Government spending on infrastructure is key for construction industry

Posted On Friday, 09 April 2010 02:00 Published by Commercial Property News
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Government spending on infrastructure remains key to the outlook for the construction sector in 2010 and beyond.

Construction IndustryGovernment spending on infrastructure remains key to the outlook for the construction sector in 2010 and beyond, the professional services group Ernst and Young said on Friday.

News that the World Bank agreed to grant a US$3.75 billion project loan to Eskom, South Africa's power utility, would have come as relief for groups in the sector.

And, a local equities trader pointed to an immediate increase in construction sector stocks on the Johannesburg Stock Exchange (JSE) at its opening on Friday.

However, construction sector leader at Ernst & Young Ebrahim Dhorat said that although increased capacity at Eskom will bode well for growth, "it may be somewhat off-set by an increase in prices".

The National Energy Regulator of South Africa's (Nersa) recently approved price increases of 24.8% on electricity tariffs from April 2010, 25.8% from April 2011 and 25.9% from April 2012.

Dhorat noted that any current positive spin in the sector came from Government infrastructure taking on the role of an economic stimulus package "given that infrastructure is a key driver of economic activity and a catalyst for growth".

"Coupled with an encouraging commodity market and expected non-residential post World Cup investor interest we should see further spending in this sector," he said.

From an investors point of view, Francois du Plessis, portfolio manager and executive director of Vega Asset Management said that following the property bubble burst in Dubai which was followed by announcements that local construction companies' contracts had been cancelled, profit warnings followed and the sector became very oversold.

"However, generally speaking these companies still have strong balance sheets and strong cash generating capacities.

"There were even some positive surprises on the income statements," du Plessis said singling out Civil engineering and building company Wilson Bayley Holmes - Ovcon (WBO) who in February, reported diluted headline earnings per share of 836.7 cents for the six months ended December 2009 from 704.4 cents a year ago.

Revenue for the period increased by 12.1% to 7.6 billion rand.

Du Plessis also highlighted Stefanutti Stocks Holdings, a provider of engineering and building construction services, who said this week that it expects its earnings and headline earnings per share to be between 15% to 25% higher for the year ended February 28, 2010, from previously.

"The World Bank's loan approval is hugely positive for the whole industry," du Plessis said.

Jean-Pierre du Plessis, an analyst at Efficient group said the construction sector had rebounded strongly over the past month, but off a very low base following a significant underperformance in 2009.

"Murray and Roberts in particular has been strong, bouncing some 20% in the last month. Much of this can be attributed to an increase in global risk appetite and growth outlook over the past month.

"While the large construction stocks look attractive based on historic valuation metrics, the future remains uncertain and we would expect further downgrades in earnings expectations to continue to put downward pressure on the sector," du Plessis said.

He said that public sector infrastructure spending continues to be pushed further out, while private sector spend remained muted.

Ernst & Young said that government and the private sector had recognised that the pace and upturn in economic growth would be dependent on effective performance and delivery in infrastructure investment.

"The reliability of government spending, project delays or changes is an agenda item for
construction companies and a key consideration in managing their business," Dhorat said.

The professional services group stressed the importance of setting out a performance agenda for infrastructure "to make communities, regions, and the nation an appealing, competitive, and sustainable place in which to live, work, and play".

It added that governments would need to fill gaps, identify and correct faults, start new initiatives and change or stop old programs, while a deep understanding of national planning, strategy and discipline was necessary; coupled with the requirement of a long-term commitment.

"Strategic, performance-based and outcome-oriented investments that carry a common regional or provincial agenda should be made that support population and economic growth," E&Y said.

The group highlighted the ability to integrate infrastructure investment and sustainable land use by mandating co-operation among departments where a regional vision is able to speak in one voice, as another key determinant in increasing the responsiveness of government.

"Related to this objective is the unifying of capital budgets to coordinate spending and the knack to pool program rands across departments ensuring that agendas across departments are not in conflict.

"All infrastructure funding requests should be screened and subject to scoring, from open space to sewers to schools encouraging smart land use and sustainable development. Municipalities that invest strategically in infrastructure should be rewarded and local governments kept accountable," Ernst & Young said.

Cees Bruggemans, chief economist at FNB, said earlier this week however, that unique to South Africa are the newly intruding infrastructure interruption as intended public sector projects become delayed and real constraints (electricity, skilled labour, railway and pipeline capacities)
make their marks in specific industries.

He said serious new growth restraints have held the country back.

"Instead of public infrastructure being our new growth locomotive, as thought for many years now, we are finding this sector alarmingly losing steam," Bruggemans said.

Last month, the FNB Civil Construction Index declined from an index value of 39 in fourth quarter of 2009 to a level of 25 in 1Q2010, and from an index of 60 recorded in first quarter of 2009.

The bank pointed to deterioration in overall business conditions and the scarcity of new work and warned the industry of 'significantly more job losses during 2H2010'.

Bruggemans said that the contraction in the overall economy had resulted in a marked decline in private sector effective demand for civil construction works, while infrastructure projects associated with the Soccer World Cup were nearing completion.

Bruggemans said that projects or portions thereof commissioned by public entities such as Eskom had also been postponed or rescoped, and expenditure at the local authority level had slowed down due to a notable slower growth in income and rising debt levels of taxpayers to municipalities, which is currently above the 2% of GDP level.

"Inefficiencies at provincial and local authority level results in long periods elapsing before tenders are adjudicated," the economist said.

Global credit ratings agency Fitch Ratings said last month that credit profiles of South African construction companies would likely remain under pressure in 2010, and that market conditions were not expected to significantly improve until mid-2011.

"Despite early signs of a gradual South African economic recovery, construction companies will continue to be adversely affected in 2010 by weak demand conditions, reduced order books, above-inflation cost increases, and more limited financial flexibility," said Roelof Steenekamp, Director in Fitch's South African corporates team.

"Fitch expects a sustained recovery in the domestic construction sector to lag a recovery in the larger South African economy by 12 to 18 months, given the relatively long lead times associated with the planning and execution of large projects and expected delays in the re-commissioning of projects that were postponed when the economic downturn deepened in 2008."

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