Press Release

Morningstar DBRS' Takeaways from 2025 Credit Outlook Europe: Risks and Growth Opportunities in Corporates

Services, Consumers, Industrials
November 25, 2024

As part of its takeaways series, Morningstar DBRS is publishing write-ups about pertinent topics discussed at 2025 Credit Outlook Europe, an industry conference series that addressed key insights and risk factors that will shape the European credit markets in 2025. The takeaways below come from the 21 November event held at the Casa de América in Madrid.

GEOPOLITICAL RISKS NEGATIVELY AFFECTING EUROPEAN CORPORATE SECTOR
Although there has been some recovery since the COVID-19 pandemic and Russia's invasion of Ukraine, revenue growth is likely to remain sluggish, and Anke Rindermann, Managing Director, European Corporate Ratings at Morningstar DBRS, emphasised that this will not be helped by the trade barriers expected from the upcoming Trump administration in the U.S. "It is very hard to forecast who will be affected in what way, but there will certainly be a tougher environment in the automotive and pharmaceutical industries, and we also expect more complications in supply chains for chemical products and oil and gas", she said.

China presents another geopolitical risk to the European corporate outlook. The country is a key supplier to the energy transition, and there is uncertainty surrounding its potential invasion into Taiwan, which could result in a global recession and affect corporate industries in a way never seen before. "In a world that has become more uncertain, we are trying more to understand supply chains and [efforts] to bring production closer to home," said Rindermann.

TOUGH MARKET CONDITIONS FOR BIG AND SMALL CORPORATES ALIKE
Industries facing challenges in Europe include automotives, as high-profile companies consider shutting down plants in Europe and electric vehicle (EV) adoption loses steam. Amaury Baudouin, Senior Vice President, Sector Lead, European Corporate Ratings at Morningstar DBRS, noted that "early adopters have already bought EVs, so there remains a significant pocket of consumers who still need to be convinced", citing concerns around range, charging infrastructure, and price points as barriers to larger EV uptake. Automotive industry profits are set to continue on a negative trend in 2025, but Baudouin points out that this decline is from record highs in 2023, when new vehicle sales recovered to pre-pandemic levels and original equipment manufacturers posted record profits. He therefore does not expect a negative impact on credit ratings, notwithstanding company-specific situations.

The European mergers and acquisitions landscape is also struggling to keep up with past peaks, despite a slight increase in activity this year. Baudouin highlighted three structural trends that will provide hurdles in 2025: (1) increased pressure from regulation; (2) fewer large acquisitions from big tech and pharmaceutical companies, as these industries are focused on developing their own technology; and (3) investors' preferences for more focused investments instead of large conglomerates.

That said, market conditions have been tough for smaller businesses. Cristina Ramirez, Vice President, Sector Lead, Private Credit at Morningstar DBRS, expanded on this in her deep dive into the private credit middle market. Middle-market companies can be profitable businesses, but they do not have the scale or diversification of big companies, so are usually in the B credit rating category. The momentum in credit rating actions remains negative in the middle market. "For every company whose credit ratings we upgraded, there are 3.4 that we downgraded", said Ramirez. She emphasised that many smaller companies cannot get funding from banks, and the middle market offers more flexibility for investors with a long-term view. This was evidenced with the important role that sponsors and lenders have played over the past year, as they have been taking measures to give some financial relief to these companies. In 2025, negative credit rating actions will continue to outpace positive credit ratings actions in Morningstar DBRS' existing portfolio, but it finds new issuers are higher quality relative to existing issuers.

Morningstar DBRS' view in Europe is nuanced, however, and the situation is evolving in different ways across the continent. "Southern European countries have previously been labelled as the problem children of the economies of Europe", said Rindermann, "but I don't think this is true anymore; former perceived safe havens like Germany and France do not look so safe now".

DATA CENTRES A MAJOR GROWTH SECTOR
One area with a more promising outlook is data centres. Rindermann moderated a panel of industry experts, who discussed the developments of the data centre market in Europe, where there has been significant activity and evolution of various forms of financing. Until recently, data centres were largely financed by banks, but there has been an increase in deals across broader capital markets. Mirco Iacobucci, Senior Vice President, Sector Lead, European Commercial Real Estate Ratings at Morningstar DBRS, pointed out that capital markets are now more like a necessity in data centre financing. "At the moment, I don't think there is a choice-there is such huge demand that banks alone can't cope with the volumes and the significant costs associated with the developments of new data centres", he said.

Iacobucci also spoke about the complications of rating data centres as an asset. "When we use commercial real estate (CRE) methodologies as a base, we want to call it real estate infrastructure. Data centres do not have reletting dynamics similar to more traditional CRE assets, as the same tenants spend millions on their setup and fitting, so it's highly unlikely that they will vacate at the time of their break options. If anything, they will often ask for more capacity, making the situation difficult to capture with normal CRE methodologies".

Although the outlook on data centres was overwhelmingly positive, Iacobucci closed the panel with a word of warning for investors: "In the IT industry, disruption is always possible, and we need to be cautious because it's a sector that evolves so quickly. It is a relatively new asset type, with not a long track record yet and as a credit rating agency, we need to keep the brake down".

Written by Ella Rigby

Notes:
For more information on European corporates, visit https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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