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To get a sense of the carnage in the construction sector, look at what has happened to Aveng. At the peak of the construction boom in 2008, it had a market cap of R27bn. Today, the figure is R1.2bn, just about a third of that of Calgro M3, a relative newcomer to the JSE.
Admittedly, these two companies are not directly comparable, and neither is Aveng a purely construction outfit, given its steel and other interests. But it serves as a bellwether for all that is wrong in South Africa’s once-booming construction and engineering sector.
Aveng, once a Top40 stock on the JSE with a proud 125-year history, recently announced a headline loss of R231m for the six months to December 2015. The story is repeated across other former titans of the sector. Murray & Roberts at its 2008 peak claimed a market cap of R34bn. Today it is R4bn. Group Five’s market cap has been cut from R8bn to R2.2bn.
Wilson Bayly Homes (WBHO) has managed to retain a modicum of dignity. Its market cap is down just a shade from R9bn to R8bn since 2008.
This was a sector that traded at an average price-to-earnings (P/E) multiple of 22 at the peak of the construction boom. It is now down to a third of that.
The accompanying chart from the SA Construction report released late last year by PwC shows what has happened to the sector’s profitability. Revenues have held reasonably firm, notwithstanding a slight drop in 2015, but net profits have been decimated.
Construction revenue decreased 7% to R129bn in 2015, but net profits before interest and tax were down 50% to a paltry R1.8bn for the entire sector.
The biggest contributors to the drop were Aveng (a revenue decline of R8.6bn), Murray & Roberts (-R5.4bn) and Group Five (-R1.6bn). These declines were partially offset by a R3.6bn increase in revenues at WBHO and R1.4bn at Stefanutti Stocks.
“These decreases were largely as a result of the weaker economy in particular for commodity markets with a notable decrease in revenue from energy, oil and gas projects,” it was stated in the PwC report. “General civil works, which is infrastructure-driven, had a challenging year. Building projects on the other hand showed remarkable strength as the cranes in Sandton’s skylines would suggest.”
Although construction companies did well to reduce operating costs in the lower-revenue environment, margins continued to fall. Construction profits seem to be following the same double dip experienced by most industries after the 2008 economic crisis, says PwC.
A perfect storm
Construction finds itself in something of a perfect storm, buffeted on the one side by a weaker economy and on the other by diminishing margins and labour strikes that have delayed project completions and therefore revenue collections.
Government’s vaunted infrastructure programme has been slow in coming, though finance minister Pravin Gordhan announced in his February Budget Speech that R870bn worth of project funding would be released.It’s a promise that has been made before, but this time seems to carry a little more urgency, as government plans to make this the kernel of its pro-growth strategy.
Research by Samantha Pauwels, portfolio manager at Cannon Asset Managers, shows the extent of the drop in the Big Five construction groups, which have lost about 79% of their value since 2007.
“This represents the complete destruction of shareholder wealth, a total loss of R60bn in value and the equivalent of a whole Capitec,” she says.
“Whilst it is no secret that both the resources and construction industries have been termed ‘dog sectors’, it is encouraging to see that, despite this, there are still a handful of companies that have been able to increase shareholder value during this tough period. Let’s be honest, the boom leading up to 2008 is never coming back. Things have structurally changed with China shifting from an investment-driven economy to a consumption-led one. Certainly, there are other fast-growing emerging markets; however, they are not nearly large enough to pick up the great fall in demand and growth to compensate for China’s economic slowdown and structural shift.”
It’s essential for companies to adapt and innovate in these challenging times, she adds.
Andrew Dittberner, chief investment officer at Cannon Asset Managers, says construction is a notoriously cyclical industry, yet there are some superbly managed companies in the sector which have been able to adapt to changing market conditions. He singles out Raubex, WBHO, Afrimat and Calgro M3.
“It is vital to pay attention to the balance sheets of these companies,” he says. “They have to be able to generate operational cash flow through the cycle. Given the thin operating margins, the tendering process is of critical importance. Getting your pricing wrong on a single project can materially impact these businesses’ profitability.”
This is an except of an article that originally appeared in the 17 March 2016 edition of finweek. Buy and download the magazine here.
