OREANDA-NEWS. S&P Global Ratings today maintained its CreditWatch with negative implications on the 'B' long-term corporate credit rating on incorporated civil engineering and construction company Astaldi SpA.

The 'B' issue rating on Astaldi's €750 million senior unsecured notes remains on CreditWatch negative. The recovery rating on this debt remains unchanged at '4'.

Our decision to keep Astaldi's ratings on CreditWatch with negative implications follows a continued outflow of working capital in the second quarter of 2016, contrary to our previous expectations that the position would improve. In our view, Astaldi's liquidity remains vulnerable to cash outflows and could further deteriorate over the short term, unless the working capital position improves in the third quarter. At the same time, we note that in July the company successfully reset its financial covenants to a more comfortable level.

In the six months to June 2016, net working capital increased by about €320 million, because Astaldi invested in several current projects--including the third bridge over Turkey's Bosphorus, motorways in Russia and Poland, in the absence of higher advance payments under new contracts.

We expect the situation will improve in the second half of the year in line with the seasonal working capital cycle--a release of funds usually happens in the third and fourth quarters--and due to expected higher advance payments for a railway tunnel project in Italy. We also assume that working capital management will improve on the back of management's effort to enhance financial discipline and reduce leverage in line with the medium-term business plan that was presented in May 2016. Moreover, in the third quarter Astaldi is due to receive the €110 million of cash for the sale of its shares in A4 Holding, an Italian motorway concessions operator, which it closed in May 2016. We understand these funds will go toward repaying short-term debt. As a result, we estimate that at the end of 2016 gross debt and leverage will remain broadly the same as at end-2015, at about €1.95 billion and with adjusted debt to EBITDA of about 5.7x.

In July, Astaldi agreed with its banks to reset leverage covenants on its €500 million revolving credit facility (RCF) to higher thresholds until the final maturity of this line in 2019. We forecast that, at least for the next 12 months, Astaldi will have adequate headroom under these covenants, which in our view has somewhat diminished immediate pressure on the liquidity position.

In the first half of 2016, Astaldi continued to grow its backlog by winning about €2 billion in new contracts. It also gradually improved profitability by achieving EBITDA margins somewhat above 2015, and completed several important projects in Turkey and Italy on time and on budget. It also signed a bridge agreement with Nalcor Energy regarding the construction of the Muskrat Falls hydroelectric plant in Canada, which has recently experienced some technical difficulties, delays, and cost overruns. The agreement will allow Astaldi to continue work on the project until the end of 2016, when we expect the contract cost and timeframe will be reassessed, and a more permanent agreement signed between the parties. We don't forecast any further negative impact on Astaldi's profitability or additional working capital outflows in respect of this project.

The ratings continue to reflect Astaldi's operations in the cyclical engineering and construction industry; its moderate size by global standards; and its exposure to country risks in emerging markets. Moreover, the company is subject to operating and contract risks and potential execution issues stemming from large projects within its portfolio, as well as from a relatively high proportion of fixed-price contracts in its construction business which account for about half of total contracts, and reduce flexibility. Nevertheless, our view of Astaldi's business risk profile is supported by its solid market position in the transportation infrastructure industry and proven ability to deliver large and technically complex projects, good visibility on revenues thanks to a sizable order backlog in execution (about €19 billion in execution as of June 30, 2016), and relatively sound and stable profit margins.

We forecast that Astaldi's financial profile will likely remain highly leveraged over the next couple of years, although we expect credit metrics will gradually improve following management's efforts to increase cash flow generation and working capital discipline and reduce gross debt. We forecast that 2016 free operating cash flow (FOCF) will still be negative due to substantial investment in working capital and concession projects. From 2017, however, we expect it to become at least break-even. Astaldi is also continuing with its plans to focus on construction activity and reduce its involvement in the concession business, which require large capital investment. Apart from the share in A4 Holding that it sold in May, Astaldi plans to dispose of other concession assets in Chile, Italy, and Turkey in 2017-2019 for a total estimated value of about €600 million-€700 million, and to use the proceeds to repay debt. We currently do not factor these transactions into our base case because the exact timing and the amounts are uncertain and, in our view, remain subject to execution risks.

Our base-case scenario assumes:Revenues to increase by about 3.5% in 2016 and 5.0%-5.5% per year in 2017-2018, on the back of the existing backlog and new order intake;Adjusted EBITDA margin to gradually improve to about 10.5% in 2016-2017, compared with 10.2% in 2015;A nonseasonal outflow of working capital of about €110 million in 2016 due to investment into new projects, followed by some release of funds in 2017, as the company implements its plans to improve working capital management;Capital expenditure (capex) and investments in concessions totaling about €110 million-€160 million per year;Dividends of about €20 million per year; and€110 million to be received in the second half of 2016 for the sale of A4 Holding. Based on these assumptions, we arrive at the following credit measures:Negative FOCF in 2016, before breakeven in 2017;Weighted-average funds from operations (FFO) to debt of about 7.5%; andAdjusted debt to EBITDA of about 5.3x. The CreditWatch negative placement reflects a one-in-two probability that we may lower the rating by one or more notches if the company does not restore its working capital position in the third quarter of 2016. We aim to resolve the CreditWatch once we review the third-quarter financial results and reassess the company's liquidity position.

We could lower the rating by one or more notches if the net working capital position does not improve, leading to a material deficit of liquidity sources versus uses and increased exposure to short-term refinancing risks. Any deterioration in borrowing terms on the local market, or increasing uncertainty regarding payments on any of its contracts, especially in the light of geopolitical risks in Turkey, could also lead us to downgrade Astaldi.

We could remove the CreditWatch negative placement and affirm the rating if we observed a cash inflow from collection of due contract payments and advances on new projects, as well as the cash-in for the A4 Holding sale.