Ratings agency Fitch on Wednesday downgraded South Africa-based building materials group Aveng’s national long-term rating to ‘BBB(zaf)’ from ‘A(zaf)’ and its national short-term rating to ‘F2(zaf)’ from ‘F1(zaf)’, stating that the company’s outlook was negative.

The downgrade and negative outlook reflected continued deterioration in the group’s financial performance and cash position owing to its weaker South African operations, as a result of negative trading conditions as well as the poor general business environment in South Africa, Fitch said.

The downgrade also reflected limitation to cash movements within the group and the relative net financial position between the group’s Australian operations and the rest of the group.

Fitch noted that Aveng’s Australian construction operations were performing more strongly than the South African construction and engineering operations and the divergence in operating performance had widened in the first half of the 2014 financial year, with operating losses of South Africa and Africa widening to R336-million from R40-million in the prior corresponding period, whereas the company’s Australian operations continued to generate profits.

Aveng’s net financial position was also considerably stronger in Australia with net cash of R2.6-billion versus net debt of R200-million in South Africa.

In that context, the restriction placed on cash movements from Australia to South Africa was considered a constraint on the ratings, Fitch said. 

The ratings agency further pointed out that, in the six months to December 31, although cash burn slowed significantly, free cash flow remained negative and, as a result, there was no material improvement in Aveng's cash position.

The group's two-year order book had been broadly stable since the 2013 financial year, leading Fitch to expect that volumes would remain under pressure and consequently fewer advance payments would be received. However, Fitch noted that the company's management was focusing its efforts on improving profit to cash conversion.

Meanwhile, the company’s margins also decreased to 1.8% during the first half of the 2014 financial year owing to labour disruptions and the loss of certain mining contracts.

Fitch noted that low-margin projects had been substantially completed and management was focusing on cost-cutting efforts.

“However, in our view, ongoing delays in State infrastructure spending, a volatile labour environment and execution risks relating to projects, as well as commercial claims, pose a material risk to the group's recovery in margins,” the ratings agency said.

Further, Aveng’s gross debt increased to R3.3-billion during the six-months to December 31, from R1.9-billion in the prior corresponding period, while the company’s negative free cash flow position declined to R89-million, owing to reduced capital expenditure, suspension of dividend payments and improved trade receivables collections.

Despite Aveng's actions to conserve cash flows, Fitch said it was likely that the tough operating environment would add pressure to the company’s overall cash profile.