Construction sector hits hard times

Heavy construction, whose fate is tied to government infrastructure roll-out and the mining industry’s capital expenditure, is in a deep funk.

Energy projects and road infrastructure upgrades may offer some relief for South Africa’s beleaguered listed construction companies, but investors without a suitably long time horizon should probably think better of being seduced by the siren of attractive multiples.

Heavy construction, whose fate is tied to government infrastructure roll-out and the mining industry’s capital expenditure, is in a deep funk.

There are few new projects in the offing, pricing and margins are under pressure and a lack of available cash on balance sheets is restraining growth.

Existing government spending has been negatively affected by cost overruns at Eskom’s Medupi, Sanral’s ongoing woes and the necessity of managing South Africa’s twin deficits, among other issues.

Mining companies, the performance of which underpins the country’s economy, are also under pressure as falling commodity prices and labour unrest have meant cost containment is the order of the day.

In search of foreign contracts to fill order books, a host of South African construction companies headed up Africa or to Australia, but similar commodity price woes and competition meant these avenues provided little relief.

Is there any share worth buying in the construction sector right now?

Vasilis Girasis, a trader at BP Bernstein Stockbrokers, said Esor stood out for share price movement, but the bigger players — the likes of Murray & Roberts and Aveng — remained under serious strain.

“The smaller niche players, with much smaller overheads, smaller order books and better profit margins, like Esor, are doing quite well in a suppressed sector. And it looks like it will stay that way for a while.

“If you’re looking for something to buy for the future, maybe Aveng could fill its order book quickly and move back up to R20 [currently R5.70] in no time, but if you don’t have two to three years to wait, I’d say steer clear of this sector.”

Rhynhardt Roodt, portfolio manager of the Investec Equity Fund, agreed that it looked “too early to buy” for all but committed contrarians.

“We’re still cautious and we hold no construction-related stocks in our equity or balanced funds, in the absence of a robust infrastructure cycle unfolding in the foreseeable future. Government coffers are currently empty for large-scale infrastructure projects.”

Roodt said the pullback in mining infrastructure spending was what had caught a lot of investors off guard.

“Order books looked healthy enough a couple of years ago, but have deteriorated rapidly, coinciding with the fall in commodity prices. We don’t see this environment changing soon.”

For investors in one of the smaller construction companies, the prospect of consolidation in a shrinking sector might seem appealing in anticipation of corporate action with a handy premium to market capitalisation, but Roodt said the lack of available cash likely meant payment through share issuances or mergers of equals.

“We’ve seen some consolidation already and we expect to see more before the sector bottoms out.”

He said the African growth story was not as strong as it was two years ago, and loss-making contracts there and in Australia had resulted in growth plans outside South Africa’s borders looking fragile.

One area that has looked positive by comparison is the home renovations and building supply market.

“The local residential market is showing signs of looking better, linked back to stabilising house prices. Companies like Cashbuild at the lower end of the market will likely see margins stabilising, but it’s highly competitive and a lot of unlisted companies play in this space.”

Roodt said Raubex had produced “decent” results based on ongoing government spending on road infrastructure.

Although it has underperformed the broader market, relative to its sector its flat share price — compared with the declining prices of its peers — since 2010 has massively outperformed.

One clear area of opportunity, according to Roodt, is in Consolidated Infrastructure Group.

“This is not a heavy construction play but has a clear African growth strategy in the power segment. It looks like a good niche in a service offering that other companies don’t really cover.

“It’s probably the only company from which I expect robust growth in this sector. It trades at a price to earnings ratio of 13 but has far better growth prospects.”

Sanlam Investment Management portfolio manager Michael Canterbury said that in the absence of post-World Cup government infrastructure spending as a catalyst, the state’s nuclear programme could boost prospects for heavy construction companies.