As a result of the conflict in Ukraine, the U.S., U.K., and EU announced unprecedented, coordinated sanctions on some Russian banks, state-owned entities, and individuals. As part of the U.S. sanctions, Germany suspended certification of the Nord Stream 2 gas pipeline. The conflict, and the related governments' responses, have further intensified the inflationary and highly volatile cost environment that is threatening the profitability and cash flow generation of rated building material companies. Companies will be tested on their ability to pass through much higher energy and raw material costs in a context where demand will likely weaken.

While the situation is still evolving fast, this article answers some of the most frequently asked questions we receive from market participants on this topic. It outlines our view on how rising energy costs, amplified supply disruptions, and renewed scarcity of specific resources will impact rated European building material companies.

S&P Global Ratings acknowledges a high degree of uncertainty about the extent, outcome, and consequences of the military conflict between Russia and Ukraine. Irrespective of the duration of military hostilities, sanctions and related political risks are likely to remain in place for some time. Potential effects could include dislocated commodities markets--notably for oil and gas--supply chain disruptions, inflationary pressures, weaker growth, and capital market volatility. As the situation evolves, we will update our assumptions and estimates accordingly. See our macroeconomic and credit updates here: "Russia-Ukraine Macro, Market, & Credit Risks." Note that the timing of publication for rating decisions on European issuers is subject to European regulatory requirements.

Frequently Asked Questions

What is the impact of the Russia-Ukraine conflict on the European building materials sector?

Companies' direct exposure to Russia and Ukraine is generally limited (with a few minor exceptions) but they face material indirect consequences.

Most rated building material companies have a multiregional footprint, with a diversified presence across Europe, and in many cases a significant presence in the U.S. On average, direct exposure to Ukraine is less than 1% of sales, and direct exposure to Russia is less than 3% of sales. There are a few companies with more significant exposure to the conflict region, such as Buzzi Unicem and Tarkett Participation. This has translated into negative rating actions only when companies entered the crisis with limited available rating headroom, as has been the case with Tarkett.

But indirect consequences are pronounced. The conflict represents the second global supply shock this decade after COVID-19, with disruptions and bottlenecks due to scarcity of specific raw materials. Energy costs have significantly risen in Europe and globally, and there are risks of energy supply interruptions in Europe. Some electricity prices have risen more than 1,000% in just over two years. Already-significant cost input inflation pressures in 2021 have been amplified, notably for oil, natural gas, and power prices in 2022. For example, natural gas in the European wholesale spot market reached a peak of €200 per MWh in March 2022, and since the start of the conflict its daily average has exceeded €100 per MWh, which is about 5x higher than in the same period in 2021.

Chart 1

We anticipate that prices of natural gas and other energy sources will remain comparatively high in 2022-2023, which has led us to revise our expectation of a price decline in the second half of 2022. In this context, we believe that building material companies' energy bills in 2022 will likely rise by 50%-100% compared with 2021. Companies more reliant on gas and less on alternative fuels will likely suffer the most. Cement companies are hit particularly hard as energy costs represented about 20% of their total costs in 2021. Geographic diversification outside Europe is a significant mitigating factor as energy price pressure outside Europe is less. Building material distributors are also less affected as energy costs are typically a small proportion of their total costs.

Do you still anticipate construction volume growth in 2022?

We anticipate that volume growth in 2022 will still be positive, at around 1.5%, but significantly less than we had anticipated in January, when we were expecting a 3% growth. This largely reflects our view that residential construction should grow less, as some households postpone their discretionary spending ahead of increased cost of living and reduced consumer confidence. On March 28 we revised downward our estimate of 2022 GDP growth in the eurozone to 3.3%. That's 1% lower than our November 2021 baseline. We forecast 2.6% growth in 2023. Nevertheless, downside risks prevail because the evolution of the conflict remains so uncertain.

Household investment decisions are typically positively correlated with consumer confidence and economic growth. We anticipate that residential renovation volumes in 2022 in Europe will on average be only marginally up compared with 2021. We expect growth to be higher in those countries bolstered by the tax stimulus introduced during the pandemic to support building maintenance and energy efficiency. However, if the high inflation does not moderate, volumes may drop in 2023. Instead, we expect that civil engineering construction will continue growing in 2022-2023, supported by the EU Next Generation funds. Steady demand for home repairs and infrastructure had been a key factor supporting companies' pass-through strategies and positive operational gearing in 2021.

To what extent do the consequences of the conflict weaken the sector's creditworthiness?

Despite the speculative-grade ratings on two-thirds of the building materials companies that we rate in EMEA, average rating headroom in the sector is good as of the beginning of 2022. This significantly mitigates risks to the ratings in the current uncertain context. As of today, we expect that the overall impact of the conflict on ratings on European building materials companies will be contained, with few notable exceptions due to exposure to weak end-markets or limited rating headroom.

Most companies reported solid results in 2021, a clear indication of fast recovery post-pandemic. Positive business conditions have fueled the recovery supported by public stimulus on infrastructure works and renovation in the residential segment, which led to volume growth and increased pricing. The positive trend, combined with substantial cost efficiency measures, allowed most companies to preserve or increase their rating headroom in 2021. Last year, we revised to stable most negative outlooks on speculative-grade ratings that we had assigned in 2020 because of the pandemic. As of Jan. 1, 2022, only 7% of rated European building material companies were still on a negative outlook, compared with 38% at the end of 2020. In 2021 we also raised the ratings on a few investment-grade companies, Heidelbergcement and Buzzi Unicem. More recently, on March 24 we upgraded Holcim to 'BBB+'.

Despite the sector's resilience, why have you taken negative rating actions in March?

While we expect that most rated European building materials companies should withstand the negative consequences of the conflict, we acknowledge that the increase in energy and raw material costs will stay for most 2022-2023 and will further challenge companies' operating performance. As a result, in recent weeks we took some negative rating actions on a few companies that were exposed to weak end-markets or that entered the crisis with limited rating headroom. Negative outlooks among rated EMEA building materials companies therefore increased to 17% of the total rated sector as of the end of March 2022, up from 7% at the end of 2021.

Specifically, we took the following negative rating actions:

• We lowered the rating on French flooring manufacturer Tarkett to 'B+' from 'BB-' and revised the outlook to negative from stable, due to unprecedented raw material price increases and uncertainty in its Russian operations. Tarkett's performance and credit metrics might further deteriorate should high raw material prices persist, or its Russian operations be severely impaired by economic tensions and sanctions.
• We revised our outlook on concrete product producer Consolis (Compact Bidco B.V.) to negative from stable on weaker results and negative cash flow. Despite limited exposure to Russia, Consolis' performance and credit metrics might deteriorate if raw material and energy prices remain high and the company is unable to pass cost increases to customers in a timely manner, leading to continued negative cash flow.
• We also revised our outlook on bathware and fittings manufacturer Ideal Standard International S.A. to negative from stable on our expectation that current volatile and inflationary environment will negatively weigh on Ideal Standard's operating performance, with cash flow staying negative in 2022 and adjusted leverage remaining high.

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Do you anticipate a significant drop in margins as a result of increased energy and raw material costs?

Yes. For most European building material companies, the EBITDA margin trend in 2022 will be significantly worse than 2021, when it had remained roughly in line with 2020 and stood at a very solid level within the cycle.

In 2021, cost pass-throughs, hedging, and positive operational leverage ahead of solid demand for building products, particularly in the residential renovation market, helped to contain the surge in energy cost inflation that started in September 2021. However, margin pressure will intensify in 2022. This is because the extraordinary magnitude of inflation in energy and other raw material costs since the start of the conflict. Partially mitigating our concerns, most European-based building material companies have significant operations outside Europe, where the pressure on energy bills is comparatively less. Furthermore, for high energy consuming companies, the energy mix in Europe includes a significant contribution from alternative fuels, whose prices have not risen as much as those of fossil fuels. In such a context, we anticipate that most companies will continue adopting a pass-through model for commodity inputs to buffer the largest portion of any cost increase, as they did in 2021. Some companies are also updating their commercial strategy by introducing steep price changes to compensate for high energy and high carbon costs. Nevertheless, companies may suffer from some time lag to offset inflation costs. Furthermore, in 2022 operational leverage may not be as supportive as it was in 2021. As such, we anticipate that in 2022 EBITDA margins will decline by 100 basis points on average, and for some companies could stand below their 2019 level. We anticipate that cement companies' margins will suffer the most.

Chart 2

Will raw materials supply chain disruption challenge the building materials industry?

While we anticipate further cost increases in 2022, we do not expect significant supply chain disruption. Unlike other sectors, building material companies do not rely on direct supply from Russia or Ukraine but source most of their key inputs locally. We note that some building material companies, particularly cement manufacturers, benefit from vertical integration and have good control over their supply chain. We also note positively that most rated building materials companies in EMEA do not have significant concentrations in their supplier base. Only in the event of gas supply shortages would local production in some European countries likely be impaired.

Do you anticipate companies will adjust and cut their capex and M&A plans?

We do not expect significant reductions in planned capital expenditure (capex) or mergers or acquisitions (M&A). We expect that business confidence and climate transition risk will continues to support investments and remain key drivers of companies' investment decisions. As a result, we do not anticipate major cuts in 2022, and we continue to forecast capital expenditure (capex) growth of about 4% in 2022, which follows a remarkable 30% rise in 2021 and a drop of 19% in 2020. Environmental, social, and governance (ESG) considerations remain at the core of cement companies' capital allocation because those companies are assigning an increasing share of their maintenance capex to improve plants' thermal efficiency while cutting CO2 emissions. We also anticipate that most companies will continue to pursue their acquisition plans, particularly bolt-on, supported by cash piles and still cheap debt. We expect companies to prioritize investments in those business segments with higher growth potential and less climate transition risk.

Have companies taken actions to reduce their shareholder remunerations following the conflict?

Unlike at the start of the pandemic in 2020, when several issuers reduced dividends and stopped their share buyback programs to respond to unprecedented uncertainty, so far companies have not taken actions to reduce shareholder remuneration in the face of the Russia-Ukraine conflict. This largely reflects the comfortable rating headroom available and companies' common belief that the performance of the building materials sector will be resilient to the effects of the conflict. As a consequence, we anticipate that shareholder remuneration will continue to remain sustained in 2022-2023.

For instance, German-based cement producer HeidelbergCement stated on Feb. 24, 2022, that it will continue pursuing the share buyback program it started in 2021, totaling up to €1 billion through to September 2023, and it is scheduled to start the second tranche of €300 million-€350 million within the first quarter of this year. Similarly, Buzzi Unicem has also continued its share buyback program that it started in 2021, and since the start of the conflict it has acquired treasury shares equaling about €95 million, reaching about 78% of the total program. Also, on Feb. 25, 2022, Swiss-based building materials manufacturer Holcim Ltd. announced it will propose a dividend payment of Swiss franc (CHF) 2.2 per share, 10% higher than in 2021.

At the same time, private-equity owned companies display high leverage metrics on average, following dividend recapitalization and refinancing made in 2021. In our view, financial policy remains the most relevant driver of ratings. While most investment-grade companies are committed to the current ratings, we believe that a decreasing buffer due to continued shareholder remuneration could become a key risk in case of much weaker macroeconomic conditions.

Do you anticipate any liquidity or refinancing issue in the sector?

We believe that refinancing risk is limited and that liquidity for most companies will remain at least adequate. While companies' ability to preserve their liquidity buffer and access to funding remains crucial to maintaining credit quality, we take comfort from the fact that most private-equity-owned companies refinanced their capital structure in 2019-2021, considerably reducing any short-term refinancing risk in 2022 or 2023. We also believe that the vast majority of building materials companies that we rate are relatively well positioned to navigate current difficult operating conditions. We assess about 55% of rated building material companies as having adequate liquidity and about 45% as having strong liquidity.

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Do you anticipate companies will shift their CO2 reduction plan due to the conflict?

We believe companies' plans to reduce their CO2 emissions are irreversible to protect their business model ahead of significant increase in carbon costs in the medium term, and that companies will keep their current trajectory of investments with no delay. This is because the EU remains at the forefront of carbon regulation, with the aim of approve and then implement its "Fit for 55" program. On March 15, the EU Council reached an agreement on the Carbon Border Adjustment Mechanism (CBAM) regulation, one of the key parts of the "Fit for 55" program, to protect the EU's local EU production from carbon leakage as an import from neighboring countries. The "Fit for 55" program paves the way for a significant increase of carbon costs for the highest-emitting sectors over the next five years, including cement. The package proposes increasing the 2030 target to a 55% CO2 reduction versus the 1990 level. The implementation of this higher target would tighten annual caps and thus lower the supply of free carbon allowances. Furthermore, the introduction of the CBAM would be accompanied by a progressive removal of free allocations, thus widening cement companies' carbon certificate deficit and meaningfully increasing their CO2 costs.

Related Research

• Russia-Ukraine Conflict: Implications For European Corporate And Infrastructure Sectors, March 16, 2022