Construction companies are being held back by government not spending on infrastructure.
The government's big plan to encourage job creation and improve service delivery calls for spending on infrastructure — but the companies that are in the running to do the construction work remain largely in the doldrums.
Finance Minister Pravin Gordhan announced in February that, as part of the national development plan, the government intended to spend R827-billion in the next three years on the building of new — and the upgrading of existing — infrastructure. About R400-billion would be earmarked for capital projects and would be funded by state-owned entities, and the rest would be allocated for the building of schools, hospitals, dams, sanitation schemes and commuter rail.
This is good news for the construction sector, which has been battling to beef up its local order book since the 2010 Fifa World Cup, and should see investors rushing to invest in the sector. But, although the JSE continues to go from strength to strength, construction sector shares are underperforming.
Price-fixing
One of the reasons is that, based on previous experience, the market is not convinced that the government will be able to spend the money in the assigned time.
Adding to the sector's woes are the price-fixing and collusion probe by the Competition Commission and the threat of the criminal prosecution of senior executives, plus increased mining unrest and the poor performance of some mining sectors, which are key for private sector investment.
Since the start of the year, the JSE Africa construction and materials index has been up 1.75% but research by the asset management company Anchor Capital listed three of the top construction companies (Stefanutti, Aveng and Basil Read) as among the 20 worst-performing all-share index shares for the year to December 2012.
The bulk of the remaining companies were in mining, although Telkom SA also made the list. The all-share index is significant because the construction companies WBHO, Murray & Roberts and Group Five, in their results released in February, all mentioned the negative impact that labour unrest had had on investment in the mining sector.
Lot of questions
David Shapiro, a Sasfin market commentator, summed up the market's view of locally listed construction sector companies: "I think there are a lot of question marks on whether the [government] spend is going to take place, whether we are going to see the kind of development that will actually turn these [construction companies] into bargains."
One analyst, who preferred not to be named, said he would not encourage investment in the sector yet. He said the market should turn around in the fourth quarter of 2013, which would be the time to start looking at their shares again. He believed that WBHO was a good investment, but that was because of its large exposure to the Australian market.
The Development Bank of Southern Africa does not believe that South Africa has the capacity to spend the R800-billion. In its State of South Africa's Economic Infrastructure Report 2012, the bank said the government had failed to implement long-term infrastructure planning successfully. The situation was made worse by the lack of maintenance, late or non-payment of contractors and cancelled or often delayed public-private partnership projects.
Robus growth
But according to the Reserve Bank's December quarterly bulletin, money is being spent in the sector.
The bank said growth in gross fixed capital formation remained robust at 7.2% quarter on quarter, following a 7% expansion in the second quarter, driven mainly by general government and public corporations.
The report said that fixed capital expenditure by government rose by 23.4% during the quarter, reflecting the construction of new roads and maintenance, and the development of water infrastructure and informal housing. Strong investment by public corporations (up by 9.3% quarter on quarter) continued to be dominated by ongoing Eskom and Transnet projects to increase electricity generation and distribution capacity and transport.
Industry Insight, an advisory company to the construction sector, stated in its report The State of the South African Construction Industry in the third quarter of last year, that investment growth by the government increased by 9% in 2012 and by 10.2% for public corporations.
Sufficient?
Since January, Basil Read has announced a R279-million road rehabilitation contract and that it has broken ground on the R1.85-billion Malibongwe Ridge development, close to Cosmo City in northwest Johannesburg.
So, there is growth but is it sufficient to sustain the construction sector?
Analyst Elsie Snyman of Industry Insight said R150-billion was spent last year. "We are seeing growth but, on the commercial side we need to see higher levels of about 5% to 6% and it needs to be sustainable."
Snyman said the sector had not returned to the levels seen leading up to the Soccer World Cup but the "freefall" was over and it was starting to come out of the recession.
She said private investors were easily spooked, however, and sensitive to negative information so they were still cautious about spending.
For one, private investors are concerned about access to electricity and high prices. Reserve Bank data clearly shows the private sector's reluctance to expand — fixed investment spending was almost unchanged at 2.8% quarter on quarter last year.
Snyman said the main driver of investment in civils (infrastructure) was the government, but this would only benefit the sector if the state was able to spend the money.
"The challenge is to get the money allocated spent where it is meant to be spent."
She said a large amount of the R844-billion set aside by government to be spent on infrastructure in the next three years would not benefit local construction companies.
"They will see about R350-billion of the money. A lot of money, about 35%, will go to Eskom and a big chunk will be spent on machinery and equipment, which is manufactured elsewhere and imported — so it will not benefit the likes of Murray & Roberts, Grinaker LTA or PPC."
Group Five chief executive Mike Upton highlighted the concerns of local construction companies when he said that the timing of the public-private sector projects remained uncertain.
The Industry Insight report pointed out that payment was also a problem.
Pursuing investment obligations
"Government continues to pursue investment obligations but procurement and payment processes still remain rusty," it said.
Snyman said there had been 1% to 2% growth in the civil sector but "this is off a high level of government spending previously".
It is important that someone in government takes control of the running of these projects and makes sure that they happen, even if it's the national planning commission," she said.
"These are long-term projects so they are unlikely to be completed in the time assigned and players in the industry need to accept this."
Shapiro said the order books of construction companies were not necessarily an accurate indication of their health because they had to take on projects that lowered margins to tide them over until more lucrative ones came along.
"Construction has always been cyclical and, when things are in a down cycle, like they are now, companies look for projects to keep them busy and they tend to do projects with lower margins.
"So, when you look at the order books of some companies, there is an increase, but it's for products with lower returns. Then, ironically, when things look up and they get good projects, they still have to complete the ones with lower returns."
This forced some companies out of their comfort zones and into new countries. "Some come back with their tail between their legs, but some like WBHO have done quite well outside of South Africa."
Unrest and problems in the mining sector have also had a significant affect on manufacturing. According to Upton, conditions in the market remain weak and there is very little mining or industrial activity.
Presenting his interim results to December 2012 in February, Upton said although Group Five's order book was the healthiest it had been in five years, the sector was very quiet.
The company, which returned an interim net profit of R147-million against a net loss of R230-million for the previous full financial year, was currently only doing work for Kumba Iron Ore and Xstrata, which "is too small for us", Upton told Engineering News.
Construction sector stocks stagnate
The ongoing Competition Commission probe into the construction industry's involvement in price-fixing and collusion has contributed to a lack of appetite for construction stocks, particularly because the companies and their chief executives could also face criminal action, which could take years to be finalised.
The investigation by the Hawks, the National Prosecuting Authority and the competition authorities of 20 of the country's largest construction firms is under way. The allegation is that they have run a cartel for decades.
Affidavits handed over in 2011 by Stefanutti Stocks staff implicate senior executives and managers in South Africa's biggest construction companies, including Murray & Roberts, Group Five, Basil Read, Aveng, WBHO and Stefanutti Stocks, as well as a number of smaller players.
When Murray & Roberts, WBHO and Aveng announced their recent financial results this year they said that they had made provisions for a commission fine according to their latest financial results.
Group Five has not, however.
In his February financial result presentation, Group Five chief executive Mike Upton said the group did not deem it necessary to make provision for penalties and fines as the "group had adopted a proactive stance from 2008 … The group continued to co-operate with the commission for the last few years in the interest of determining if it had any exposure and to take advantage of the commission's leniency programme to limit the risk of penalties and/or fines."
A legal source said, however, that companies are taking legal advice and are concerned about the probe and the criminal cases that now seem "inevitable".
Aveng head Roger Jardine said the company had "submitted a comprehensive application to the commission in terms of the fast-track offer process, and submitted a settlement offer to the commission in June 2012".
"Aveng Group's view remains that the investigation must be completed as soon as possible in order for the industry to move forward," he said.
Jardine, who joined Aveng in 2008, has said that the construction sector has been rife with corruption. This suggests that an in-depth investigation would implicate almost every company in the sector, which is not viable.
In a statement accompanying its interim results, WHBO in February said it had been in contact with the commission, and "we hope to conclude this process shortly".
A legal expert who asked not to be named said the firing of top management by some companies was unlikely to protect them from prosecution.