Friday, 21 August 2009 02:00

Looking out for new markets

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.

 

Tuesday, 11 August 2009 02:00

Afrimat sees improvement in construction

Afrimat said that despite a slower trade performance in the year to February 2009, improvement is already evident in the months since year-end.

Group Five is one of the construction firms that have continued to see growth in earnings, benefiting largely from the government’s multibillion-rand spending on infrastructure.

Thursday, 22 January 2009 02:00

Construction contracts lost

THE global credit crisis and reduced oil prices in the Middle East are taking their toll on South African construction companies, with Murray & Roberts and Group Five announcing cancellations of contracts.

Construction IndustryWith dismal global economic news pointing to deteriorating energy demand and keeping oil prices under pressure, the Middle East is now forced to slash or cancel ambitious infrastructure projects, affecting construction companies’ bottom lines.

Dubai has announced a review of its own infrastructure capital project programme as a result of the worsening economic crisis.

Group Five said yesterday Dubai authorities had terminated a R3,3bn contract and had suspended one for R654m.

However, the group said other contracts to the value of R563m in Dubai, Abu Dhabi and Jordan were not affected.

“Such suspension and termination action is catered for in the contracts, such that the contractor has recovery rights and will be fully compensated for its costs incurred, with a reasonable margin,” it said.

Group Five said it remained committed to the Middle East and continued to review its prospects in light of these developments and against the ongoing opportunities that existed in the region’s economies that had energy resources and industrialisation strategies that suited its capabilities.

The group said that its African and eastern European operations remained buoyant and it expected a strong improvement in earnings for the full year.

Group Five said yesterday it expected headline earnings per share to be 45%-55% higher for the six months to the end of last month, compared with the previous half.

On Tuesday Murray & Roberts said one of its contracts in the Middle East had been scrapped.

The group said it would close out its position in terms of the contract and it was not expected there would be any material effect on the financial results for the year to June.

 

Monday, 19 January 2009 02:00

Construction groups bank on state work

Construction companies are counting on the government’s multi billion-rand spending programme in infrastructure projects to see them through the lean economic times caused by the global credit crunch, which has seen work from the private sector dwindle.

Construction IndustryThe global economic meltdown has created a lot of uncertainty for construction companies, most of which saw private sector work decline towards the end of last year.

A number of private sector clients of construction companies have suffered cash flow problems due to the financial crisis, which has affected certain projects.

From the second quarter of last year, the construction sector has been severely downgraded by the stock market on fears of a recession and depleted future work opportunities.

With commodity prices plummeting in recent months, the mining sector, which provides a big chunk of work to several construction companies, has scaled back on capital expenditure.

However, with the government reiterating that it will not put the brakes on its infrastructure spending programme, construction companies will be seeking more exposure to this public sector investment.

In his medium-term budget speech last year, Finance Minister Trevor Manuel said the government would continue to invest in several areas of infrastructure, including rail, roads, ports and energy in a bid to boost economic growth.

Group Five CEO Mike Upton said last week the group had a “reasonably good” order book to see it through the turmoil. “This (the order book) is quite well in tune with the public sector spending. The private sector has taken a turn for the worst, with capital spending, especially in mining, expected to drop significantly,” he said.

At the end of June last year, the group's one-year order book stood at R8,5bn, which it said at the time reflected its strategic positioning in the public infrastructure cycle with a mix of 65:35 in favour of public works.

“We are not negative at this stage but cautious.

“Our projections are not the same as last year, and we are not seeing the same security of work as we did six months ago. We have seen a number of projects from private sector clients that have been curtailed in recent months due to the credit crunch.”

WBHO CEO Louwtjie Nel said with work from the private sector drying up, the company was shifting emphasis towards government projects.

He said whereas two years ago the split between public and private sector work was about 20:80, that split was now about 50:50.

“We were traditionally focused on private sector clients, but we are now swinging in a big way towards government infrastructure work, such as roads, energy and hospitals — which should get us through 2009 quite comfortably.

“Beyond that, nobody really knows what is going to happen,” he said.

Nel said the group’s civils division was feeling the pinch the most as work, especially from the mining sector, had almost dried up.

“But overall we are now getting well exposed to government spend.”

Murray & Roberts said its outlook for this year had not changed from what it was in November when the group reported that it had been forced to restructure its operations in the light of the global credit squeeze.

The group said then that it had delayed or suspended some of its projects as some of its clients felt the pinch of the credit crunch.

“There are a number of significant public works and other strategic opportunities in the group's domestic and international project pipeline that are likely to proceed and which will provide stability through the difficult times ahead,” it said.

 

Record order books are expected to help construction stocks maintain decent earnings growth in the new year, but beyond that the future is uncertain as the global credit crisis eats up future work opportunities.

Construction IndustrySouth Africa‘s big-four construction firms boast a combined R120 billion order book, thanks to the phenomenal sector growth in the lead-up to the 2010 Fifa World Cup, as well as developments in other markets.

While these order books will certainly build up construction groups‘ coffers, the global economic slowdown – which is expected to deepen next year – may open floodgates of project cancellations and delays.

So, while “the outlook for next year is pretty decent, future work opportunities have been reduced”, says one analyst, who declined to be named.

Already Murray & Roberts, the country‘s largest construction firm, has had to adjust its books after its Trump Tower joint venture in Dubai was suspended, wiping R3,2-billion off its R61-billion order book, although the firm landed a R6-billion contract to build a terminal at Dubai International Airport shortly after this.

Underscoring predictions of the tough trading conditions ahead are union claims that Murray & Roberts is planning to axe workers as the rough trading environment restricts its ability to expand.

Group Five disclosed in an interview that there “had been a small and immaterial reduction” in the number of projects in the African mining sector and that “one small housing project” for a mining firm had been cancelled.

Eskom has also terminated the procurement processes for the proposed multi-billion-rand Nuclear-1 power plant project.

Aveng and Murray & Roberts were in two separate consortiums bidding to build the power plant, with Aveng saying the termination was “understandable” and that it had confidence in the continued infrastructure roll-out in the markets in which it operated.

“I don‘t think we have seen the last of these project cancellations and delays,” the construction analyst said.

Project flow from the mining sector is expected to worsen in the new year, with Group Five having already seen a slowdown in African copper mining.

Mining companies across the world are cutting back on production as weakening commodity prices bite into earnings, with Anglo American and Anglo Platinum expected to slash capital expenditure in half when they announce revised spending plans next week.

Together with public sector spending, construction companies also based their original rosy 2009 outlooks on “continuing demand for commodities”, which was expected to spur expansions in the mining sector, although many miners are now cutting back.

Aveng has downplayed the impact of the global crisis, saying its project pipeline remained strong, but it is “taking longer for clients to finalise projects”.

For the next few years the sector is banking on South Africa‘s multibillion-rand infrastructure spending, but if the national treasury is unable to raise funds offshore to counter shrinking foreign capital inflows it may need to reprioritise its spending plans.

South Africa is spending R600-billion over the next three years to upgrade and build new roads, power generation and transmission, rail, ports, pipelines, hospitals, prisons and schools.

Another analyst said the fact that Eskom – which accounts for the bulk of the infrastructure package – had to shelve its nuclear project suggested that even governments, albeit to a lesser extent, were feeling the pinch of tighter credit lending.

“Those with no exposure to public sector spending are in for a rough time,” the analyst said.

But all big-four construction companies are comprehensively exposed to this multi-billion-rand package, with Murray & Roberts saying it will drive annual growth of 15% to 25% through to at least 2014.

 

Wednesday, 10 December 2008 02:00

Stefanutti wins Kusile contract

Stefanutti Stocks said that a consortium of JSE-listed companies it was leading had won a civil works contract for Eskom’s Kusile power station in Mpumalanga.

JSE-listed construction company Group Five yesterday reported a strong performance for the year to June, despite tougher trading conditions in the second half of its trading period.

Mike UptonIt was able to ride global stock markets turmoil, higher interest rates, a weaker rand and load shedding in the first half of the year thanks to a buoyant construction sector and its product and geographic diversification strategy.

“Against these factors, we believe our strategy of balancing our portfolio of businesses in targeted geographic spread where we have strong markets in African resources and high-growth economies in the Middle East made us much more resilient to the turbulence than before,” said CEO Mike Upton.

The group said revenue rose 16% to R8,9bn from R7,7bn in the previous period, while operating profit before fair value was up 62% as Group Five shifted its focus from private to larger public sector infrastructure projects and consolidated its operations abroad.

Fully diluted headline earnings per share increased 70% to 398c from 233c in the previous year. Disposal of its 3,5% stake in a highway in Hungary had resulted in the fair value adjustment of R111m, the group said.

Cross-border operations, including activities in the Middle East and eastern Europe as well as the rest of Africa, accounted for 34% of total revenue with the rest being generated locally.

Overall operating margin before fair value adjustments improved from 5,1% to 7,1% after all costs, and cash generated from operations rose to R1,8bn for the year to June.

Upton said the results reflected the group’s continued shift from a “pure contractor to that of a diversified construction services, materials and investment group with product and geographic diversification”.

The construction division remained the group’s largest revenue contributor, turning over 79,5% of total revenue and 60% of operating profit. The group reported a record 12-month construction order book of R8,5bn, a growth of 76% from last year, while the current total order book stood at R14bn.

Construction materials and investments and concessions respectively contributed 7,7% and 6,5% of total group revenue and 22,3% and 8,4% of operating profit.

“The construction market, especially in SA, is very healthy and likely to remain so for the foreseeable future in the key sectors in which Group Five has strategically positioned itself,” Upton said. “The opportunities in the order book provide us with the scope to choose higher-margin contracts, improve cash-flow management and maximise our allocation of resources.”

Internationally, Upton said the group would continue focusing on African resources and power markets and continued growth in eastern Europe and the Middle East.

In SA, it would pay particular attention to public sector spending in such areas as low-cost housing, infrastructure public-private partnerships, power generation, roads and water.

“The group has a clear strategy and a balanced portfolio of business diversification aligned to the markets we serve. Given this, we expect to continue on our growth trajectory next year, with strong earnings,” Upton said.

 

Friday, 04 July 2008 02:00

Taking Stocks for future

One of the top three or four construction companies in SA within the next few years — that’s the target status for Stefanutti & Bressan (S&B), as a sequel to its impending R1,1bn acquisition of unlisted Stocks Limited. Competition commission approval is expected by the end of July.

Willie MeyburghS&B has a market capitalisation of R2,4bn. When it listed in August last year the issue was 21 times oversubscribed. After going in at R12/share, S&B has traded as high as R27 but dropped in recent months to around R15,50.

In a joint statement the companies said the merger would position the enlarged group “as a major competitor in the first-tier construction sector, with almost R5bn turnover and 8 000 employees”, and it is not seen as a cost cutting exercise.

Stocks Building Africa was launched in 2001, after the old Stocks & Stocks was taken off the exchange as a consequence of some tough times. Management bought out what was left.

S&B CEO Willie Meyburgh says S&B heard that Stocks was interested in listing again, and that S&B had convinced the company that throwing in its bulk with S&B was the smarter move.

The industry in SA is dominated by a few large companies in terms of capacity. At the top are Murray & Roberts and Aveng subsidiary Grinaker-LTA; in the second tier are Group Five and Wilson Bayly Holmes (WBHO); and the smallest of the traditional big five is Basil Read.

There is not much competition in the top two tiers, and this allows these contractors a lot of leeway when it comes to negotiating price.

“We would like to be in the same league as the Group Fives and WBHOs, and in time get to the level of M&R and Grinaker,” says Meyburgh.

“We need to upscale to be able to take on the larger projects on our own, so that we can keep more of the margin for ourselves. It will also raise the profile of the company.

“Our competitors know the name Stefanutti & Bressan, but investors and the public in general don’t really know the company or the quality of the company.”

Before embarking on this deal, S&B had wanted to diversify itself geographically. “We said we wanted to get into first-class emerging markets such as Dubai or Abu Dhabi,” says Meyburgh.

The transaction entails a swap of about 40m shares, while Rand Merchant Bank — a substantial shareholder in the unlisted Stocks — will be paid R382m by S&B for its stake.

S&B already has a strong offering. The group is well established in civils (concrete structures such as bridges) and construction. It is also exposed to mining, which is expected to continue investing in new capacity. S&B builds and maintains slimes and tailings dams, and is involved in contract mining for open pit mines.

The group also has well-established building divisions in the Western Cape and Gauteng, with a smaller presence in KwaZulu Natal — where Stocks has a strong presence.

The deal may have come at a good time for Stocks, as a slowdown in building is expected after consecutive interest rate rises.

It will be up to the Stocks team to take advantage of the Gulf area, where petrodollar-funded building activity appears to be isolated from global economic pressures. Stocks has a handful of small joint ventures operating in three of the Arab emirates, which S&B are hoping to be able to leverage off into larger contracts.

Perhaps the biggest and most valuable gain for S&B is an experienced team of managers with a strong entrepreneurial flair. Gino Stefanutti, S&B’s founder and chairman, says: “People have asked us, ‘Why are you buying a building company?’ but we say that this is mainly a construction company. For example, if you look at the work they have done at Cape Town airport, the parking lot — it’s a civil's job. These people can be returned to civil's any time,” says Stefanutti.

“The beauty about Stocks is that they are owner-managed. They were all part of the leveraged management buyout — they are just like us. We get on well. Like us they are contractors and not professional managers.”

With more bodies on board, S&B will be able to staff the stream of larger projects that it expects to win tenders on. Government has committed itself to spending about R515bn over the next three to five years, with more work likely to follow.

Meyburgh says the group has a vision of reaching turnover of R10bn within the next three years. A double-digit operating margin is also being pursued.

Though the Stocks acquisition will dilute operating margins slightly (7,2% in financial 2008), it will be earnings-enhancing. The value of the merger will only really make itself felt in February next year. At that point there will have been at least seven months of Stocks trading in the numbers.

On a forward p:e of 12 for S&B, it seems the market is missing out on yet another trick. Meyburgh says the company is going to perform better than its forward p:e would lead one to believe, emphasising that at these levels there is a lot of value to be had.

 

Wednesday, 12 March 2008 02:00

Civil engineering powers ahead

While the residential and nonresidential construction market is heading for slow growth this year because of higher interest rates, the civil construction sector is expected to grow 33%.

Construction IndustryLocal construction companies stand to benefit from the boom that is expected to carry on until at least 2015, influenced largely by governmental infrastructure spending of R560bn over the next three years.

Coupled with this is Eskom’s R1-trillion budget to build power stations, Transnet’s building of railway lines, ports and fuel pipelines, and private sector expansion programmes.

Strong demand and rising commodity prices are also driving expansion in the mining sector, which will benefit the construction sector.

According to Reserve Bank data, the value of construction works reached an estimated R46bn last year, a 32% increase in real terms from R34,7bn in 2006.

South African Federation of Civil Engineering Contractors (Safcec) economist Pierre Blaauw says the estimate is an annualised figure, with the final number due at the end of this month. “Turnover this high was last seen during the construction boom in the 1970s, when the industry recorded a figure breaching the R40bn mark for the first time,” Blaauw says.

“Safcec’s numbers indicate growth between 25% and 30% for the civil engineering industry alone last year.”

He says the good news is that spending on the government's R560bn infrastructure budget started only last year and that this year and next should see further growth for the industry.

“We expect a 13%-16% increase in civil engineering industry turnover this year. It may sound small compared to last year’s record number, but this comes off a higher base,” he says.

Despite challenging macro economic conditions, infrastructure spending is steaming ahead, which bodes well for the industry, which has experienced 80% growth in turnover since 2004.

Blaauw says infrastructure spending is a prerequisite to maintain economic growth.

Blaauw says the biggest challenge the civil engineering industry will face this year will be capacity constraints. Companies will need to increase their capacity by acquiring new capital assets, locating and securing the necessary skills, buying up smaller firms, and expanding their education and training budgets.

Most big construction companies are already at work on projects such as the Gautrain, stadiums, and upgrading of airports and ports.

The likes of Murray & Roberts, Aveng and Group Five are either part of infrastructure development programmes or are bidding with international groups to build power stations and big projects.

Cadiz African Harvest portfolio manager Rajay Ambekar says gross fixed capital formation had peaked at about 30% in 1976 but has since been coming down to the current 15% of gross domestic product (GDP). “The target is 25% of GDP,” Ambekar says.

International construction companies are partnering with local companies that are unable to cope with the load and lack expertise, especially for big projects. “No South African company can build a power station on its own. A lot of civil construction would be done by local companies while technical expertise is brought by international companies,” Ambekar says.

However, he says there is a risk of delays that are outside companies’ control, which could be costly. Blaauw agrees, saying there will be more supply-side constraints than demand-side constraints.

According to Statistics SA, the construction industry showed the biggest jump of all economic sectors in acquiring capital assets from 2005 to 2006, recording a 73% increase. Salaries and wages rose 16,6%. Blaauw says it is likely the industry will have doubled in size between 2004 and next year. .

In 2006 there were four large international construction firms registered with the Construction Industry Development Board, rising to 11 last year.

“We are likely to see a further increase in competition from abroad over the next two to three years, as well as from smaller companies growing into larger firms able to compete for bigger contracts.”

 

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