OREANDA-NEWS. Fitch Ratings says OHL SA (BB-/Stable) suffered a drop in profits in its construction activity in 1H16 as a result of unprofitable legacy contracts and delays in commencing new contract work. Positively, OHL's actions to strengthen its balance sheet have resulted in the Spanish construction and concession operator being better positioned than a year ago to offset potential liquidity issues caused by lower cash flow.

OHL's lacklustre results in construction for 1H16 were mainly driven by an unexpected rise in costs in some of its older contracts. Of the reported EUR270m LTM to June 2016 recourse EBITDA, construction accounted for around EUR100m and the rest was contributed by recurring dividends from concessions.

While we expect recurring dividends from OHL's concessions business for the whole of 2016 to be similar to the previous year (EUR155m), we forecast a slow recovery in construction business profitability driven by new projects in lower-risk developed markets. In addition, we expect cash flow to benefit from positive working capital movements, which typically provides cash inflow in the second half of the year.

In the medium term we expect OHL to improve the cash conversion of profits generated, as the company is now re-focusing its construction business in lower-risk developed countries, with cash flow also benefitting from a reduced working capital cycle.

In the past nine months, OHL has substantially simplified its debt structure. Some of the proceeds of both its EUR1bn capital increase and the recent sale of the 7% stake in Abertis (EUR815m) were used to repay debt at its concession-owning subsidiary. By partly repaying the margin loans linked to the share price of OHL Mexico and Abertis, OHL significantly reduced the risk of margin loan triggers, which is positive for the group's liquidity. Although these transactions occurred at OHL Concesiones level - therefore outside our perimeter of analysis - Fitch views the debt reduction positively as it reduces the likelihood of cash support from the parent company.

Fitch focuses its analysis on the recourse perimeter, adjusting metrics to reflect the ring-fenced nature of the concession business by excluding related funds from operations (FFO) and non-recourse debt but including recurring dividends from the non-recourse operations. In its net leverage metrics, Fitch uses available cash (EUR595m at end-June 2016) as a potential source for debt repayment, as no cash contribution will be needed to fund equity commitment at concession level in the next three years.

A successful restoration of the company's profitability, leading to Fitch-adjusted net leverage to around 2.0x and EBITDA interest cover above 3.0x (including recurring dividends) on a sustained basis could lead to a positive rating action. Conversely, Fitch's adjusted recourse net leverage above 4.0x and EBITDA interest cover below 2.0x on a sustained basis could lead to a downgrade. Based on the LTM figures to June 2016, Fitch-adjusted FFO net leverage was 3.8x, and the figure for 2016 is expected to be around 3.6x, both within the range of sensitivities for the rating.