BUILDING AND CONSTRUCTION COMPANIES – Not a pretty site – Project reviews in the mining sector have raised uncertainty about growth and helped undermine building and construction share prices (South Africa)

Posted by Gilmour Poincaree on December 4, 2008

28 November 2008

by Andrew McNulty


A few months ago, building & construction shares were priced at a large premium to the local stock market. After steep falls in recent weeks, that has changed markedly.

Murray & Roberts (M&R) and Aveng, the two biggest companies in the sector, have fallen by almost 60% in less than three months. They now trade on historical p:e ratios of less than eight, in line with – or below – the market average.

This may seem anomalous, as infrastructure and related investment is expected to be the healthiest area of the economy over the next year. Several companies have reported large order books and expressed confidence that the work will go ahead.

But the shares reflect dwindling investor confidence in the sector and increased uncertainty about the earnings outlook beyond next year.

Earnings and order books remain strong

Uncertainty about the outlook has increased

The price weakness is linked partly to weakness in specific areas. After the collapse in commodity prices, mining companies are reviewing capital projects and some have announced project deferrals. The steel sector is cutting production and curbing prices. And activity in the residential sector is flat or declining.

These changes will directly affect some companies’ earnings. At Aveng’s AGM on October 24, chairman Angus Band said a lower steel price and lower vehicle sales will be bad for the group’s manufacturing and processing businesses, which include Trident Steel, a trading company.

However, Band also highlighted a broader change. His annual review, written in July, said the infrastructure landscape remained “very positive”, with opportunities extending well beyond 2010, especially in the power, roads and transport environment, while commodity prices were expected to fuel demand for infrastructure projects for mining houses.

At the AGM, Band said the global investment climate had since changed significantly because of the liquidity squeeze and economic slowdown.

He added that Aveng’s customers will “inevitably find it more difficult and more expensive” to fund projects and that’s likely to affect the group’s order books in the medium term.

Aveng’s share has fallen 33% since Band made that statement. For many investors, it confirms a more uncertain and possibly bearish outlook for a sector with a cyclical history.

“Nasty surprises are the norm in the international building & construction sector,” says independent analyst Mark Ingham, who has specialised in the sector for more than a decade. “A few companies, such as WBHO, have been consistent, but people did get carried away with the ‘dotcon’ theme.”

Ingham cites two areas of uncertainty. One is order books, and whether these companies will continue to secure new work in the medium term to replace existing projects. The other is margins, which are at historically high levels but may fall as competition increases.

“I’ve felt for a while that margins are topping out,” Ingham adds. “In the commercial & residential sector, margins are slipping as more firms are competing for work again. The smaller contractors are already under strain.”

Coronation Fund Managers analyst Quintin Ivan says construction has been one of the most cyclical sectors on the market, and there’s little reason to think that has changed. “They don’t have annuity income streams. It’s feast or famine,” he says.

Ivan adds order books have grown to high levels, which could make it difficult for these companies to maintain growth in a slowing economy.

Investec Asset Management portfolio manager Chris Freund says the recent price declines in the sector mostly reflect selling by foreign investors and are part of a global pattern.

A year ago, rising infrastructure spending in emerging markets was being cited as a reason to buy stocks that benefit directly. Slowing global growth, withdrawal of capital from emerging markets and currency weakness are now seen as reasons to question whether spending will continue as planned.

The selling reflects a broad approach but the prospects – and uncertainties – vary between companies.

In a trading statement this week, M&R says it maintains the market guidance published earlier for the year to June 2009, but cautions shareholders to be prudent with this as “the potential impact of current market volatility may manifest itself on the construction sector and group performance in the future”.

It says cash flow constraints in a few clients has resulted in suspension or delay of projects in each of the group’s markets. It adds its project order book provides a solid performance foundation for the period up to 2012 and beyond.

This includes public works and other strategic projects – local and international – that are likely to continue and will provide stability through the “difficult times” ahead.

Cautious investors say the large SA groups’ international activities are in areas that could become more competitive. Aveng and M&R have operations in Australia; M&R and Group Five have important contracts in the Middle East. Lower prices for oil and mining products could lead to less spending on infrastructure in these regions.

However, offshore operations have helped to diversify these groups’ order books and may help mitigate weakness in domestic markets.

For now, public sector spending in SA is expected mostly to go ahead as planned. Energy and transport remain key areas. Ingham says Basil Read is well placed to benefit from an expected upturn in local roadbuilding. Raubex could also do well in this sector.

Cement & and lime producer PPC’s cement volumes were flat in the year to September. CE John Gomersall says margins are under pressure because of surging costs such as energy and transport, and the group may add an energy surcharge to its prices.

However, Gomersall says the effect on the SA economy from global market volatility is likely to be less in the infrastructure sector than in the formal residential sector. He adds that cement demand for rural and affordable housing is expected to continue, as government plans to eliminate the backlog of almost 3m houses by 2014.

Freund believes shares in the sector have been oversold. They could rise sharply when private-sector projects have resumed and there is evidence that order books are growing again. The sector would also benefit from an upturn in commodity prices.

But the shares are unlikely to recover much while the uncertainty about the growth outlook continues.



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