By Rigel Patricia Scheller, Director, Scope Ratings

Measures to offset rising energy costs range from hedging energy purchasing, changing a company’s fuel mix and making investments in energy efficiency to signing long-term fixed-priced energy contracts or power purchase agreements and investing in on-site power generation. All can contribute to reducing the volatility of energy-related costs and increase consumption of renewable energy at competitive prices.

The credit outlook remains largely stable for the sector, but it faces short- to medium-term uncertainties from multiple headwinds. Rising fuel and energy prices, steeply increasing interest rates and fears of recession have clearly clouded the outlook.

The expected slowdown in economic activity, which will constrain growth in demand as operating costs continue to rise, presage steep declines in revenue and EBITDA margins.

Figure 1: Revenue growth for selected European construction materials companies
(% YoY)

Source: public information, Scope Ratings

Pent-up construction demand countered by supply-chain problems, soaring costs

The industry has benefited from a strong rebound in orders and sales after the pandemic – see Figure 1 – partly reflecting pent-up construction demand from the commercial-property and home-building sectors, visible in the strong 2021 and H1 economic recovery in Europe and abroad. Europe’s biggest building-materials companies by sales reported revenue growth of 13% YoY on average in 2021 and more than 20% in H1 2022.

However, with doubts are growing over the strength of demand in H2 and next year, further cost increases could delay, if not prevent, much new construction taking place. Slowing economic growth and rising interest rates are a particularly difficult mix for the residential sector, as higher borrowing costs cool housing demand.

Cement making is power-hungry business

The degree of risk depends on which construction materials a company produces, as not all processes require as much energy as others.

The sub-sectors most at risk are energy-intensive industries like cement, bricks and concrete. The steady increase in the energy prices in the past 18 months triggered between a 20% and 30% increase in electricity expenses of the largest cement companies in 2021 and H1 2022 compared with the same periods a year earlier.

The cement sector still relies on coal as other fuel sources to fire a good number of its cement kilns. Though there has been a big move away from fossil fuels, power and fuel costs account for about 30% to 50% of the price of cement which is directly or indirectly linked to crude energy prices when it is sold.

As Europe’s gas and electricity prices surged to record highs in recent months, German building materials supplier HeidelbergCement AG and Spanish construction company FCC SA subsidiary Cementos Portland Valderrivas shuttered some production of cement clinker in Spain, two examples of the pressure the industry is under. The moves by the cement producers mirror action by other European gas-dependent or energy-intensive industries such as fertiliser production and aluminium and zinc smelting and some steel making.

Passing on energy costs mostly slow and only partial

Cost increases inevitably lead to compressed profit margins unless they can be passed on to customers. For the building materials sector, it is typically only partial and takes time. The “price through” of procurement prices in the markets for concrete, cement and bricks tends to be slow not least because the markets are local.

Building materials are heavy and bulky, so difficult and costly to transport over long distances. This benefits the producers with market and pricing power, leading to relatively high prices but low volatility. Producer prices of these sectors rise and fall more slowly than for other building materials like timber or plastic.

Price risk also depends on which building materials a company produces, as not all processes require as much energy as others. Lightweight materials are subject to lower, but less volatile margins than the cement production.

Europe’s building material companies achieved improved selling prices in the H1 but not always enough to keep up with rising costs. The average EBITDA margin of top building material companies fell by 2.5% percentage points in the first half of 2022 YoY.

Figure 2. EBITDA margin (%) at selected European buildings material companies

Source: public information, Scope Ratings

Sector shows capacity for adaptation

The degree of the costs difficulties faced by companies depends on how they try to mitigate the market volatility. Some companies however have managed to pass the cost pressure to the customer. Switzerland’s Holcim Ltd. and Hungary’s Masterplast Nyrt. (BB-/Stable) were have recorded positive price-over-cost ratios. Holcim addresses some of this price risk via commodity swaps with maturities between one and three years, use of alternative fuels and its proximity to the world’s largest cement markets.

Austria’s Wienerberger AG is less exposed to price risk as its lightweight materials production is significantly less energy intensive than the production of cement. The firm also has a policy of buying in advance a large share of gas and electricity required for production in the coming years, having purchased 90% of its gas for 2022.

However, there are other risks, not least that of disruptions to gas supplies and further increases in electricity prices as Russia blocks off more of its energy exports to Europe.

Longer term, the European building materials sector also faces regulatory-driven cost increases as part of the energy transition. Companies are under pressure to reduce their own environmental footprint while investing in materials to help the construction industry meet its emissions and other environmental goals – all which requires investment and possibly higher operating costs.

Figure 3. EU construction prices and costs (2015=100)

Source: Eurostat, Scope

Fiscal stimulus in EU, US provides underlying support for sector

On the other hand, the sector is on the receiving end of substantial fiscal stimulus in Europe and elsewhere.

Measures range from offsetting the impact of the Covid pandemic to projects focused on the energy transition and investment in other environmentally friendly infrastructure initiatives.

The most visible are the EU’s Green Deal (worth EUR 1.0tn) and the US Infrastructure Investment and Jobs Act (USD 1.2tn) which will support demand for building materials in the years ahead.