The long-term fundamentals in Egypt are very attractive in just about every sector, and construction is no exception. A demographic bulge and current needs mandate upgrades in housing stock, office towers, retail and commercial space, infrastructure and otherwise. The contracting market has two major players, one each in the public and private sectors, a handful of mid-sized firms and thousands of small contractors. However, those companies have had to ride out sizeable short-term instability resulting from the upheaval of the Arab Spring, with a number of major projects delayed or cancelled.
That being said, Egypt’s market demand is such that even amongst the scaling-back of large-scale developments, activity has helped keep the sector from sliding further. Minor contractors, for example, got a boost from a surge in illegal building. However, while the first half of 2012 saw a stuttering revival in project activity, challenges for contractors include securing project financing and managing costs and cash flows until the political situation resolves itself and new private sector building opportunities grow.
INFRASTRUCTURE PLANS: There certainly is no shortage of work that is needed, whether by the public or private sector. The country needs several additional electricity plants, and a deficit of housing units was running close to 1m, though a precise measure is not possible due to a lack of reliable data.
Egypt has a goal of deriving 12% of its electricity from wind power by 2020, and this means constant building of wind towers. The country had also revived a plan for nuclear power, and two major contractors formed a joint venture to explore options. That plan was put on hold after the Fukushima meltdown in early 2011, but remains a possibility, depending on the new government’s priorities and choices.
BACKBURNER: In addition to the regular activity mandated by demand, the country had also articulated plans to boost infrastructure spending. The government wanted to share part of the investment cost with private-sector interests by tendering some of the projects as public-private partnerships (PPPs). This focus went on the backburner, however, due to political upheaval. “A large portion of money was at Egypt’s doorstep,’’ said Omar Taha, an analyst for Cairo-based securities firm Beltone Financial, noting the number of government tenders available. “If you were a contractor there was a vast portfolio of contracts you could tender for. It’s not clear what’s going to happen now.” Security remains a concern.
“On top of many foreign investors’ list of indicators to watch for are stabilisation of the political, security and currency situations,” Ahmed Hafez, chairman and managing director of Ideal Standard, an international bathroom fixtures supplier, said to OBG. “Once these main issues are resolved investors will breathe a lot easier when they are considering investing in the Egyptian market.”
STIMULUS SPENDING: In the wake of the 2011 revolution, the transitional government pushed some projects forward as stimulus spending, such as the Assiut Barrage and new industrial works. These and other projects led to surprising profits in 2011 for some contractors, but were not enough by themselves to prevent the sector from contracting by about 0.6% in the final quarter of 2011.
Near the top of the new government’s agenda is a need to revive the tendering process. “If no immediate action is taken by the government right now to initiate new projects, a major slowdown will be felt at the end of 2012 or beginning of 2013 in the Egyptian construction sector,” Osama Bishai, managing director of Orascom Construction Industries (OCI), told OBG. The government is now less able to afford its share of the financial burden of PPPs because the country’s supply of foreign currency reserves crashed after the revolution.
Profits from infrastructure PPPs typically take a decade or more to materialise, which is a longer period than Egypt’s current election cycle. This means private partners will be signing a deal with one government with a view to working with its successors before it realises its rewards. The challenge for the construction industry is to keep the private sector comfortable with the government as a PPP partner during longer project terms.
MIXED RESULTS: Contractors have had a challenging time navigating the fallout from the upheaval of 2011. State-owned Arab Contractors, for example, one of the region’s largest construction firms, saw a 25% drop in profits over the first half of the year. However, a handful of construction firms reported healthy numbers for 2011 – firm Hassan Allam Construction saw 26% revenue growth, for example. Conditions are expected to be tougher in 2012, but not only because projects were moved up by the country’s caretaker government.
Cost pressures are also a factor. Prices are already likely to rise for some materials, such as cement and steel, because the policy thrust for gas will likely focus less on enabling energy-intensive industries, such as construction materials, than it has in the recent past. “Many large-scale projects in real estate and the hotel industry either stopped or were put on hold,” Manish Mehra, the chief executive of Scib Paints, said about the revolution’s early days. “There were also huge increases in the prices of raw materials; however, price inflation, which was running at 15% during April to September 2011, stabilised during the latter part of the year.” These concerns could also lead to new innovations in building materials. “There are many niche segments for construction-related industries,” Tor Hatlo Johansen, general manager of Jotun Paints, told OBG. “Many contractors and developers in Egypt choose to apply cementex to building exteriors, for example. In actuality, this is not paint but a colourless cement which is plastered onto bricks. If this segment could be brought into the market, the opportunities would be endless.”
In the informal market, the purchase of building materials and hiring of small contractors is estimated to comprise 60% of building in Cairo and 50% overall. Here, activity was particularly robust as Egyptians took advantage of a chaotic time and a caretaker government perceived as otherwise preoccupied.
DECISION TIME: Furthermore, until the country works out a way to cut its budget deficit, through an IMF loan or otherwise, there is the potential worst-case scenario of a currency devaluation. Egypt had previously prepared for its infrastructure drive with a 2010 law regarding PPPs.
Several projects had already been built on a PPP basis before then, including a water treatment plant in suburban Cairo with financing from the International Finance Corporation, the private sector and consultancy arm of the World Bank. Similarly, a consortium between OCI and Spain’s Aquila submitted the winning tender for construction of a large wastewater treatment project.
After more than a year of uncertainty, the population and economy are eagerly awaiting stability now that the country has succeeded in choosing a democratically elected president. The new government’s attention may be captured early on by several politically charged issues, such as pension reform or energy subsidies, but there are not as many complex issues regarding construction.
Indeed, the construction sector is expecting to see a boost from public-sector spending in the medium-term, said Khaled Ghareib, the head of research and strategy for the Egyptian operations of Lafarge, a French cement and construction-materials provider. “There is a real backlog of infrastructure projects just waiting for the new president to put into action,” he told OBG. “So at some point soon informal construction will be replaced by infrastructure.’’ Major contractors were lining up as of summer 2012 to bid on PPP projects that would make them long-term partners for government projects. For example, OCI’s project backlog in early 2012 already had a larger share of Egypt exposure than it typically does, according to OCI’s corporate business development and investor-relations associate Erika Wakid. Hassan Allam Construction announced in May 2012 its intention to bid once PPPs are again on offer.
The new era may, however, have some indirect negative impacts on the construction industry, including increased costs for materials due to higher natural gas and electricity prices. Still, such costs are unlikely to crimp the continuously rising demand for real estate, infrastructure and new commercial space.
INTERNATIONAL BACKING: With a handful of developers now restarting delayed projects, there are signs of a more robust recovery over the coming 12 months. Even amongst the projects reorganised in the wake of the revolution, international financing is a common feature – another positive signal for a possible post-revolution building surge.
One project moved up into 2011 was the Grand Egyptian Museum to be located near the Pyramids of Giza. When it opens in 2015, it is expected to be the world’s largest archaeological museum. The Japan International Cooperation Agency (JICA) is financing 65% of the contract for the third phase awarded to OCI and BESIX Group, worth $815m.
The Cairo metro’s ongoing expansion is also attracting international funding, again from JICA and others, in part in return for the use of equipment from those countries. Among others, Mitsubishi has delivered train cars, while tracks were made by Toshiba and Kinki Sharyo, a light-rail specialist.
These deals are frequently negotiated on a government-to-government basis, a spokesperson for the National Authority for Tunnels (NAT), which oversees the metro project, told media in early 2012. There is still room for local firms to take part in the work, and many are participating in the ongoing construction of the Cairo metro’s third rail line.
The line is planned from Cairo International Airport in the city’s north-east to Sixth of October City in its south-west. The first phase opened in February 2011 and has been popularly dubbed the “revolution line’’. The rest, a project for which OCI is now sharing the work with foreign contractors such as France’s VINCI, is due for completion in 2013.
NAT’s master plan for the metro envisions six lines. The fourth is a tourist-focused effort, running from downtown to the Pyramids in under 30 minutes. JICA announced the terms of a $416m loan for the project in March 2012; there will be a 40-year maturity at rates between 0.1% and 0.2%, and it is tied to the use of Japanese technologies and contractors. It is the first official development assistance loan since the revolution began, according to JICA. Global firms are expected to remain the lead contractors for the time being. This is not because local firms lack expertise: several local companies, such as OCI’s general contracting arm or specialist engineering consultancy ACE Consulting Engineers, have been around for decades, are experienced enough and already are operating internationally. However, authorities seem to agree that international expertise remains valuable, as does the ability to build a multinational consortium with access to both private sector foreign capital and development banks and aid agencies.
REAL ESTATE: While public sector works were sped up in the wake of the revolution, the reverse is true for real estate projects in the private sector. There, questions of corrupt land deals during the old regime have tied up parcels of land earmarked for development. “Judicial setbacks and scrutiny over government land deals have now brought the construction sector to a near halt,” Mahmoud Bdeir, the president of Sipes Paints, told OBG. The pause, however, has exacerbated the existing housing shortage brought on by the large number of young, low-income newlyweds in search of affordable homes. Most of the land under dispute has been in either New Cairo or Sixth of October City. According to a study by Jones Lang LaSalle, a Chicago-based real estate consultancy, the market anticipated 17,000 new units in these areas during 2011, and as a result of political turmoil supply dropped to 12,750, a 25% reduction.
New supply of office and retail space in 2011 was lower by roughly the same percentage, according to the firm. However, its study only accounts for two areas. According to research from Prime Securities, of the 168,900 residential units scheduled only 118,000 would ultimately be delivered.
Though there is a lack of consensus over the shortage of housing in Egypt (estimates range from 1m-1.5m), it is clear that 2011 made that shortage worse. Work that could have come during 2012 for planned communities or apartment blocks will instead be commissioned in the future. But industry participants remain confident that market conditions will improve in the longer term.
“The country needs to see massive development in housing and infrastructure and we are expecting that the construction industry will flourish in Egypt once political stability is improved. Egypt needs major housing schemes for its population,” Mostafa Al Hassan, the chairman of Global Consolidated Contractors, a local logistics, construction, contracting and procurement company, told OBG. While the completion of these projects will help stimulate growth in ancillary services, more government guidance would be welcome in some areas, with the property management industry being one such area pointed to by those involved in the sector.
DIVERSIFICATION STRATEGIES: Egyptian contractors large enough to do so have been looking overseas for work, in particular in the MENA region. “You’re covered because you’re in many markets and so you’re well diversified,’’ Wakid said. “But also, governments were spending more money than they usually would. We won $1.5bn in work purely pushed on by the revolutions.’’ OCI’s total orders in 2011 reached $4.2bn, with $1.5bn coming from Egypt. Typically, however, OCI’s home country accounts for 20% of revenue and 20% to 25% of its backlog.
Due to its large population, the need for infrastructure is extreme in Egypt, although the same long-term narrative – high demand for housing, electricity, water and other basic infrastructure – is present across much of the region.
OCI in its 2010 annual report, the most recent available as of May 2012, said it had identified $1trn in planned infrastructure projects running through 2016 in the MENA region. Another report by Arab Finance, a Cairo-based online brokerage, said on the eve of the Arab Spring countries in the region had announced $820bn in infrastructure spending from 2011 to 2015. Saudi Arabia had the biggest plans, valued at about $400bn, followed somewhat distantly by Algeria ($150bn) and Kuwait ($104bn).
Vertical integration is also attracting the attention of domestic contractors. “We are concerned about the impact on our business of factors such as inflation, the possible devaluation of the Egyptian pound and a shrinking pipeline of domestic project awards,’’ wrote Kamal Allam, the chairman of Hassan Allam Holding, in a company newsletter that cited vertical integration as a mitigation strategy.
Conversely, others have spun off holdings in companies such as building materials producers. OCI sold its cement division to Lafarge in 2007, for example, and in May 2012 won shareholder approval to separate its fertiliser and construction company into two separate entities. This will create a separate publicly traded listing for each, likely by late 2012, giving portfolio investors looking for a MENA-region construction play another potential option.
WAITING FOR THE PAYCHEQUE: One of the main negatives to government work is the issue of payment delays. Egypt has been routinely slower to pay contractors than the private sector. While details are unavailable, it is estimated that the government arrears to contractors as of early 2012 totalled LE10bn ($1.67bn), according to local media reports.
A new minimum wage is also a concern. “Many companies in Egypt who have a majority of blue-collar workers have experienced labour issues such as strikes and new payment demands,” Mehra told OBG. “There is talk of a new minimum wage coming into law requiring LE1200 ($201) a month, which will have a serious impact.” Moreover, Wakid said OCI values private sector contracts in the industrial sector the most because payments are quicker, down payments are larger and margins are higher, in the 20% range. Margins on public sector work in Egypt come in at the mid-teens, she noted.
OUTLOOK: With presidential elections having taken place, the construction sector in Egypt is now beginning to gear up for more work. With builders’ pipelines looking more barren than expected, the challenge will be to manage finances and costs.
Better governance may be the pay-out over the longer term. “A new era of transparency and accountability may be one of the more positive things that has been born from the revolution,” Bassam Daher, area manager of Consolidated Contractors Company, said. Indeed, politics may have more positive roles to play as the sector keeps moving itself forward.
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