Construction firms: Balancing demand and capacity

08 January 2013

The recent global financial crisis and the Arab uprisings have led to cut-throat tenders and meagre margins. Contractors hope there will soon be a pick-up in awards

The region’s construction companies are still struggling to regain their balance four years after the real estate downturn caught the industry off guard.

Times have been hard for contractors since 2008. The first wave of the crisis saw billions of dollars of contracts terminated or put on hold followed by a period of calm as firms concentrated on their remaining projects. Now in 2012, as those projects are completed, companies have started to face the harsh reality of a much smaller market that is unable to sustain the current capacity.

Since 2008, our clients have scaled back their ambitions and their activities, and we have had to do the same

Head of a Dubai-based contractor

“We have had to ask some really tough questions,” says the head of a Dubai-based contractor. “Since 2008, our clients have scaled back their ambitions and their activities, and we have had to do the same. We have to accept that the market is different now and things have to be done differently.”

Restructuring strategy

Change is a painful process. This year, major construction companies across the region have started to restructure their businesses so they are better suited to the requirements of today’s smaller market. Others are preparing to make the decision soon. “I am just waiting for the day that we have to make the same decision,” says a local contractor working in Abu Dhabi.

The numbers make the decision a clear one. In 2012, clients across the GCC, Lebanon, Jordan, Egypt and Algeria have awarded $51.4bn of construction and infrastructure contracts according to regional projects tracker MEED Projects. That is 31 per cent less than the $74.9bn awarded in 2011.

Despite the slowdown, there have been some major contract awards. A consortium of Turkey’s TAV, Athens-based Consolidated Contractors Company (CCC) and Dubai-based Arabtec Construction won the $2.8bn contract to build the midfield terminal at Abu Dhabi International airport. A team of the Qatari/Belgian Dredging International and Middle East Dredging Company (Medco) secured the $1.2bn contract to complete the dredging work for the New Doha Port project in Qatar.

In October, Kuwait finally awarded the $2.6bn contract for the Subiya causeway to a consortium of South Korea’s Hyundai Engineering & Construction Company and the local Combined Group Contracting Company. In Saudi Arabia, the joint venture of UAE/Australian Habtoor Leighton, TAV and the local Al-Rajhi was awarded the contract to build an aircraft maintenance facility at King Abdulaziz airport in Jeddah.

While these awards are welcome, they are not enough to replace the projects that have been completed. For cashflow, spending on construction projects across the GCC is forecast to fall by 28 per cent this year, largely due to a sharp decline in investment in the UAE, according to data from MEED Cost Indices.

Spending in the UAE, which has been the region’s largest market, totalled $3.91bn in January and it is forecast to fall by 60 per cent by the end of December when $1.58bn will be spent. The UAE is experiencing the dramatic fall because a raft of existing projects are being completed this year, and not enough new work has been awarded over the past two years to replace it. In 2012, there will be $58.3bn of construction projects completed in the UAE, according to data from MEED Projects. Since the second half of last year, there has only been $21bn of new contract awards to replace those completed schemes – a shortfall of more than $37bn.

The sharp fall in awards in the UAE means it will be replaced by Saudi Arabia as the region’s most active market in terms of spending, even though the kingdom’s performance this year is expected to be largely flat at about $1.9bn a month.

The UAE and Saudi Arabia dwarf the other four markets. The monthly spend will be $700m-900m in Qatar, $350m-400m in Kuwait, $170m-210m in Oman, and $150m-190m in Bahrain.

Reducing capacity

Less money being spent on projects means the market needs less contracting capacity. “We have scaled back significantly,” says an international contractor working on projects across the region. “As schemes wind down, companies normally lose headcount, but this year we have taken it a step further and significantly cut staff at the company’s regional headquarters. The reason was that the company does not produce enough turnover to support that level of overhead anymore.”

As firms scale back, the market should move towards equilibrium for the first time in nearly a decade. In the five years prior to 2009, it became increasingly difficult for clients to secure the services of good contractors as they boasted full order books and could afford to turn down work.

The 2008-09 real estate crash resulted in projects being put on hold, and the dramatic reduction in work available turned the tables. For the past four years, consultants, contractors and suppliers have all complained that the level of competition is unreasonable as clients call the shots again. In Abu Dhabi this year, a tender for a major hotel and resort development was issued to more than 20 companies, and contractors say that has become the norm rather than the exception.

When there are so many firms on the tender list, the job will go to whoever makes the biggest mistake in price

Regional contractor working in Abu Dhabi

“We accept that contracts need to be competitively tendered, but when there are so many companies on the list, the job will go to whoever makes the biggest mistake in his price,” says a regional contractor working in Abu Dhabi. “That is not good for the contractor and the client is so obsessed with getting the lowest price that he does not care that it is also bad for the project.”

Margins have been eroded by the cut-throat competition. In 2009, contracts in the UAE – mostly in Abu Dhabi – and the smaller GCC markets were secured by firms that priced work with very little margin. In Saudi Arabia, margins remained strong. In 2009, contractors in the kingdom claimed that margins were up to double digits as the government pressed ahead with its infrastructure investment plans.

The good times did not last long. Contractors from the rest of the region soon realised that Saudi Arabia offered the best potential for securing work, and firms from the UAE, Egypt and further afield quickly found their way onto bid lists, driving margins down.

“Saudi Arabia was a great market for contractors in 2008 and 2009,” says a contractor based in the kingdom’s Eastern Province. “That started to change when new competitors came in, and today the margins are slim.”

Indecisive construction clients

An added risk for contractors when considering tendering for work is indecision. Clients across the region are still jittery when it comes to large-scale capital investment and this means that many tenders take a long time to be awarded, if they are awarded at all.

In 2012, Jordan and Kuwait are the only two markets reviewed that recorded a growth in their construction sector, with the other eight countries all recording a drop in the value of construction deals awarded. With more than $77bn of construction and infrastructure projects in the bidding stage, contractors are eagerly awaiting a pick-up in awards.

This was already a feature of the market before 2011, but since the recent Arab Uprisings, the political instability in North Africa and the Levant, and the fear of destabilisation in the GCC, tenders now often take more than a year to be awarded. It is even a problem for projects in Saudi Arabia that have a strong economic basis and government-backed clients with the financial resources to move forward with their plans.

The trend has been bucked in markets where the volume of work on offer still exceeds contracting capacity, and the best example in the region is Qatar. With $70bn of projects planned ahead of football’s Fifa 2022 World Cup, Doha needs additional contracting capacity.

While some of that will come from the expansion of domestic companies such as Midmac Contracting and Aljaber Engineering, much of it will come from foreign firms seeking work on major projects such as Doha’s new metro network, major highways, hotels and football stadiums. The 2022 deadline will also ensures that tenders are awarded relatively promptly. Even though firms in Qatar still say work could be awarded more quickly, there have been several major contract awards in the country this year. In addition to the $1.2bn New Doha port award, the $961m Lusail Expressway, $640m Doha Expressway and the $412m package 1c of the Msheireb Downtown scheme ranked among the largest contract awards.

The good news for contractors is cut-throat tenders, meagre margins and indecision may become a thing of the past. As contractors downsize, there will be less overhead to sustain and they will need less work to sustain themselves. Also, as their appetites diminish, there should be fewer companies prepared to tender for projects.

On the other side of the contractor-client equation, developers are for the first time in four years successfully launching new projects and booking off-plan sales. This sales revenue means developers no longer have to rely on cash reserves or banks for move forward with projects.

In April, Dubai-based developer Nakheel launched a new scheme on the Palm Jumeirah called Palma Residences. The firm sold a number of properties on launch and quickly moved to appoint a contractor for the work as the scheme was self-financing.

Since then, Nakheel has launched the Palm Views and a new mall project on its Palm Jumeirah development.

Housing demand in the UAE

Nakheel is not the only developer starting to experience a resurgence in interest for its projects. The local Emaar properties sold all of the units for its The Address The BLVD downtown development in Dubai on the first sales day.

Other smaller developers are following the lead of Nakheel and Emaar. “We are getting a lot of interest from Dubai developers again,” says the head of a Dubai-based architectural consultant. “We are close to signing agreements for two high-rise schemes. It is still too early to say, but if projects such as these go ahead, then I think we can say Dubai’s market is back. If that happens then other markets will pick up too.”

At some point in the future, the region’s construction market will have to reach an equilibrium where contracting resources and the volume of work ongoing and in the pipeline are balanced. This has not been the case for the past four years and now as real estate developers regain confidence and contractors restructure their businesses, that elusive equilibrium may finally be achieved.

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