Looking out for new markets

Posted On Friday, 21 August 2009 02:00 Published by eProp Commercial Property News
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There are indications that recovery may be on its way for some companies in the construction sector, but how strong will it be and how long will it last?

Construction IndustryA year ago, construction companies had thick profit margins and a seemingly never-ending line of large projects in the offing. They had geared themselves for what the most optimistic executive may have seen as an era of perpetual growth.

The credit crunch in the latter half of last year abruptly removed the rose-tinted glasses. Suddenly companies found themselves in cost-cutting mode and were trying to assess if their order books were as strong as they had thought.

Looking at recently published results and trading updates from a number of construction companies, indications are the sector is in a healthier state than previously thought. Numbers for the 2010 financial year are expected to be good. Group Five, for instance, increased revenue by a healthy 36%, to R12bn, and operating profit 25% to R797m for the year to end-June.

This does not mean the wider malaise in the economy is not affecting the sector. Aveng warns that headline earnings per share will be 20%-25% lower for the same period.

The sharp drop in commodity prices at the end of last year hurt construction companies like Aveng, which makes steel products.

But despite such knocks, companies have mostly adapted well to the new environment by cutting costs, says Rhynhardt Roodt, an analyst with Oryx Investment Management

Group Five says it has restructured its steel operation to cope with the new environment. “It is the right size for a market that is a little weaker,” says CEO Mike Upton

Besides the fall in commodity prices, the drying up of project financing has not helped, as it has effectively reduced the pool of projects and led to the cancellation of some — even in rich regions like the Middle East.

In Dubai, Murray & Roberts (M&R) and Group Five have seen the cancellation of projects valued in the billions of rands. “We did not think national projects would be affected. We were taken by surprise,” says Upton.

Group Five lost a R4bn project and moved quickly to cut overheads. South Africans were repatriated and contracts with foreign workers terminated. But it helps that 90% of the value of this project was replaced with new contracts in SA, says Upton.

The cancellations in Dubai do not mean there is no life in the construction sector in the Middle East. More than US22bn worth of contracts has been awarded across the Middle East since the beginning of the year to July 24, says business intelligence website MEED

Despite the disappointments, SA companies operating in the region still believe they have a future there. M&R had nearly R15bn erased from its order book. But on the upside it has signed a R4bn deal to build a hotel in Abu Dhabi. Group Five’s order book for civil engineering in the region stands at R590m.

The worst seems to be over in the Middle East but, despite a recent rally in construction stocks, concern about the longer-term health of construction companies is about how they would manage in an environment that may have lower economic growth than what they have become used to over the past few years.

The order books of companies might be full for the next 12 months or so, but what might happen after the infrastructure for the soccer World Cup is completed is spooking investors.

This is why the valuations of companies in the sector are trading at a relatively low p:e. The sector’s overall p:e is only 7,86 and the construction index is down from a high of 84,13 points a year ago to 50,3.

The latest research on the sector backs this view. The FNB civil construction confidence index dropped from 60 in the first quarter to 48 in the second.

The deterioration in private-sector fixed investment in mining, manufacturing and property development is given as the reason for the drop in the index.

The construction sector is not blind to the challenges — it foresees not only tougher competition but also more irregular patterns when it comes to awarding contracts. “It could get a little lumpy out there,” says Upton.

With fewer tenders on the table, margins are expected to become a lot slimmer and Roodt says he will not be surprised if a few unlisted companies go under.

Upton, however, is confident his group will continue to do well and says there is about R70bn worth of work out there that the company is interested in. A large portion of this work comes from government’s R800bn infrastructure development programme.

Bidding for more government work during a recession might seem like an obvious move for construction companies but it does not come without risk. First, government is not a prompt payer and, secondly, there is concern over the state’s capacity to generate funding for these projects.

Upton points out that Group Five is also looking at other areas of growth, like building business in other African countries. He says that some mining projects that were initially cancelled when metal prices collapsed last year are now going ahead.

The struggling economy can also foster a better environment for mergers. Basil Read and the mining-focused TWP announced last week that they were in merger talks. Roodt says merging in the current climate is smart because whatever costs arise from the deal can be dealt with while the economy is still weak.

But for the industry to really get its wind back, the banks will have to start lending again, says Roodt. Without funding, projects just don’t happen. “It’s more important than low interest rates,” he says.

 

Last modified on Thursday, 03 October 2013 20:36

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