Aveng woes no litmus test of construction sector

Posted On Wednesday, 04 February 2004 02:00 Published by Commercial Property News
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CONSTRUCTION stocks were hit hard on Monday after Aveng warned its profit would fall by half. But the stampede lost momentum fairly quickly, and most of the shares in the sector, apart from Aveng, had recovered lost ground by the close of trade.

Carl Grim AvengAnd rightly so Aveng's troubles are not an indication of the general state of affairs for construction companies. It certainly is not all sunshine and roses out there; the strong rand continues to slash profits and delay capital projects, but Aveng's latest warning arose from three particular roads construction contracts in Africa that went pear-shaped.

That came on top of the company's warning last year that profit would fall between 10% and 30% because of the rand's appreciation. The additional 20% is attributable directly to the African activities of Aveng's roads and earthworks division, so it does not necessarily follow that all South African construction companies should be tarred with the same brush, so to speak.

In fact, SA's large construction companies have made a lot of money out of African roads projects in the past. Most have also burnt their fingers on occasion, so they are aware that they carry substantial risk.

With the rand at its present level, local construction companies are just not competitive enough to bid for these projects and build in a margin big enough to compensate for that risk. That is why few sector analysts are unhappy with Aveng's decision to avoid large African road and earthworks contracts going forward. Some see this call, combined with the dip in the share price, as a buying opportunity.

Road contracts' perils

AVENG CEO Carl Grim gave some interesting insight during postprofit warning interviews into why African road and earthworks contracts carry so much risk.

Some of it is self-evident, such as the fact that physical conditions are almost impossible to predict when building a road covering several hundred kilometres, compared with the geographically confined site of a building or bridge construction project.

An unexpected section of especially difficult terrain can set a project back long enough to consume whatever margin has been built into the project.

Then there are the problems of access, lack of infrastructure, corruption and political instability that come with contract work in any third-world country.

Grim points to a structural problem with the way the World Bank and other international development organisations go about commissioning road projects. They tend to start with a monetary allocation, which becomes the budget within which both design engineers and the eventual construction tender winner have to work.

If the design does not suit the prevailing conditions and available materials, it is the construction company that ends up carrying the can.

The more logical approach is to identify the need for a road first, then estimate what it will cost and seek financing. That may explain why Aveng remains keen to bid for road contracts in SA, where this way of doing things is standard practice.

Output hitches costly

DELAYS in getting Palabora's new underground copper project up to full production means SA's largest producer of copper is missing out on a price boom. Copper demand is growing faster than refineries and scrap dealers can get the metal on to the market, with the result that copper prices are hitting levels not seen in six years.

Copper for delivery in March is now trading at between $1,14 and $1,15 a pound on the Comex commodities market in the US. Copper prices have gained more than 40% in the past year. The prices have been driven mainly by soaring Chinese demand.

Palabora, 49% held by Rio Tinto and 28% by Anglo American, said last week that its net production for the year to the end of December was 77100 tons, 8,5% down on the previous year.

The cost of getting the underground operation up and running has also risen: it will now cost R460m, from the initial estimate of $437m, to build production up to 30000 tons of ore a day.

In the last three months of its financial year Palabora processed almost 22000 tons of ore a day. The firm now plans to bring in more secondary breaking equipment to increase production, but shareholders could be forgiven for thinking this is all too little, too late. After all, Palabora has been complaining about "equipment deficiencies" for some time.

Management cannot be faulted for focusing on managing rock stress with a view to improving the longer term management of the mine, even though this has delayed the development of the undercut. While they are working on getting this right, though, shareholders are missing out on something of a bonanza.

Rate cuts' ripple effect

THE effect the past year's spate of interest rate cuts has had on small companies cannot be underestimated, both in terms of the boost to the demand for goods and services, and the reduced cost of borrowing.

Sharply lower interest payments were the main reason distribution group Brandcorp's net pretax profit rose 27% to R37,7m for the half year to December. Interest paid fell to R148000, from R5,3m previously.

Before interest costs were taken into account, Brandcorp's profit was only 8,2% higher at R37,7m on a 2,9% decline in turnover to R362,4m.

The Reserve Bank's monetary policy committee might want to take the Brandcorp example into account when it decides whether the economy can afford any further interest-rate reductions in the current cycle.

Last modified on Friday, 21 June 2013 22:02

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