Long-term growth forecast for South African construction sector remains positive

Although South Africa’s construction industry remains a major economic engine, the industry has struggled to maintain pre-2010 highs, when World Cup-related work kept annual growth in double digits. The years since have been marked by project delays, labour unrest and a subdued macroeconomic environment which saw figures for employment, profits and new projects decline in 2014 and 2015.

Despite these challenges, the industry’s long-term forecast remains positive, with major new investment expected in the coming years under the government’s National Infrastructure Plan (NIP), while contractors find themselves benefitting from steady expansion in the residential real estate sector. That being said, 2016 will likely see stakeholders continue to grapple with rising materials costs and still-low levels of GDP growth, as well as depressed commodity prices, which will in turn have an impact on both mining activity and government expenditure.

Economic Role

The sector is an important contributor to economic growth. Statistics South Africa (Stats SA) reports that the industry employs more than 1.18m people on a contract or permanent basis, and the state received 19% of value created by the industry in 2014 through direct taxes, while taxes on employee salaries also benefit public coffers.

South Africa’s construction sector is dominated by large, listed players, with public infrastructure projects and private real estate builds representing the two biggest growth drivers in the industry. The industry is overseen by the Department of Public Works, which acts as the state handyman, regulating the industry, managing state-owned infrastructure and overseeing the Expanded Public Works Programme, a job creation initiative that employs unskilled and semi-skilled labourers in the execution of public projects. As of September 2014, the country’s largest listed construction players by market capitalisation were Pretoria Portland Cement Company, Murray & Roberts, Aveng, Wilson Bayly Holmes-Ovcon (WBHO), Group Five, Raubex, Distribution & Warehousing Network, Afrimat, Stefanutti Stocks and Sephaku.

Downturn

Exogenous pressures have dampened activity in recent years, as the country has endured a series of macroeconomic headwinds that have had a negative impact on new builds, spending and private financing. Currency depreciation, materials and labour inflation, falling commodities prices and reduced spending have left stakeholders struggling to gain traction and maintain profits in recent years, with Creamer Media reporting in January 2015 that the industry has been in a slump since World Cup construction slowed in 2008. Investment contracted by 11.3% that year, and achieved an average annual increase of just 0.2% between 2011 and 2013.

“There’s no doubt at the moment that the engineering industry is really in the doldrums. The two biggest projects happening are Eskom’s two big power stations, and they’re significantly over time and over budget. Commodity prices are at their lowest level in the past four years, and with South Africa being an export-intensive country, mines have pulled back on or cancelled a lot of their capital projects. The private sector is struggling to find money to spend, and the public sector is the same,” Norman Milne, director of Basil Read and past president of the South African Forum of Civil Engineering Contractors, told OBG.

Listed Companies Growth

Although PwC’s second annual “SA Construction Report”, published in November 2014, found that that the construction materials sector showed modest gains in 2014, listed companies have witnessed an erosion of market capitalisation and the performance of the Johannesburg Stock Exchange’s (JSE) Construction & Materials Index and the JSE All Share Index diverged noticeably. Indeed, the JSE All Share Index reached a record high of more than 55,000 points in late April 2015, while the Construction & Materials Index has struggled to maintain market capitalisation, indicating a multi-year trend of underperformance.

PwC reported that listed construction companies showed mixed performance for market capitalisation in 2014, with 10 companies reporting an increase and five a decrease. Total industry market capitalisation declined from R68.1bn ($5.88bn) in June 2013 to R67.4bn ($5.82bn) in June 2014, and fell a further 1.6% to R66.3bn ($5.73bn) in September.

Although construction revenue rose by 7% year-on-year (y-o-y), driven by increases of R4.1bn ($354.24m), R1.5bn ($129.6m) and R1.3bn ($112.32m) at Group Five, Murray & Roberts and Aveng, respectively, this was largely the result of greater revenue from overseas operations due to the depreciation of the rand. However, those companies focused primarily on the domestic market faced a more difficult situation.

Costs Rising

Despite rising revenues, companies realised lower profit margins. A major factor in this is the increase in building and materials costs, which have cut sharply into industry profitability.

In its “Q2 2015 Housing Review”, Absa Bank reported that building costs continued to rise at a faster rate than the consumer price index, impacting both the prices of newly built houses, as well as existing home renovation. According to the bank, the cost of having a new house built rose by 9.7% y-o-y in Q1 2015, following an 8% y-o-y increase in Q4 2014. The bank attributes this to rising materials, equipment, transport, labour and land development costs.

“The inflationary effect has been a bit surprising. Cement prices are growing at a higher rate than consumer price inflation levels, and although the cost of steel is declining, it’s priced in US dollars, so the weakening rand offsets any benefits there, while a pullback from the mining sector is affecting order books. So overall, construction inflation is definitely positive, and it’s less to do with financing than materials and labour,” Rowan Goeller, construction analyst at Macquarie South Africa, told OBG.

Nonetheless, a number of encouraging signs from the financial performance of individual companies, order book growth and planned public infrastructure projects, particularly new utilities projects, have led to a brighter mid-term industry forecast.

Government Support 

One of the largest pipelines for new projects remains the public sector, which has for a number of years now – in spite of a constrained fiscal situation – been behind some of the largest revenue-earning projects in the country.

The overarching national development policy, the 2030 National Development Plan (NDP), is one of the main engines for public sector activity. The NDP aims to eliminate poverty, slash unemployment and reduce inequality by 2030 by developing human capital, productive capacity and infrastructure.

Another important framework for infrastructure investment is the NIP, launched in 2012 with the aim of strengthening the delivery of basic services and increasing employment via investment in roads, ports, airports, railways, power plants, dams, health care facilities, water and sanitation, and housing. Under the NIP, the government plans to invest R827bn ($71.45bn) between the 2013/14 and 2016/17 fiscal years, with the majority of the investment to be sourced from state-owned utilities provider Eskom, which will invest R205.1bn ($17.72bn).

Recent Budgets

In the 2014 budget, the government announced plans to spend R847bn ($73.18bn) on infrastructure improvements until 2017, while its Medium-Term Expenditure Framework included plans for Eskom and other state-owned companies, such as the South Africa National Roads Agency and Transnet, to spend R381.8bn ($32.99bn) on new builds and upgrades. In March 2015, the government unveiled an annual budget heavily emphasising infrastructure, including plans to spend R105bn ($9.07bn) on housing projects and associated bulk infrastructure requirements, R3.5bn ($302.4m) for infrastructure development within its network of special economic zones and R10.5bn ($907m) in transfers to universities for infrastructure upgrades, as well as announcing plans to help cities mobilise financing required for rapid infrastructure investment and maintenance.

Spending Disconnect

Despite the urgent need for infrastructure upgrades and high industry hopes for public investment, government expenditure has not always translated into holistic industry growth, nor been awarded as originally planned. PwC reports that although capital expenditure by public-sector institutions increased by 4.8% during 2013 to reach R212bn ($18.32bn), new construction work simultaneously contracted by 2.2% to R133bn ($11.49bn), while spending on plant, machinery and equipment rose by 28% to R48bn ($4.15bn).

Between 2010 and 2013 capital expenditure on new construction and maintenance projects grew by just 5.7%, far less than inflation, with PwC concluding that growth in public capital expenditure is the result of higher spending on inputs and equipment rather than new contracts for construction-related work.

Silver Lining

Stakeholders have complained about the government’s ability to roll out capital and infrastructure, with expenditure focused on smallscale maintenance projects. However, this does have the benefit of giving opportunities to smaller local players amidst gradual improvements in the timeliness of payments, with draft legislation set to make 30-day payment compulsory.

“There are opportunities for smaller companies. If you’re working for government contracts, things have picked up, and more importantly the government is paying on time, which wasn’t happening a few years ago. From a cash flow perspective this means things are fairly buoyant, and from what capital equipment dealers are saying, sales are actually fairly decent. There is a government drive to foster small construction companies and grow them into medium and large-sized contractors,” Goeller told OBG.

This trend was evidenced in July 2015, when Pretoria Precast Cement reported that total cement industry sales in Q1 2015 rose by 15% to reach 2.87m tonnes, as a result of strong demand from smaller players, offsetting a slowdown amongst larger firms.

Public Projects

Much of the government’s work focuses on infrastructure, in particular in power and transport, aiming to set the stage for a cycle of renewed activity in the medium term. An ongoing shortage of electricity has had a serious impact on growth, and timely rollout of planned new power projects, as well as the NDP’s Renewable Energy Independent Power Producer Procurement Programme, which aims to generate 3725 MW via renewable sources by 2030, will be critical for progress on the government’s planned infrastructure investment.

These upgrades will enable further investment in transportation and utilities infrastructure, another critical government priority. The 2015 budget allocated R1.1bn ($95.04) for the Moloto Road project, R80bn ($6.91bn) for 220 water and sanitation projects, and R18bn ($1.56bn) in funding for a new electrification programme. François Viruly, director of property research firm Viruly Consulting, has identified these sectors as growth catalysts for the next upswing in the country’s construction cycle.

“South Africa enters a construction boom every 20 or so years. We had one in the 1960s, one in the 1980s and one from 2001 to about 2008. The important issue is that each of these mega-cycles is also associated with the structure of the South African economy. The boom in the 1980s was largely driven by decentralisation, whereas in the 2000s it was robust economic growth. I would suggest that the main driving force for the next boom will not be GDP growth, but the country’s next technological drive, which will be in public transport,” Viruly told OBG.

One promising long-term development in the pipeline is South Africa’s proposed nuclear energy programme, which could benefit local contractors. “The nuclear procurement programme is being pushed quite hard by the government, and nuclear projects would be bigger than the World Cup spend. We could essentially move back into an environment where there is a large public sector-driven construction cycle, although it would be spread over 15 or 20 years. In the short term we’ll fall into sustainable civil construction levels of about two-thirds of what we’ve had during the World Cup,” Goeller told OBG.

Residential Builds

The residential building sector is also expected to help sustain future construction growth, particularly in the latter half of 2015. Absa Bank’s Q2 2015 real estate update found divergent trends in levels of new homebuilding activities during Q1 2015. According to the bank, volumes in the planning phase expanded, while volumes in the construction phase declined, with the number of new housing units for which building plans were approved rising by 4.6% y-o-y to hit 18,441, driven by a 40% surge in planned new flats and townhouses.

Outlook

With capital and contracts still limited, the sector’s slowdown is not likely to reverse itself in the near term. However, despite these impediments, new opportunities for smaller players as well as a planned spate of major infrastructure projects, particularly in utilities and transport, could see the sector regain its footing before the end of the decade. In addition, private residential builds will continue to buttress growth and provide stability, helping the industry to weather the worst of the present storm.

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The Report: South Africa 2016

Construction & Real Estate chapter from The Report: South Africa 2016

The Report: South Africa 2016

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