The increasing pace of transition among Chinese engineering and construction (E&C) companies is a main driver of widening credit differentiation in the sector, Fitch Ratings said in a recent release.

Fitch expects contractors that diversified into renewable energy, power, and industrial projects to shield their margins amid subdued demand for traditional projects.

Meanwhile, companies reliant on residential housing and conventional infrastructure could observe slower contract momentum, fast EBITDA drops, and increasing leverage, the rating agency said.

Leaders such as China State Construction Engineering (SHA:601668) have notably reduced their residential housing exposure to about 15% last year from 35% in 2021, while power-focused peers like Power Construction Corp. of China (SHA:601669) and China Energy Engineering (HKG:3996, SHA:601868) posted strong margins and EBITDA, according to Fitch.

High capital expenditure kept free cash flow (FCF) negative for most issuers last year, despite improved working capital management, Fitch said.

Leverage continues to be a pressure point for E&C companies' standalone credit profiles, with retained negative FCF weighing on EBITDA gross and net leverage, the rating agency said.