Ferrovial S.A. – Annual report – 31 December 2022
Industry: construction; transportation
BASIS OF PRESENTATION AND NEW ACCOUNTING STANDARDS (extract)
Impact of the Ukraine war and the macroeconomic situation
On 24 February 2022, Russia began its invasion of Ukraine. At the date of preparation of these consolidated financial statements the conflict has not come to an end.
Although Ferrovial’s direct exposure to the conflict is limited, the macroeconomic scenario triggered by this situation includes broad-based price rises, essentially affecting energy and commodities, supply issues and difficulties in the distribution chain for certain materials, particularly in the construction industry. In response, interest rates are rising, impacting the banking and financing markets.
1.2. CURRENT ECONOMIC SITUATION AND GOING CONCERN EVALUATION
1.2.1 Going concern assessment
Ferrovial is confronting 2023 in a position of very high liquidity. In December 2022, ex-infrastructure projects, liquidity reached EUR 6,118 million, including liquidity lines available at the ex-infrastructures level in the amount of EUR 964 million. The ex-infrastructures net cash position stood at EUR 1,439 million at end-December 2022. It should also be noted that the Group’s short-term assets and liabilities, including cash and debt, show a positive balance at end-December 2022.
As in the prior financial years, in order to conclude as to the Company’s capacity to continue as a going concern, the Group has analyzed future cash needs, focusing on the financial years 2023 and 2024, also including a pessimistic scenario with a series of stress assumptions regarding the Company’s cash flow, most notably:
- Reduction in additional dividends from infrastructure project companies in 2023 and 2024 (50% in the case of airports and toll roads and all dividends in the case of energy).
- Construction business cash flows for 2023 and 2024 are projected to fall by 50% in terms of 2022 working capital (excluding provisions and lease payments), estimated at around EUR -90 million per annum.
- Contingent capital contributions of around EUR 100 million per annum.
The conclusion drawn from the analysis demonstrates that, although the scenario would entail a deterioration of the Company’s cash position, cash resources would continue to be sufficient to meet commitments. Therefore, based on the available information, no material uncertainties have been identified with respect to events or conditions that could raise significant doubts regarding the Group’s capacity to continue operating under the going concern principle for twelve months following the date these Annual Accounts are signed.
1.2.2 Impact of COVID-19
More than two years after the World Health Organization declared the Covid-19 global pandemic, 2022 was a turning point to returning to pre-pandemic normality. This has allowed the countries in which Ferrovial operates to lift the restrictions on mobility and on economic activities that were in force since the start of the pandemic, although at an uneven rate depending on the country, and with ups and downs caused by the new variants and successive waves, especially with Omicron at the start of the year. The direct result of this has been the recovery in demand for the activities carried out by Ferrovial and the confirmation of the favorable outlook.
Accordingly, it may be concluded at year-end 2022, and despite the fact that certain assets have not recovered the traffic levels of 2019, that Ferrovial’s activities are no longer directly affected by COVID-19 and the associated restrictions. Nevertheless, the pandemic has implied a change in the habits of infrastructure use, highlighting the consolidation of hybrid work models, with the associated impact on peak hours, as well as the increased traffic recorded by heavy vehicles, related to the increase in e-commerce.
1.2.3 Impact of the Russia and Ukraine conflict.
The conflict between Russia and Ukraine began on 24 February 2022. The conflict has not reached an end at the issuance date of these Consolidated Financial Statements. The European Union, together with the United States and most NATO countries, condemned the attack and approved various economic measures in the form of sanctions on the Russian economy so as to dissuade them. The measures taken are affecting the economies of all countries.
The ensuing macroeconomic scenario has caused widespread price rises, essentially relating to energy and commodities.
In some cases, there have also been supply issues and difficulties in the distribution chain for certain materials, particularly in the construction industry. In response, interest rates are rising, impacting the banking and financing markets.
Ferrovial’s direct exposure to the conflict is limited, since none of the Group’s businesses operates in Russia or Ukraine. The Group businesses closest to the conflict area are the construction business Budimex (in Poland) and the concession for the D4R7 Bratislava ring road (in Slovakia), as both countries have borders with Ukraine. However, none of the businesses have been significantly impacted to date.
The indirect impact on Ferrovial’s activities varies depending on the nature of the business. Although Ferrovial does not envisage material effects as a result of the conflict, the Construction business has been the most vulnerable due to the increasing costs of certain raw materials. The Toll Roads business has been positively impacted due to the rate rise in assets directly linked to inflation and is adversely exposed to the possible impact of rising fuel prices on traffic. Finally, no relevant impact is expected in the Airports business due to the scant exposure to passenger traffic from these regions in the airports managed by Ferrovial, although the effect of inflation on ticket prices could have a certain dissuasive effect.
With the aim of presenting the global impact of the Russian-Ukrainian conflict and in line with ESMA’s recommendations, this note provides an explanation of the impact on the financial statements, an analysis of the possible impact of the conflict on the impairment of assets and an assessment of the potential impact on the main financial risks.
1.2.3.1 Impact on the financial statements for 2022 and mitigating measures adopted
The effects of the Russian conflict with Ukraine on Ferrovial’s business results are described below:
Construction Division
The Construction business was primarily affected by inflation: rising prices of materials, more expensive energy and thus an increase in workers’ salaries. The conflict has also caused issues in the supply and distribution chain for certain materials, leading to delays and reducing their supply.
This all put pressure on project margins, which varied depending on the geography, and has resulted in a worsening of the operating income of the Construction division in 2022 of approximately 100 million euros.
In the event that inflation levels remain similar to the current levels in the future, we do not estimate any material negative net impact in our Financial Statements in addition to those already mentioned.
The mechanisms in place to mitigate the effects, are essentially two: direct claims to customers or use of specific indexation formulae to pass this cost on to customers (in contracts that specifically include such mechanisms).
Other types of contracts (mainly in the UK) are free from such risk as they are target cost plus contracts in which the price is calculated based on cost incurred plus an agreed mark-up.
In some countries such as Spain and Poland, price rises are partially offset under the following laws:
- In Spain, RDL 6/2022 of 30 March (on urgent measures under the National Plan to respond to the economic and social consequences of the war in Ukraine) offsets price rises of more than 5% up to a ceiling of 20% of the total contract amount for contracts entered into with the central government (this plan may also be endorsed by regional governments and local corporations).
All Spain’s regional governments and our main public customers have now adhered to the plan. This mechanism does not apply to energy prices, only to costs of other materials such as steel, bituminous products, aluminum and copper.
- In Poland, the Infrastructure Ministry updated the road price review mechanism, increasing the maximum offset from 5% to 10%, which affects this type of civil works contracts. However, the maximum is still 5% for Railways.
These mechanisms allow us to conclude that approximately 80% of the division’s portfolio is protected against the effects of rising inflation.
The impact of these mitigating measures on future results is currently difficult to quantify and will depend partly on the outcome of negotiations with clients in the coming months. Under the Group’s accounting policies (Note 1.3.3.4), income from cost compensation claims is only recognized where recovery is deemed highly probable.
In addition, Ferrovial has implemented an action plan to mitigate the adverse effects aforementioned both for projects in progress and for those that are in the bidding stage. Among other actions, the plan includes monitoring the supply situation and reporting monthly on material price rises and estimated trends, developing artificial intelligence and data analysis systems to predict prices and making fixed price commitments to avoid volatility.
Airports Division
The Airports business was not directly affected by the conflict, as described.
The passenger trend was directly related to the evolution of the pandemic and restrictions during the year, as explained in the previous section:
At Heathrow, traffic with Russia and Ukraine historically accounted for less than 1% of the total (0.99% in 2019, 0.94% in 2020 and 0.72% in 2021). Therefore, the impact on the financial statements and covenants is immaterial.
The recently included Dalaman Airport (Turkey) reached around 900,000 Russian and Ukrainian passengers in 2019. They accounted for 20% and 7% of its total international traffic, respectively. In 2022, the upturn in British travelers (+16% v. 2019) and the recovery of domestic traffic partially offset the loss of Russian and Ukrainian passengers.
Despite this, there is a risk that the airlines may pass on the increases in the price of flights causing demand for travel to fall, in a negative economic scenario in which fuel prices rise considerably. However, such effects are hard to quantify.
Toll Roads Division
As mentioned previously, the Toll Roads business is not directly affected by the conflict.
In this case, and unlike Construction, inflation has a positive impact since many asset tariffs are linked to the Consumer Price Index. One example is the case of the Dallas toll road assets (NTE, LBJ and NTE35W), where the soft cap is updated each year based on the annual rise in inflation. The soft cap was increased by 7% in 2022 and by 6.5% in 2023.
Conversely, rising fuel prices could adversely impact traffic, particularly in a flexible scenario allowing home working. In an economic recession scenario in which purchasing power declines, demand for assets of this kind could fall.
Finally, it should be noted that rising interest rates could also affect the capacity to finance new projects awarded and could also lead to tendering processes being cancelled and that generally speaking the volume of works tendered could be lower. In the case of the North American toll road portfolio, the interest rate hike to control inflation had no adverse effects, as the borrowings accrue interest at fixed rates. In order to hedge interest rate risk, in the projects whose borrowings bear interest at a variable rate, the concession holders have arranged interest rate hedges on the projects’ debt.
Traffic trends on the main toll roads in North America in 2022 (compared to pre-pandemic levels in 2019) are analyzed below:
A positive trend may be observed in the table above in relation to the evolution of the pandemic and no material adverse impacts may be observed as a result of the conflict.
Compared to 2019, 407 ETR traffic was impacted at the beginning of 2022 by the resumption of mobility restrictions in Ontario province to halt Omicron, measures that were lifted in March.
LBJ remained below 2019 levels primarily due to the positive effect of the construction work carried out in the area in 2019. Compared to 2021, NTE 35W’s traffic was affected by the acceleration of the NTE3C works as from second quarter of 2022.
Cash flow effect
The impact of the conflict on Construction business cash flows relates to the adverse trend in short-term working capital (to make large payments), which will progressively recover in the medium term thanks to various recovery mechanisms, particularly claims to be made to clients and specific indexation approaches.
Dividend receipts are not expected to be affected.
1.2.3.2 Impact on asset impairment
As mentioned previously, the businesses have not been significantly affected by the conflict between Russia and Ukraine. However, the current macroeconomic context of rising rates pushed up the discount rates employed in the impairment tests performed, though to a lesser extent in the Toll Roads and Airports Divisions due to the impact of inflation on rates. Despite the situation described no indications of impairment of the Group’s assets have been identified.
1.2.3.3 Impact on financial risks
The interest rate hike did not have a material effect on the Company’s financial statements because 92% of the Group’s borrowings are at fixed rates or are hedged by derivatives, as explained in Note 5.4
Indeed, as indicated below in Note 5.5.b to these consolidated annual accounts on derivatives, prospects of increasing interest rates have had a positive impact on equity due to the increase in value of these interest rate derivatives of EUR 302 million.
As regards rising inflation, besides the business impact, from a financial instruments point of view, the negative impact on equity of EUR -119 million in Autema (Note 5.5.a) is notable, due primarily to the expected increase in inflation.
Accounts examples 