Mega-projects abound as a nation rebuilds itself

Like many sectors in the country, construction has had more than its fair share of challenges in recent years. Yet in spite of the downside risks, the prospects for the building industry have not been brighter for decades. As Ayman Tolba, the chairman and CEO of Leena Real Estate, told OBG, “Egypt’s young and growing population can support strong growth in the construction of middle-class housing for the next 10-15 years, but the sheer breadth of projects needed will require significant financing exceeding the capacity of local banks, meaning foreign direct investment (FDI) will be a must. Current legislation does not allow innovation in the construction sector, which means we need to loosen regulations to allow for newer, more innovative building technologies such as those used in eco-friendly construction.”

Continuation of new cities around Cairo, complete with offices and shopping malls, plans for 1m new affordable homes in the social housing segment, the expansion of the Suez Canal, the development of 75,000 sq km of land on either side of the canal for industry and the myriad other infrastructure schemes are turning Egypt into a hive of activity – a vast change from even a year ago. “The residential, office and retail buildings segments are expanding quickly, driven not only by population growth but also by new investments,” Walid Gad, the managing director of Schindler Egypt, told OBG.

Of course, challenges remain. Among difficulties to be overcome are the diminution of energy subsidies as part of an overall campaign to put national finances on a sustainable footing; the consequent increase in prices through higher transport costs; the slide in the value of the Egyptian pound, especially in 2013, making imports more expensive; and, in a country where job creation has become almost a national mantra, the ironic possibility of labour shortages hitting the encyclopaedic list of projects.

Inflation

A report issued by Gleeds Construction Consultancy Egypt in the middle of 2014 said the broader economy had seen “a sharp reduction in the rate of annual inflation”.

However, on the cost of construction materials, Gleeds warned of continued price increases throughout 2014, in large part a result of expectations for the dramatic rise in publicly funded building work. Despite the potential problems, the report forecast increased activity in the construction sector alongside heightened interest by foreign investors, especially in the retail and residential segments. The firm’s expectations for the infrastructure sector of “improved activity in the medium term” came even before the country raised an impressive LE64bn ($9.1bn) within eight days in September 2014 to pay for the Suez Canal expansion.

The rise in the Gleeds index of construction material prices from 100 in January 2007 to 107 at year-end was based on actual costs. Over the years cost inflation in a “normal” operating environment was calculated at around 6-7%, although spikes well above this norm have been recorded.

A 20% rise in the first half of 2008, for example, was blamed on the large number of expatriates returning home to invest in the real estate market as well as to escape from the global financial crisis. The inflation rate moderated later in the year and the index hovered within around 2% up or down on 130 for four years. However, the beginning of 2013 saw a significant jump in prices due to a range of factors, including fuel shortages, a nosedive in the value of the Egyptian pound, civil unrest, the downgrade of Egypt’s credit rating, anticipation of a cut in subsidies and a lack of electricity. All of these helped push up costs until the index rose by 15% to 155 towards the end of 2013. Despite a slowdown in 2014, prices are expected to accelerate in 2015 and 2016 to propel the index to 188 and between 197 and 203 by the end of those two respective years.

GDP Share

Inflation naturally has an effect on the contribution that construction makes to GDP. In fact, the increases in GDP contribution in 2001 and 2002 were entirely down to inflation so there was no real expansion of the sector at all. The following two years saw slight real growth, although 2005 was the turning point. The significant increase in construction’s real GDP that year, just under 4%, was affected because inflation dropped and the market expanded. It was the beginning of a trend that lasted until 2010, with a growth rate moving up from 4.09% to 4.59% of GDP. The value, both public and private, increased from LE52.6bn ($7.5bn) in 2010 to LE76.7bn ($10.9bn) in 2013, although the GDP share stayed constant at around 4.5%.

Infrastructure

Funding infrastructure projects in emerging markets can be quite challenging, particularly for an economy like Egypt’s where debt markets can prove costly – although as the Suez project has demonstrated, it can still be a viable option. However, in recent years as the government has sought to contain spending, the search for infrastructure financing has accelerated. Bruce Haswell, regional director for Gleeds, told OBG, “The sheer breadth of infrastructure projects currently under consideration for the coming years will require a huge spending drive, and will be almost wholly reliant on FDI.”

Aside from a few statements over the first half of 2013 outlining plans for public-private partnership (PPP) projects, 2013 saw little movement but by 2014, momentum had picked up. The Ministry of Transport brought back experts – all Egyptians – from various parts of the world to prepare detailed plans for transport improvements both in the capital and the country to be put out for tender.

Currently, Egypt is seeking to shift away from its previous reliance on FDI or loans as a means of funding public projects. The new philosophy is to draw as much funding as possible from local sources, which has several advantages. In some cases, like the Suez Canal expansion project, which involved the raising of debt not only through banks but also through coupon sales to local investors, the local market offers one little-tapped option.

PPPs offer another increasingly promising route. Egypt has significant experience in PPP projects, following the establishment in 2006 of a dedicated PPP unit in the Ministry of Finance, and has rolled out a number of developments using the structure – although there is room for improvements.

Waleed Abdel Fattah, senior vice-president and North Africa regional manager of Hill International, the US construction consulting firm, told OBG, “To encourage more PPPs in the construction and real estate sector, investors will need clear regulations and contract protections.” Emphasising the vast range of possibilities ahead, Fattah added, “The fact that the country is in need of developments across multiple sectors translates into many opportunities for investments. If there is sufficient power, construction of new factories should reach the levels seen in previous years.” Haswell agreed. “Since there is no clear policy on how government entities will be able to finance future borrowing for infrastructure development, PPPs will automatically become the alternative,” he added. “However, such projects need greater certainty and transparency from the government.”

A Million Homes

Egypt’s formal housing market has always faced problems keeping up with the sizable demand in a country where the population is growing by 2.5% a year. The shortage is such that informal construction now comprises a large proportion of residential build, although the government is hoping to address that through large-scale public housing projects, including one that intends to provide a million homes for the poor.

In March 2014, a major UAE construction firm, Arabtec, agreed to build the houses in a $40bn project backed by both Egypt and Abu Dhabi. Founded in Dubai four decades ago, Arabtec helped to build the world’s tallest skyscraper, the Burj Khalifa in Dubai, and has the Louvre project in Abu Dhabi on its books. Internal restructuring issues at Arabtec over the summer of 2014 had little impact on the million-home project, with statements in October by Arabtec’s chairman, Khadem Abdulla Al Qubaisi, reiterating that its construction projects remained on track and Aabar – an Abu Dhabi-based investment firm that holds a 21.57% stake in the company – continued to support it. Arabtec Holding will be responsible for raising the cash needed to pay for the project, although given the amount and the recent turmoil it is likely that Aabar will be heavily involved in sourcing the finance. Egypt’s Prime Minister Ibrahim Mahlab had announced the government had reached an agreement with Arabtec that all of the funding would “come from abroad” and be Arabtec’s responsibility.

Staffing the project may be a challenge, however. Arabtec had said earlier in the year that it had a workforce of around 63,000, although according to a report by HSBC, the company needs to hire an additional 17,500 white-collar employees to deal with its workload. One solution suggested was to outsource some of its heavy workload.

The million affordable homes will be built over at least a decade on 13 plots of land across the country currently belonging to the Egyptian armed forces. According to local press reports, two options are being considered: either Arabtec would pay cash for the land or offer a number of the units free of charge to the government and the military. The first phase, including homes in the Cairo districts of Al Aboor and Badr City, was slated to start at the end of 2014.

Karim Sami Saad, the chairman of Samcrete, said the project would have a significant impact on the construction sector as a whole. ”The deal signed with the UAE for the low-cost housing units will benefit the entire supply chain and will be marked by an increase in the number of power, water, sewage treatment and road infrastructure projects,” he told OBG.

The UAE is not the only Gulf country directly involved in providing new homes in Egypt. In June 2014 Reuters reported that the Saudi Egyptian Construction Company (SECON), jointly established by the two countries in 1975, was increasing its capital fourfold by injecting $245m to begin a new build campaign in Egypt. According to local press reports, the Saudis would put $124m in cash into the company while Egypt’s contribution would be 100 feddans (42 ha) of land in three cities worth around the same amount. Housing Minister Mustafa Madbouly said SECON would concentrate on “medium-income housing units”, although no details were provided. According to Ahmed Dasha Badrawi, the CEO of Sixth of October Development and Investment Company, “To encourage private participation in low-income housing developments, land prices need to decrease significantly, alternative structures for issuing land need to be used other than auctions, or domestic companies need to be given the same facilities and privileges being provided to some foreign investors.”

Power

In addition to the residential market, and just as the cement industry is in the process of adding coal to its energy mix, Egypt is working on solving its chronic power shortages by offering tenders for projects to add 8 GW of electricity sourced from a combination of coal power, wind, biomass and solar. The Ministry of Electricity and Energy announced in November 2014 that it had set new tariffs for power generated from renewable sources that were intended to be “attractive for investors”.

Ashraf Salman, the minister of investment, said that two coal power plants would be tendered in the 2014/15 fiscal year, which ends on June 30, 2015, and that the plants would provide half of the envisaged additional power. The other half would be sourced from wind and solar, with each providing 2 GW, and tenders for the $7m projects will be issued in the same time frame. In line with the overall philosophy of self help, Salman added that factories would be set up to manufacture new and renewable energy plant components after the solar and wind tenders have been offered, allowing local producers to compete with importers.

Suez Project

Digging started in August 2014 on the Suez Canal expansion (see analysis), which is designed to cut transit times from 18 hours to 11 hours and send canal revenues soaring from around $5.4bn, the estimate for receipts in 2014, to $13.5bn by 2023. The main reason for current delays in transit times is that width restrictions enforce a system of one-way convoys. After the works are completed, two-way traffic should be possible for the entire length of the canal. The original timescale for the project was set at five years, although this was rapidly reduced to three years in the context of an atmosphere where all projects were wanted “today not tomorrow”. After intervention from the president, even this time was cut to an ambitious 12 months.

Zones & Parks

As part of the capital spending campaign, the government is planning five projects to construct technology parks across the country. The parks, which will provide turnkey infrastructure and facilities for technology service firms and manufacturers, will cost around $2.8bn and in turn and in time they will provide a boost to state revenues.

Minister of Communications and Information Technology Atef Helmy said the parks projects will be offered to investors before the end of 2014, and the projects are expected to be completed by 2020. He added that investors in South Korea and Japan had already shown interest in the projects.

The technology parks will be zoned and located in the governorates of Assiut, Bani Suef in Upper Egypt and the governorates of Alexandria and Menoufiya in the North Delta. The design of the parks will resemble that of an existing technology park located in the 6th of October City.

Three international logistics centres for food commodities are planned to be built in Damietta, East Port Said and Safaga, according to an announcement in October 2014 by the minister of supply and internal trade, Khaled Hanafy (see analysis and Transport chapter). The ultimate goal of the centres is to secure Egypt’s food supplies, as well as to reduce the costs of distributing them throughout the country.

The two-year project, which is to be carried out in collaboration with the Ministry of Transport and the Ministry of Housing, will cost around EGP13bn ($1.8bn) and is expected to take two years to complete. Altogether around 20,000 jobs will be created during both construction and operation.

Technical and engineering studies for the three centres are being conducted by Alexandria University and the Academy of Maritime Transport.

Retail Development

Despite the importance of and need for residential construction, the majority of construction spending over the medium term is still geared towards non-residential activities, a result of a continued paucity of dedicated industrial, commercial and office space. Dubai retail developer Majid Al Futtaim (MAF) intends to invest around EGP16.5bn ($2.3bn) in Egypt over the next five years.

Four shopping malls in Cairo, Giza and Alexandria will cost some LE11.3bn ($1.6bn) and create around 38,000 jobs. The overall MAF plan also includes 32 hypermarkets, worth LE5.2bn ($738.4m) and creating a further 4500 jobs.

George Kostas, CEO of MAF Properties, was reported in the media to have said the company was “on track” to open the 160,000-sq-metre Mall of Egypt by January 2016. He told press, “We faced some delay last year for one or two months but the contractor is making good progress.” A 50:50 joint venture between Orascom Construction and BESIX Group won the $400m construction contract.

Steel

With so much of the country currently resembling a construction site, the price of two fundamental commodities – steel and cement – becomes even more important than ever. In October 2014 the Ministry of Industry and Trade imposed temporary tariffs to protect domestic steel rebar manufacturers from foreign imports. However, Mounir Fakhry Abdel Nour, the Egyptian minister of industry and trade, said the tariff of 7.3% of the value of cost, insurance and freight per tonne would last for “a maximum of 200 days, but could eventually be made permanent”.

Earlier in 2014 – in May before the subsidy cuts had impacted energy prices – OBG spoke to Ahmed Hindawy, team head in the research department at Prime Holding, a company whose activities include asset management, investment banking and investment research. Hindawy said (at that time) that the steel prices reflected moderate margins for producers and were not too high. The LE4850 ($689) a tonne included 8% sales tax so the net price was approximately LE4400 ($623).

Anti-dumping fees safeguarded most domestic producers from slightly cheaper Turkish imports, which were priced at around LE4200 ($596), Hindawy told OBG. “Most of the demand is for quality over a small drop in price, but it would be good for the domestic producers if those fees were re-imposed,” he added. And indeed five months later they were.

Illegals

A report on the prices of construction materials by Gleeds Construction Consultancy Egypt attributed a 4% increase in the price of reinforcement steel bars in April 2014 over the previous month to an increase in the exchange rate with the dollar, fuel and electricity shortages, a rise in the price of industrial fuel and electricity, and an increase in the international price of steel billet. In the following month there was a phenomenon not likely to be common in Egypt for some time. The price of reinforcement steel bars went down by nearly 1.6% due to a drop in market demand, albeit one caused by a shortage of labour.

Gleeds added that the availability of imported rebar increased the amount in the market and formed a price ceiling so local producers could avoid losing their shares. The price of reinforcement steel bars was expected to increase in the third quarter of 2014 due to electricity shortages and the gradual removal of subsidies on energy.

Prime Holding’s Hindawy told OBG that rebar demand over past two years had not decreased – it simply had not grown. In slow times for the official industry, rebar and cement demand had been maintained by illegal buildings. After President Hosni Mubarak was ousted in February 2011, small landowners started building hundreds of thousands of homes on land that was originally designated for agriculture, Hindawy added. This was made possible by an almost total lack of law enforcement and was spread around all of the governorates.

World Prices

The high level of input costs, along with depreciation and the slower growth of recent years, have prompted Egyptian steelmakers to say that if protectionist measures are not used the domestic sector could be threatened by exports from countries such as Turkey and Ukraine, both of which have measures to protect their steel industries. “We support any decision that will help domestic manufacturing,” Ahmed Abou Hashima, chairman of Egyptian Steel, the country’s second-largest steel manufacturer, was quoted as saying. “Steel production in Egypt, which is a long-term strategic sector, needs to be supported so it can be competitive in the market.”

The manufacturers started requesting that the government impose anti-dumping measures on rebar and wire rod imports from Ukraine, as well as China and Turkey in July, after a reduction in Egypt’s energy subsidies increased domestic production costs.

The value of the Egyptian pound is also crucial to the industry because around 95% of steel costs, excluding energy, are from imported materials.

In September, Egyptian steel prices rose by LE115 ($16) a tonne, bringing the average for the domestic product to LE5315.50 ($755) per tonne, compared with LE4900 ($696) a tonne for imported steel. That revealed a much wider gap than had been evident earlier in the year. However, both prices are a big step removed from the world’s lowest prices. On September 22, 2014 China booked out a shipment of rebar waiting to load in Tangshan at $426.50 a tonne (or LE3050). Since China is vastly overproducing and is frequently accused of dumping, a simple comparison may not be fair. Be that as it may, steel is an expensive commodity in Egypt and the country will need a lot of it in the coming years.

Cement

The problems of the Egyptian cement industry began to come to a head in July 2014, following rising energy costs alongside interruptions of natural gas supplies which caused cement production at several companies to grind to a halt (see analysis). The Egyptian Natural Gas Holding Company cut off the flow of gas to 10 plants, which account for two-thirds of the industry’s output. The price of an alternative used by some cement firms, mazut fuel oil, had more than doubled from $143 to $328 a tonne in 2012 but at least it was available, more than could be said for gas. The decision to allow cement producers to use coal as an alternative to the cheap, if now unreliable, gas was announced by Khaled Fahmy, the minister of environment, in June.

The cement industry had grown used to a supply of cheap gas – $2 per million British thermal units (mBtu) at first, or about a third of the price it had to pay by 2013. This is now forecast to rise again over the next few years, even if it is available for the industry. The figure of $6/mBtu is already higher than the $4.50/mBtu applicable in the US market but better than the $10.2/mBtu quoted by the IMF for Russian gas in Germany or the $11/mBtu quoted by the EIU for “Europe”. Cheap is a relative term.

Meanwhile, in Egypt conversion to coal-fired lines is in full swing – at about LE135m ($19.2m) a line – and the price of cement produced this way is forecast by Prime Holding to be around $5.50/mBtu, or perhaps $6/mBtu if a carbon tax is imposed (see analysis and Industry chapter).

Labour Issues

The official level of headline unemployment at the beginning of 2011 was around 9%, according to Kareem Zahran, a cost engineer for Gleeds Construction Consultancy Egypt. However, the number of jobless has since risen to 13.4% because of a slowdown in construction, which according to Zahran used to absorb temporary workers. The costs are fairly inexpensive compared with neighbouring countries and availability is high, he told OBG in May 2014. Given the rush of activity from August onwards, availability could well be shrinking fast.

“The skill base is poor because the focus on technical education is not strong right now,” Zahran told OBG. “Generally, cheap secondary education has produced a lot of people with degrees or higher, while most of the industries are pretty primitive, requiring low skill sets because there is very little research and development,” he added. As in many countries in the region, public sector work has low productivity with continual increases in salaries, said Zahran.

In 2010 the total public sector wage bill was about LE80bn ($11.4bn). Three years later it crossed the LE200bn ($28.4bn) mark, although much of the increase has been eaten up by inflation. The minimum wage for state employees was raised as of January 1, 2014, from LE700 ($99) to LE1200 ($170), and there is a demand from the workers’ side for it to go up to LE1500 ($213). This does not apply to the private sector, however, where to some extent the figures are set by market supply and demand. Anecdotally, construction labourers are said to earn between $3 and $8 a day, which on a six-day week at the higher rate would produce around $200 a month. Equally in the construction sector monthly salaries of LE3000 ($426) are quoted as being common but these are for skilled or semi-skilled jobs, such as an engineer (LE2750, or $391), technical officer (LE5000, or $710) or a project manager (LE7000, or $994). Yehia Zaki, director of Egypt operations at international project consultancy Dar Al Handasah, told OBG, “Labour law with minimum and maximum pays can be challenging at both ends. With a set maximum pay, it will be hard to retain skilled workers, and the minimum pay will decrease low-skilled workers’ employability.”

Outlook

Egypt’s raft of projects and ideas is breathtaking. It is also being played out against a background of wholesale change in the country’s finances, with a strong shift from current to capital spending. A budget proposal that slashed the fuel subsidy bill from LE144bn ($20.4bn) to LE100bn ($14.2bn) while proposing extra taxes such as capital gains and a three-year, 5% tax was rejected by President Abdel Fattah El Sisi because it left an overall budget deficit of around 12% of GDP. The government went back to the drawing board to find a way to reduce the deficit further – to 10% – and returned with a plan to introduce a value-added tax.

The ambitiousness underpinning the construction plans – as well as the country’s finances – is certainly impressive, but project delivery will be crucial in sustaining the momentum, particularly given the externalities, such as job creation, that the country’s construction sector provides.

Overall, the macro forecast for the country is improving thanks not only to a more favourable exogenous environment but also the structural reforms being put in place, and with an economy this size, the impetus will carry it through the medium term.

The investment bank EFG Hermes expects inflation to accelerate to 12.6% in the fiscal year that ends June 30, 2015, an increase from a fraction over 10% in the previous period. In addition, the investment bank also reduced its growth forecast from 3.5% to 2.9% over the same period because of the effect of higher inflation on consumer spending. Both figures may well be reasonable expectations.

The Egyptian government’s public spending campaign will obviously help goose growth further, and should the planned projects be delivered in a timely manner, then the combination of economic growth, new roads and new buildings could help mark a much-needed turnaround in the country’s economy and perhaps a return to form for what has traditionally been one of the Middle East’s more dynamic markets.

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The Report: Egypt 2014

Construction & Real Estate chapter from The Report: Egypt 2014

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