Just don't drop those bricks

Posted On Monday, 11 December 2006 02:00 Published by eProp Commercial Property News
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Large projects are driving up share prices. But will they all be completed? The construction industry has spawned more listings this year than any other sector

Construction IndustryLarge projects are driving up share prices. But will they all be completed? The construction industry has spawned more listings this year than any other sector. On top of that, the growth performance of the construction & building materials index has been almost double that of the all share index (Alsi) - 64% growth against 33%. Most of the companies were coming off low bases after a few years of rather pedestrian performance.

Nevertheless, the sector has been singing, thanks to the relatively benign interest rate environment and the R410bn that government plans to spend on infrastructure investment. Also, oodles of money is in the pipeline for the 2010 Fifa World Cup - R15bn from government's pot and an estimated R100bn from the private sector. After decades of miserable conditions, there is more work than ever before and companies are in the enviable position of being able to pick and choose their contracts. The sheer scale of the long-awaited boom has even attracted the interest of US and UK funds, which have piled in to the blue-chip construction stocks.

So it looks as though investors may have more trouble falling off the proverbial log than making money out of this sector. But they should beware. The frenzied demand for new listed stocks such as WG Wearne and Afrimat suggests there may be froth in the market. In addition, this isn't a sector known for risk-free returns. And the risks shouldn't be sniffed at.
Gavin Bantam, an analyst with Nedcor Securities, says one of the biggest risks facing construction companies is in the execution. "There is a lot of work around but they actually need to do it," he says, adding that all it takes is "one or two projects going bad to wipe out a company's performance.

Execution risk is the biggest risk, I think, which hasn't been priced in to the share prices of the listed companies]." Another danger zone is that large projects have long gestation periods. Most of the large infrastructure-related projects take between 18 months and two years and in an extreme case, such as the Gautrain, four to five years or
more. "Over a longer period of time there is a greater chance that something can go wrong," he says.

The R24bn Gautrain project carries its own special risks. The biggest of these is that it is a fixed-price contract. This means that Murray & Roberts (M&R), the lead contractor, will have to have guessed right on price increases on a range of materials (such as steel and cement) as well as the rand (a lot of inputs are being imported) as far as five years from now.
But Sean Flanagan, an executive director of M&R, is confident the company has done its sums right and is more concerned about other risks to the massive project.

Cy Jacobs, a fund manager with 36One Asset Management, says there are significant risks for the larger construction companies such as M&R on large fixed-price contracts because they depend on the performance and pricing of the subcontractors. Flanagan says there will be well over 100 subcontractors working on the project. Jacobs says: "I think the major investment risks are in the larger contracting companies, such M&R and Aveng. The individual contract risks are huge."

Each one of these very large projects is a one-off that has not been done elsewhere, so there is no experience to borrow from. Flanagan and Aveng CEO Carl Grim agree that skills and materials are the two biggest risks facing the industry. "The whole question of availability of skills and materials becomes a significant issue with a major project such as the Gautrain or the 2010 stadiums," says Flanagan, who is responsible for M&R's execution of 2010 World Cup stadium projects.

The size of these projects alone poses a threat. As Stocks Building Africa's Rob King points out, a 1% mistake on a R200m project is a lot less than a 1% mistake on a R1bn project. M&R have created a separate project team in the corporate office to handle the commitments to building the Gautrain. The company has recruited over 200 skilled professionals from all over the world who have the skill and experience with projects of this scale and complexity. Grim says the skills shortage is not only a threat on the contractors' side but also on the clients' side, especially if the client is government. This is because the client has to have the skill to manage the various stages of a long-term project.

The client also needs to be nimble-footed to cope with unexpected developments on site, which could mean delays or project specifications needing to be adjusted. Having an under-resourced municipality dealing with the complexities of a civil engineering project specification could lead to delays and costly legal battles. King adds that bigger projects pose a particular problem for smaller to medium-sized firms that don't have the depth of skills and are doing projects which are bigger than they have attempted in the past. "I don't think some of the smaller guys have priced that in and they may lack the resource [skills] infrastructure. Big projects need more senior skills than many of these guys have."

Some people in the industry are more sanguine on the issue of the skills shortage. Spencer Hodgson, CEO of the Construction Industry Development Board, a government body, says a review of the skills needs in SA does not point to a crisis. This view is shared by most of the employers in the sector, who know the skills can be imported. But importing engineering and project management skills can be 30%-50% costlier than hiring locally. Despite the reservations, analysts believe there is big money to be made in the sector. Investors should just remember that this does seem to be a classic case of higher reward entailing higher risk.

Last modified on Thursday, 17 October 2013 10:35

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