There’s still no sign of im­prov­ing con­di­tions for the em­bat­tled con­struc­tion sec­tor, writes An­dries Mahlangu

Financial Mail - Investors Monthly - - Contents -

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




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