The eurozone crisis is clearly at the forefront of investors’ minds. The poll revealed that although around 50% of respondents intend to increase their holdings, certain jurisdictions are favored over others in terms of investment opportunities.
“Our survey shows that investors have a growing appetite for covered bonds, but are selective in what they buy. They expect to increase exposure to Scandinavia, Australia, UK and the Netherlands, which is where most of the supply has come from in the first weeks of 2012,” said Beatrice Mezza, Senior Director for Business & Relationship Management at Fitch.
The poll also revealed that investors are continuing to adapt in the face of structural changes and ratings pressure that the market has witnessed in recent years. In-line with last year’s findings, the vast majority of respondents (83%) can buy non-’AAA’ covered bonds. Their rating limits for non-’AAA’ covered bonds were evenly split between ‘AA’, ‘A’, ‘BBB’, and no limit at all. In addition, a growing number of investors – 71% compared to 62% a year ago – are prepared to buy covered bonds with soft-bullet maturities. The percentage of participants that would only buy hard bullet covered bonds has decreased to 29% from 34%.
However, investors appear less willing to innovate with regard to types of collateral, with only 35% of respondents comfortable buying covered bonds secured by assets other than mortgages or public sector loans, and requiring a higher spread to do so.
When asked to rank the sources of information used to monitor their holdings, respondents valued rating agency research highest. 68% of investors deemed it necessary for covered bonds to have two or more ratings for them to buy them, in-line with 2010 results.
For details, see Covered Bonds Investor Survey