09 Sep 2014 Long term prospects for Construction Industry on the up
We asked Olof Bergh, analyst from Sanlam Private Wealth, to reflect on the prospects for the Construction Sector. This is what he had to say:
Engineered for success?
After 7 years of significant underperformance we assess whether the construction sector has laid the foundation for future investment success.
The construction sector has delivered terrible investment returns since peaking in 2007. Since then the sector has halved in value and underperformed the All Share Index by a whopping 70%. Over the last 5 years post the crash, the Construction & Materials Index is down 20% while the JSE All Share Index more than doubled. That is however in the past and we believe much of the foundation has been laid for future investment success in selective cases.
Firstly it must be noted that at the peak of the construction boom the sector was enormously overvalued. After successive years of strong earnings growth the market lost all rationality and priced the sector for perfection, being consistently high future earnings growth. As so frequently happens in capital markets, shares priced for perfection end up as disastrous investments.
The inevitable happened: growth slowed, companies had overinvested and in so doing over-extended their balance sheets, due to the excess capacity created tenders became more competitive and less profitable, complex engineering projects taken when ‘nothing could go wrong’ backfired causing massive financial distress. As a consequence many of the companies had to address their capital structures, largely through rights issues. Furthermore the sector was accused of anticompetitive behaviour by the Competition Commission and investigated. Against this backdrop the shares understandably got sold down aggressively.
The sector has however come a long way and addressed many of the concerns.
– Order book growth has slowed but the quality is much improved with generally enhanced margins. Furthermore SA government related work is at a relative low and expected to make a comeback in the medium term as major infrastructure projects finally get implemented. This will act as a tailwind for order book growth.
– The companies have collectively diversified, particularly with reference to geography, and as a consequence face less concentration risk.
– Major mistakes relating to mega projects undertaken without a due understanding of the risks cost many companies significantly. The lessons have been learnt, the companies have focussed their offerings and expertise and risk parameters and processes have been improved.
– The companies capital structures have been largely improved through rights issues, asset sales and restructuring of debt. Liquidity concerns have accordingly largely been addressed.
– The Competition Commission investigation has been concluded and fines levied. No further action is expected on this front. There remains the risk of civil claims, although to date there has been very little action from potential claimants.
Due to the sharp share price declines, and the abovementioned actions undertaken, the sector offers attractive opportunities. We favour WBHO and Aveng.
Analyst – Sanlam Private Wealth.