Aldesa : Light at the end of the tunnel? Initiation of coverage with a Stable credit opinion and a Speculative Buy recommendation

>Credit opinion: Stable // Market recommendation: Speculative Buy - We adopt a Stable credit opinion. Aldesa is a small-sized construction company, which leads to high concentration risks in terms of customers and geography (Mexico = 100% of recourse EBITDA). On the other hand, we recognize its ability to mitigate the weak level of public contracts in Spain/Mexico with its growing exposure to private clients. We think that Aldesa is relatively conservative on project selection, as illustrated by its good track record of execution. Though, we note that the current leverage (adjusted recourse leverage of 8.0x at end-March 2017) is high and leaves little downside protection. After massive FCF consumption of EUR -44m at the recourse level in 2016, we expect a stabilization of FCF this year, whereas the potential recovery in Spain and in Poland may pave the way for a leverage improvement in 2018.We have a Speculative Buy recommendation on the 2021 notes (B2/Fitch: B neg, Ytw of 11.1%, z+1107 bp). They offer the highest yield in the HY construction universe which fairly compensates for its credit weaknesses (high leverage, concentration, macro risk in Mexico, low FCF) in our view. The 2021 notes have rallied since end-March 2017 (good preliminary results in 2016) and strengthening of the MXN). Still, they offer a c. 600 bp premium compared with the JPM B Index and we think that they should perform well if the company is able to stabilize its FCF in 2017 and improve EBITDA in 2018, which is our current scenario.Support factors - • Aldesa’s international expansion and its diversification towards private projects helped to mitigate the downturn of the public construction market in Spain/Mexico. Spain now represents 20% of total sales in 2016.• Potential recovery prospects in Spain and Poland from the low levels reached in 2016.• Good track record in terms of project execution.• Adequate liquidity that can address the seasonal working capital swing. There are limited near term maturities (provided off-balance sheet financing is extended) and significant headroom under bank debt covenants (1.9x recourse net leverage at end-2016 vs. a leverage test of 3.75x).Points to watch - • Small size of the company (EUR 846m of consolidated revenues and EUR 91m of EBITDA in 2016) compared with HY peers OHL, Astaldi and Salini Impregilo.• Strong dependence on Mexico (77% of consolidated EBITDA and 100% of recourse EBITDA in 2016). Aldesa is therefore sensitive to macro developments and FX movements in Mexico since no hedging is in place (most of the recourse debt is denominated in EUR).• High leverage ratios of 6.7x (consolidated) and 8.0x (recourse including off-BS financing, 3.4x on a reported basis) at end-March 2017, leaving little headroom in case of downside.• Limited FCF generation, which should however improve from EUR -44m in 2016 to EUR -4m in 2017 at the recourse level, in our model.• Reputation risk, in case of alleged illegal conduct.