In 2008 the Gulf appeared to be the most lucrative market in the world for construction companies.
There were close to $2 trillion of construction projects planned or under way, and with a limited number of contractors capable of taking on major projects, the big players could name their price and command double-digit margins.
Local Saudi contractors claim that the margins are good, but they are pricing the high-end jobs wrong
Today the situation has been reversed. The demand for contractors has collapsed, so there are not enough projects to keep companies busy, and fierce competition means margins have been squeezed so tightly that contractors are now looking for more profitable opportunities outside the region.
The collapse of the project market since late 2008 has been well documented. Dubai’s offshore Palm Deira project was the first high-profile scheme to be put on hold, but it was quickly followed by billions of dollars-worth of other real estate schemes developers could no longer afford to build.
According to regional projects tracker MEED Projects, there are now $492bn of construction projects cancelled or on hold across the region, with $298bn, or 60 per cent, in Dubai.
Despite the fall in the number of opportunities available to contractors, there was still work on offer. The Dubai market saw little in the way of new contract awards in 2009, but in Abu Dhabi there was still $12bn of contract awards, and, as a sign of how the region’s market has changed, Saudi Arabia overtook the UAE for the first time with $30bn of awards.
Despite the new work awarded, at MEED’s Arabian World Construction Summit in late May, construction companies for the first time began to say they were prepared to turn their back on the Gulf and look for better returns in other markets.
“We are not willing to reduce our margins. If we can’t get our margins here, we’ll go somewhere else,” says Riad Kamal, chairman of Dubai-based construction firm Arabtec Construction. “We’re already looking to places, such as North Africa, Turkmenistan and Kazakhstan. We’d prefer to work [in the Gulf], but sometimes it’s not feasible.”
Margins have fallen because although there is still work being awarded, it is not enough. There were $64bn of construction contract awards in the Gulf in 2009, down 35 per cent from the $98bn awarded in 2008. This is a problem because most construction firms at least tripled in size between 2004 and 2008, and large volumes of new work are needed to keep their vast resources busy.
The issue is most acute for large Dubai-based contractors, such as Arabtec. Its home market, traditionally accounting for most of its turnover, has stopped awarding contracts. In 2008, there were $44bn of construction contract awards in the emirate, $9bn in 2009, and so far in 2010 there has been just $5bn of projects awarded.
The slowdown in Abu Dhabi has been less severe. The value of construction contract awards fell to $12bn in 2009, from $26bn in 2008, and this year it has awarded $5bn of contracts. But unlike Dubai, where there are few if any major projects currently being priced by contractors, there are $30bn of projects currently out to tender.
The slowdown in the capital has forced local contractors’ margins down, but more importantly, they have been cut by contractors looking to replace work that has been cancelled or completed in Dubai.
“Margins in Abu Dhabi are very low at the moment. The 2010 margin is less than half of 2008 [12-15 per cent], and even that doesn’t secure work,” says a regional contractor working in the UAE. “We were recently pricing a major project in Abu Dhabi using a margin of 6-7 per cent. We thought that was quite aggressive, we finished up last and were about 15 per cent higher than the lowest bidder.”
Markets that are more difficult for new players to penetrate have offered better margins over the past two years. “We had record margins in 2007 and 2008,” says a contractor based in Saudi Arabia’s Eastern Province. “On some projects we were able to price a margin of up to 40 per cent. But those times were exceptional. There were a lot of projects and not many people working in the kingdom, so we took advantage of it.”
But as competition in the kingdom increases, margins will, like those in Abu Dhabi, come down.
“Today the margins have come down to about 10 per cent, and I believe they will come down by another 30 per cent [to 7 per cent] this year as competition comes into the market from Dubai, the UAE and other countries,” says the Eastern Province contractor.
Foreign contractors working in the kingdom are sceptical about how good the margins actually are. Many of the projects currently being tendered are highly complex, and there is a risk that companies underestimate their costs.
“Local Saudi contractors claim that the margins are good, but my personal opinion is that they are pricing the high-end jobs wrong, and underestimating the cost – it’s a learning curve. It’s something that contractors working in the UAE went through in the mid-to-late 1990s, and the same is happening now in Saudi Arabia,” says the regional contractor.
Whether companies are prepared to work in the kingdom for poor margins depends on the contractor. “The issue of cutting margins to be competitive is a very hypothetical one. A price that meets one company’s margins may be well below that of another company. Every company has its own strategy and its own management decisions to make,” says Ali Kolaghassi, vice-president, Saudi Oger.
Arabtec, which is listed on the Dubai Financial Market and needs to produce profits for its shareholders, says it is not prepared to work in markets or on projects that are not profitable. “The competition across the market is fierce. As a public company, we cannot take on work for continuity sake. There needs to be a concentrated effort on the part of contractors to say enough is enough,” says Kamal.
Alternatively, companies that are privately held may prefer to maintain a presence in the market and are prepared to work on projects, even if there is no margin. “The Saudi Binladin Group must always be present. It must always be seen to be involved with projects, whether it makes money or not. SBG’s company policy is that we’ll be active and we’ll be bidding wherever there is work,” says Mutaz Sawwaf, chief executive officer (CEO) of Construction Products Holding Company (CPC), an affiliate of the Saudi Binladin Group, and Arabtec’s local partner in Saudi Arabia.
Another option for contractors is to streamline operations and reduce costs to create margins even when prices are low. “Competition has come from all directions. We’re starting to look … at design and contract administration to see if we can’t create more of a margin for ourselves. We’ve addressed the challenge internally,” says Laurie Voyer, CEO and managing director at Dubai-based Al-Habtoor Leighton Group.
Companies will be forced to look more at the bottom line as the downturn in construction continues. “I don’t see any improvement in the future. Over the past few years main contractors over invested in plant and equipment, and no one has started a fire-sale yet. Instead they are trying to utilise their resources, even if they don’t make a profit,” says the regional contractor. “Given the size of the companies in the region, and the limited number of projects available, it will take a long time for them to fill their order books.”
Slim margins are not just bad news for contractors. They are also bad news for clients. While clients may initially benefit from reduced capital expenditure, it is often at the expense of the project as the contractor realises it is losing money, tries to save on cost and delivers a substandard product. “It worries me a lot when companies win work just to maintain continuity. If you can’t deliver the best project to the best of your ability, it undermines both the market and the project,” says Tim Judge, senior vice president, at US-based project manager Hill International.