There’s still no sign of improving conditions for the embattled construction sector, writes Andries Mahlangu
Construction companies diversifying income streams away from SA
Struggling construction shares took another step down in the first quarter of 2015, testing the patience of investors who have stayed the course through hard times — at least over the past five years.
Murray & Roberts, Wilson Bayley Holmes-Ovcon (WBHO) and Aveng have now been relegated to JSE small-cap status, leaving PPC as the only construction play in the mid-cap universe.
“The construction sector has some headwinds,” says Regenesys Investments CE Devin Shutte, pointing to slowing domestic demand and rising costs.
Confidence along the value chain has also taken a knock in the quarter under review, according to an FNB/BER survey. It cites a sharp fall in residential building activity, which weighed on the confidence of main contractors and manufacturers of building materials in particular.
The survey reveals the percentage of respondents that are satisfied with prevailing business conditions in six sectors, namely architects, quantity surveyors, main contractors, subcontractors, manufacturers of building materials, and retailers of building material and hardware.
SA’s economy, to which the construction sector is largely geared, is projected to grow by a mere 2% this year because of tepid global economy and electricity supply constraints that continue to undermine business confidence.
Adding to the toxic mix is the slowdown in government’s multibillion-rand infrastructure spend, which has left many of these firms struggling to find major projects, leading to intense competition for low-margin tenders.
One of the largest contributors to government’s capital infrastructure expenditure lately has been the construction of Eskom’s power stations, Kusile and Medupi. The latter is due for completion this year.
As a consequence, many companies have sought to diversify their income streams away from SA, which is battling in the low-growth environment. The cyclical construction sector also partly feeds off the resources industry, which has been battered by the fall in commodity prices.
The fallout has forced the hand of some big miners to cut back on their capital expenditure, which is a vital source of support for the construction industry.
“We think, generally, that construction shares will continue to face headwinds for most of 2015. The mining sector will remain under pressure for the foreseeable future and the government practice of making big construction-related projects more amenable to smaller, medium-sized businesses means greater competition among the majors for acceptable business,” says Imara Asset Management SA chief investment officer Bruce Williamson.
“In addition, the government requirement that construction companies not only widen the package of their existing employees, but also empower and train locals on the job, only spells margin pressure.”
Indeed, earnings of major construction and engineering companies have come under renewed pressure, leading to the severe markdown in their share prices. Aveng, which is the biggest construction and engineering group by revenue, saw its headline EPS fall by 58% in the six months to December from a year earlier period.
BP Bernstein Stockbrokers portfolio manager Makwe Masilela reckons the big construction companies still have a long way to go before they are strongly back on their feet. This is because they disappointed their biggest client — government — when they allegedly colluded during the construction of soccer World Cup stadiums and after paying fines there’s still a possibility of facing the courts.
To this end, the Competition Commission in March referred a case of “collusive tendering” against Group Five to the Competition Tribunal and recommended a fine. The commission said this was part of the second phase of its fast-track settlement process relating to investigations into alleged collusion in the construction
It’s a cyclical industry and there doesn’t appear to be a near-term catalyst to significantly improve earnings across the sector
industry, which included 2010 soccer World Cup projects.
The commission said Group Five colluded with WBHO and Concor, a subsidiary of Murray & Roberts, on the rehabilitation of part of the national road between Senekal and Vaalpensspruit in the Free State, which was worth R190m. Group Five plans to contest the fine.
The reputational damage and weaker operational performances have combined to dent investor sentiment, leaving the JSE construction & materials index at its lowest level since 2005.
Aveng and Murray & Roberts have lost two-thirds of their market values over the past rolling five years, even though the latter reintroduced dividend payments for the first time since 2010 in the 2014 financial year. Group Five has lost about a quarter while WBHO has been an outlier relative to its peer group as its shares are close to flat in the similar period.
“We think that in the coming months the order book and revenues might give investors some reason for hope, but project delivery and cost pressures will keep us on the sidelines. Apart from a short-lived position in Group Five, our single exposure to the broader construction market has been via Afrimat,” says Imara’s Williamson.
Afrimat has indeed been one bright spot in an otherwise bleak picture in a sector that remains vital to the country’s economy and employment. The minerals and construction materials supplier has rallied 459% to R18/share over the past five-year rolling period.
Williamson argues Afrimat management understood government’s need to develop rural areas and positioned itself to participate in such infrastructure opportunities. “The company has a strong contracting skill set positioned across most of SA and is able to support rural development by way of drilling, blasting, mobile crushing and screening. Within the group they also have some particularly well located open pits.”
The small-cap counter expects headline EPS to rise by between 15% and 25% in the year to January 2015.
In contrast, Basil Read Holdings has shed a staggering 76% in value to R2,70/share since 2010, underlining the challenges in the sector that resulted in the liquidation of Protech Khuthele last year. Basil Read suffered a net loss of R820,9m in the year to December 2014, hit partly by loss-making contracts.
Value investors will have been looking at this sector for some time now but to date it’s been more of a value trap, according to Absa Wealth & Investment Management’s head of private clients asset management‚ Craig Pheiffer. He adds: “It’s a cyclical industry and there doesn’t appear to be a near-term catalyst to significantly improve earnings across the sector or cause the sector to rerate.”
Investors have for a number of years shunned the construction and resource sectors in favour of the so-called defensive stocks such as pharmaceuticals in a broader industrial space. This has been despite the improving order books of some of the construction players following the end of the 2010 Fifa World Cup tournament, which had brought with it mega projects, boosting share prices.
The JSE construction & materials index has halved in market value on the rolling basis since 2010 while the all share index has risen 80% over the same period.
“This is not a valuation play — cheap can get cheaper — but rather a cyclical play. When fundamentals improve, the companies with the strongest balance sheets should be able to capitalise on this most effectively,” Shutte says, recommending that the sector be avoided until the cycle turns.
The lack of construction projects has also put pressure on the steel sector, forcing the small-cap Alert Steel into a business rescue last year.
Pheiffer says some counters will do better than others in the shorter term and “hence we can call it a stock-picker’s market, but one would expect that if we did see that catalyst for the sector — for example a faster-growing economy and greater gross fixed capital formation — then a rising tide would lift all the ships. For now, that tide still looks to be far out and we’ll be observing from the sidelines for now.”
The road has certainly been bumpy for the construction plays and looks set to remain so in the foreseeable future, save for a few shining examples such as Afrimat and building materials retailer Cashbuild.
The cyclical construction sector also partly feeds off the resources industry, which has been battered by the fall in commodity prices