Swot Analysis of the Construction Sector in South Africa

An all-inclusive view on the strengths, weaknesses, opportunities and threats you can expect when venturing into the South African construction sector. Use this guide to help you gain a firmer grasp on what it will take to succeed in the construction business; in 2016 and beyond.

The construction sector is a significant contributor to employment and economic growth in South Africa, according to PWC’s report: SA construction 3rd edition.

It contributes 3.9% to national GDP; however, the industry has slumped following the completion of 2010 Soccer World Cup projects. Strikes and labour unrest continue to negatively impact the construction sector causing delays on significant projects around the country.

The Government’s National Development Plan (NDP) and its continued commitment to public infrastructure investment of R810 billion over the next few years remain positive for the sector. However, the government has had to reduce its planned expenditure, due to tough economic conditions within the country, and this placed added pressure on the heavy construction industry, which benefits from national infrastructure development.

A look at the latest research reveals the following strengths, weaknesses, opportunities and threats that appear in the construction industry:

Strengths

The construction industry is crucial to South Africa’s economic growth, and contributes a significant portion of the GNP. It also plays a critical role in development and contributes considerably to South Africa’s GDP. The construction industry also contributes to the labour market; according to Stats SA the South African construction sector employs more than 1.4 million people.

There have been a number of encouraging indicators from individual company’s financial performance, order book growth and planned infrastructure projects; specifically new utility projects have resulted in a more optimistic mid-term industry forecast.

The construction sector is a significant contributor to employment and economic growth in South Africa, according to PWC’s report: SA construction 3rd edition.

It contributes 3.9% to national GDP; however, the industry has slumped following the completion of 2010 Soccer World Cup projects. Strikes and labour unrest continue to negatively impact the construction sector causing delays on significant projects around the country.

The Government’s National Development Plan (NDP) and its continued commitment to public infrastructure investment of R810 billion over the next few years remain positive for the sector. However, the government has had to reduce its planned expenditure, due to tough economic conditions within the country, and this placed added pressure on the heavy construction industry, which benefits from national infrastructure development.

A look at the latest research reveals the following strengths, weaknesses, opportunities and threats that appear in the construction industry:

Small business growth

Government has been focusing its monetary and infrastructural support on small scale manufacturing projects, which gives emerging local players opportunities. Additionally, there will be an added benefit with draft legislation that will make 30-day payment compulsory, which will gradually improve the timeliness of payments.

 “There are opportunities for smaller companies. If you’re working for government contracts, things have picked up, and more importantly the government is paying on time. From a cash flow perspective this means things are fairly buoyant, and from what capital equipment dealers are saying, sales are actually fairly decent. There is a government drive to foster small construction companies and grow them into medium and large-sized contractors,” explains Rowan Goeller, construction analyst at Macquarie South Africa.

More evidence of this growing trend is the increase in industry sales. In July 2015 Pretoria Precast Cement reported an increase in 15% of total cement industry sales, reaching a total of 2.87m tonnes. This resulted from a strong and growing demand from smaller construction firms, which is offsetting a slowdown among the larger firms.

Alternative construction options

A promising long-term development that will benefit the construction industry is in the pipeline. This development is South Africa’s proposed nuclear energy programme, which could possibly benefit local contractors and support local businesses.

Goeller believes: “The nuclear procurement programme is being pushed quite hard by the government, and nuclear projects would be bigger than World Cup spending. We could essentially move back into an environment where there is a large public sector-driven construction cycle, although it would be spread over 15 to 20 years. In the short term we’ll fall into sustainable civil construction levels of about two-thirds of what we’ve experienced during the World Cup.”

Weaknesses 

Currently, South Africa’s construction sector is in a challenging cycle and, as a result, its index trading is at 69% lower than in 2009 during the global financial crisis (GFC).

PWC says that eight of the nine construction companies covered in its construction report have experienced a decrease in market capitalisation. Overall, market capitalisation within the construction industry decreased by 38%, compared to the previous PWC study conducted in 2014. Additionally, market capitalisation declined a further 9% in the four months that followed.

Louwtjie Nel, Chief Executive Officer of WBHO explains the company’s strategy for foreseeable future: “We can’t see it getting better in the short term. We think we’re going to be under pressure for another year or so, so we’ve just got to keep our heads down and do good projects.”

Outlook deterioration

According to the PWC report, construction companies Aveng, Group Five and Murray & Roberts have lost more than its market value during the past two years, due to the deteriorating construction sector outlook.

The entire industry is also still recovering and trying to move on from the collusion scandal that was related to the awarding of World Cup contracts. This collusion scandal lead to 15 companies receiving hefty fines and could still result in substantial regulatory reforms for the entire industry, warns Competition Commissioner Tembinkosi Bonakele.

Lack of work

Avior Capital Markets’ Roelof Brand says: “Industry order books have benefited from a boom in residential and commercial building demand in South Africa, which too may start to slow as interest rates rise.”

“New building projects alone aren’t enough to support the industry. We do not have mega projects that can keep thousands of people busy for multiple years,” adds Aveng Chief Executive Officer Kobus Verster. “To really get a step change, we need to have a real roll-out of the long awaited and promised infrastructure development programme in the country.”

Skills shortage

The competitiveness of the construction industry, paired with a significant skills shortage, places substantial pressure on businesses to deliver on projects. As a result there is poor execution of contracts, which creates margin erosion and losses.

Additionally, the risk of poor quality control on sites is also increased. This causes reworking of areas of poor quality, which increases the cost of projects; and increases the delay of delivering the final project.

High risk

The construction industry is inherently a high impact, and hazardous, industry for workers to be in. Major incidents, such as the collapse of a pedestrian bridge in Sandton, while a tragedy in its own right, also reflects poorly on the whole industry.

The implications on the reputation and ability of the construction company to procure work in certain sectors can become compromised, which means it will take many successful projects before the bridge-collapse incident is forgotten or its damage is lessened.

Opportunities

“It’s tough and it’s going to be tough,” Roelof Brand, Cape Town-based analyst at Avior Capital Markets, says about the outlook of the construction industry. “For things to change materially we need substantial infrastructure investment and we need mining capital expenditure to restart.” However, the potential is there for the construction industry to materially progress.

According to Marc Ter Mors, head of equity research at Johannesburg-based SBG Securities, a large and growing part of SA’s infrastructure investments have been within equipment, such as locomotives, instead of investing in civil construction. Projects are also being divided into smaller portions, which are allowing smaller construction businesses the opportunity to compete with bigger businesses for work.

Overseas opportunities

Various construction companies have not been affected to the same extent as those mentioned previously. As an example, WBHO shares have only declined 6.2% throughout the past two years; in comparison Aveng declined by 84% and Murray & Roberts by 59%.

WBHO continues to be more successful than its competitors as a result of building activity and contracts in Australia. Additionally, WBHO decreased its exposure to the mining industry, compared to some of its competitors. Less exposure to mining benefited WBHO because mining companies throughout the world have significantly decreased construction projects to build and expand any mines, because of a slump in metal prices.

Many construction businesses are now looking beyond its domestic market for work. Infrastructure opportunities throughout the rest of Africa and Australasia could allow some of the larger construction companies to thrive, despite a South African work shortage.

Africa has a near constantly growing demand for infrastructure and services. Many African countries struggle with a lack of residential and commercial properties. Our local construction businesses have also been advised that perhaps they should target intra-African trade and export-related opportunities.

Skills development

Stakeholders in the construction sector have noticed the lack of skills previously mentioned and have already started to correct this weakness. Larger contractors have begun launching skills development programmes to meet its demand for skilled employees.

These businesses are being courted by government, to attempt a partnership with the Presidential Infrastructure Co-ordinating Commission to increase government’s training efforts.

Rising work opportunities

Government has also begun to increase its support into social infrastructure; this includes housing, schools and the laying and building of roads. As a result, the construction industry can expect work opportunities within the public sphere.

The government has also established a National Development Plan (NDP), which is holding the promise of future growth. There are positive future developments, such as the Commonwealth Games scheduled for 2022, which will offer the construction industry a lucrative opportunity.

Short-term liquidity issues should be managed by construction companies in order for these businesses to take on the type of projects that will meet South Africa’s growth demands.

The Presidential Infrastructure Co-ordinating Commission (PICC) is in the process of planning to build and expand six new dams within South Africa and Lesotho over the next decade, in order to address South Africa’s long-term water and sanitation needs. Thulas Nxesi, Minister of Public Works says that the PICC will oversee a new strategic infrastructure project (DSIP), which is aimed at avoiding a repeat of SA’s electricity crisis within the water sector.

Threats

The South African economy has been affected by the global economic downturn. Businesses need to focus its time and energy on risk management options, as this is a critical component of effective management strategy within the South African construction industry.

To become competitive within the industry, construction businesses need to appropriately manage its risks as well as strategically price the risk element within its business contracts. Your company will need to remain proactive towards addressing potential risks, in order to remain both sustainable and competitive throughout the current challenging economic period.

Weakening rand

Global economic issues have caused South Africa’s economic growth to slow substantially, and this makes for a sluggish construction sector.

In 2015, South Africa was hit by serious knocks to the rand in relation to the dollar. As the rand decreased in value, project costs rose along with the price of construction materials, such as steel and oil. The commodity markets were significantly impacted, and, subsequent revenue decreases could be felt by many of the major construction firms, including Murray & Roberts and Group Five.

A currency that is performing poorly results in plummeting profitability for construction companies across the country. When economic growth stalls, so does demand for increased construction projects.

Industrial unrest

South Africa continues to experience ongoing industrial unrest, which can cause project delays and disruptions. This is also yet another hurdle in the decision making process, particularly when construction companies invest in new capital projects within the mining sector.

Strikes have reached an all-time high in terms of number, duration and violence and are inflicting significant short and medium term damage to the economy. These disruptions have impacted both project and business performance.

Recent widespread, and persistent, industrial unrest placed additional pressure on underlying contractual relationships. These strikes can increase the risk of construction companies not being compensated for expenses due to delays and disruptions.

Labour strikes can cause damage to builders, as contracts can be cancelled and companies can respond to industrial actions with cutting headcount and various other costs. Businesses can also get stricter about which contracts to bid for, which can aid in improving margins and profitability.

Power outages and supply

Power supply continues to be a large concern for construction companies. Eskom’s power struggles can have a serious impact on construction projects, causing costly delays. A reduction in public sector expenditure, and delays, involved in energy projects such as Eskom’s Medupi and Kusile power stations places further uncertainty on energy supply in the mid-term.

During March 2015, construction on Eskom’s 4 800MW Medupi coal-fired power station ceased as workers downed tools, which was just one of this project’s obstacles and delays. In the long run, increasing power shortages may force the construction industry to start investing in automation, which could cause untold consequences and challenges in the future.

Lack of skilled workers

The South African construction industry has grown substantially throughout the previous decade, which has resulted in a shortage of skilled or trained workers within the sector at all levels.

The success of any business is greatly impacted by the skills and expertise of its team. Additionally, the effectiveness of your team completing contracts and projects will also be impacted by their skills and expertise, and could possibly undermine your expansion if skills are found to be lacking.

There are very few trained artisans, and fewer newly skilled employees coming into the construction industry, particularly within the younger generations. This, along with a shortage of first-level staff skilled at supervision can place pressure on your business.

Employees that are skilled have sought contracts elsewhere, only to be met with high salary demands. Staff salaries already contribute 29% of total operation costs and the more skilled your employees are, the higher the salaries they are demanding.

Slow growth

A growth strategy places a high demand on construction companies to maintain appropriate leadership capacity. Growth within the South African construction industry has declined in the recent years because:

• The deterioration of business confidence and the volatility of the labour markets have resulted in limited foreign investments within the country, specifically in the construction industry.
• Government has been reducing expenditure on infrastructure related projects.
• Competition between construction firms has continued to drive down margins.
• Expansion into a new market has been hindered by volatile commodity prices and exchange rates.

Cash flow

A constriction of cash flow is a risk to the success of any company’s ability to make additional acquisitions and meet growth targets. Here are a few elements that can contribute to your construction company’s liquidity challenges:

• Declining margins and tough trading conditions across the industry and throughout the country.
• Significantly larger cash investments that are needed for each new project.
• Industry labour unrest causes delays and disruptions during a project or contract.
• The final commercial close-out of a project can result in a substantial amount of cash being unavailable in working capital.

South Africa will continue to experience challenging conditions in the construction industry. As a result of competitive pricing, customers are beginning to show signs of distress and these conditions are resulting in high levels of credit risk for companies from its private customer base.

The sector slowdown isn’t likely to reverse itself in the current conditions of limited capital and contracts. Despite these obstacles, new opportunities are still available for smaller players along with planned series of infrastructure projects, specifically in utilities and transport.

These projects could see the construction industry regaining momentum before 2020. Additionally, private residential projects will continue to bolster growth and provide stability, which should assist the construction industry in successfully riding out this downturn.

“Originally published on BizConnect Standard Bank : Swot analysis of the construction sector in South Africa "