The bulls that saw off the bear

This year has not been the easiest for the construction sector - so much so that this has even become something of a cliché. Infrastructure contracts have made life a misery for construction companies. A lot of contractors have lost their financial liquidity, there have been bankruptcy filings, including those of such giants as PBG. But this sudden slump has not come out of the blue. "The direct reasons for the weakness of listed construction companies can be found in the offers that were calculated considerably below the costs estimated by investors as well as in the steep rises in the prices of construction materials and services over the last two years. There has also been a shortage of organisational solutions, such as the symmetrical division of contractual risks between the ordering party and the contractor, the indexation of the value of contracts to changes in construction costs, or the securing of payments between the contractors and sub-contractors. Also, the procedure of choosing the contractor that offers the lowest price in public tenders, which is often considerably lower than offers from the competition, has added to these problems," explains Adrian Kyrcz, an analyst in the brokerage house of the BZ WBK bank. Maciej Krokosiński, the manager of Deloitte's audit department, points out some other reasons. "The key phenomena influencing the difficult situation in the sector include payment gridlocks between the general contractor and the investor as well as between the general contractor and the sub-contractor. The period between the acceptance of work by the investor and the invoice payment currently exceeds four months. Consequently the period between the purchase of materials that are necessary for the execution of the construction work and the payment date for this work has been extended to over six months. In this period companies have to finance themselves from their own or external funds, which generates liquidity problems," comments Maciej Krokosiński.

Developers are not doing very well either. The WIG-Developers index is plummeting, even though the companies listed on it are not currently making losses. Nonetheless, the present situation is having an impact on their margins. "The sale of apartments by the biggest stock exchange players dropped by app. 15 pct y-o-y in H1 and the deceases were more severe in Q2 than in Q1. The reasons for this include: the low supply of mortgages, which results from a new recommendation of the Financial Supervision Authority and limits the debt carrying capacity; low price limits for apartments that qualify for the Family's Own Home programme; the expected economic slowdown; and the unstable situation on the job market, which is influencing Poles' purchasing decisions," says Adrian Kyrcz. An additional factor affecting the functioning of companies in the sector is the so-called Development Act that has recently come into force, imposing considerable restrictions on project financing.

Taking on the bear
The stock exchange rollercoaster is burying some and lifting up others. Therefore we should applaud those enterprises that have managed to extricate themselves from unfortunate projects. "A large group of companies have approached risky construction contracts rationally and simply did not get involved in such operations because they predicted the problems that might ensue. Moreover, the companies that usually had a high balance of cash assets and were able to contract their work immediately after signing an agreement managed to avoid the risk related to material price changes and were able to avoid losses during the execution of infrastructure contracts," claims Maciej Krokosiński. Adrian Kyrcz emphasises that the companies which cope best in the development and construction sectors are those with strong balances, low insolvency risks, positive operating cash flows, and/or that pay dividends. "The acquisition of new loans and rolling current liabilities towards banks and bond holders has become difficult due to the toughening of the banking sector and investors with regard to financing construction and development companies. That is why companies with a relatively low debt will cope best," adds Adrian Kyrcz. Enterprises are cutting costs and adjusting their room for maneouvre in line with the potential of the market, which may turn out to be even several dozen per cent smaller in the next two years. Greater caution is evident among developers with regard to land purchase transactions aimed at increasing their land banks for future projects. There have also been signs that building sector players have been soberly observing what is going on and are now trying to repulse the attack of the stock exchange bear.

By adding a new category to our Awards, Eurobuild wants to focus on motivating companies in this direction. "We would like to award companies that have not only sustained the pressure from the downward trends, but have also managed to cope and continue developing their operations," says Katarzyna Matejuk, who is responsible for the organisation of the Eurobuild Awards 2012 Gala in December on behalf of Eurobuild. Awards will be presented in two new categories: the best construction company on the WIG-Construction index and the best company on the WIG-Developers index. Construction and development market analysts are to assess the companies on the basis of a questionnaire, which is to include such questions as: the quality of the financial results for the first three quarters of 2012, the companies' finances and their success in maintaining their financial liquidity, their search for different sources of income, new contracts, new fields of operation, prospects for the future, the extent of their readiness for the economic slowdown, the market position of a given player, big mergers, successful entry into new market sectors, dividend policies, and the fluctuations of their share prices in the period from January until September 2012. Experts will then be able to select a short-list of three companies and grant them 1, 2 or 3 points respectively, depending on which, in their opinion, has coped best in the current market conditions. The winners will be revealed during the Eurobuild 2012 Gala, which is to take place on December 6th at the ?Warsaw Hilton hotel.

Things can only get better... some day
Analysts agree that the current situation is not going to end any time soon and is going to drag the weakest players down to the bottom. According to Maciej Krokosiński, the problems we are observing at the moment result from decisions which were made much earlier. "The companies' troubles are the result of decisions taken in the 2009-2011 period, i.e. the moment when firms decided to take on infrastructure contracts. This is when contracts were being agreed under aggressive terms - very low margins and with a low margin of error regarding the prices of materials and other unforeseen events," argues Maciej Krokosiński. In addition, the portfolio of orders related to EU funds is set to shrink considerably and the sector will consolidate. What is likely to happen next? "I expect the first positive effects no earlier than 2013. The volume of residential development should drop in the next few months compared to H1, due to the weakening GDP growth in H2 and the unstable situation on the job market. But sales could be stimulated by lowering apartment prices," predicts Adrian Kyrcz. Maciej Krokosiński is slightly more sceptical and does not expect the next two years to bring a definite improvement in the mood of the construction sector. "The 2013-2014 period will not be a turning point for the construction industry. A lot of companies can expect to face a fight for survival and the market itself will consolidate after the collapse of the weakest entities. The fact that tenders for building contracts in the energy sector will have been settled will also have a considerable influence on the situation in the sector," he adds.

However, industry abhors a vacuum, and this one is already starting to look to other sectors that represent a potential source of profit. "A natural direction for the big players on the construction market will be the energy contracts mentioned earlier, related to Poland's energy security programme. The government is expected to allocate PLN 60 bln for this purpose over the next few years. Some big construction companies will diversify their operations and look for opportunities in other industries, such as in the waste utilisation sector. Another area that might prove attractive for construction companies is public private partnership contracts. One solution could be their expansion abroad, although a lot of firms are cautious about this. In Western Europe there are not too many tenders or opportunities for winning contracts at the moment, while the eastern way is burdened with high risk due to its political and economic instability," comments Maciej Krokosiński.

Every cloud has a silver lining, so highlighting?some of the positive examples, in the form of the new Eurobuild Awards prizes for the best Warsaw stock exchange-listed construction and development companies, is one way of cheering up the whole sector.

Aneta Cichla