A constructive way forward

The past few years have been a hectic time for everyone. With rising inflation, including the price rises in raw materials and labour, the sky-high interest rates intended to counter these increases, and to top it all, investors being spooked by the outbreak of war in Ukraine. One sector in Poland that has certainly been licking its wounds is the construction industry, but the question remains: is it heading for a crisis? “Hopefully, not yet,” says Bartłomiej Sosna, a construction market expert at construction consultancy Spectis. “Construction firms managed to retain their margins in 2022 despite having to cope with rising costs, recording an all-time high in terms of net profit. This was partly due to the partnership approach pursued by the contracting parties, which allowed for the prices of selected contracts to be negotiated,” he argues, and then adds: “Moreover, the financial standing of medium-sized and large contractors improved slightly in H1 2023 compared to H1 2022 and in financial terms this was a record period for construction companies.” However, the woes of the industry cannot be so lightly dismissed.

“The increasing number of insolvencies in the construction sector, which rose by almost 100 pct quarter-on-quarter and by 150 pct year-to-year is very concerning,” admits Jakub Jędrys, the head of the building and project consultancy at Savills. “The construction market is definitely in a downturn where there’s an inadequate number of new orders to ensure a steady cash flow to cover the high costs,” he points out, highlighting figures published by Statistics Poland (GUS) for September, which show a drop of 9.5 points for business confidence in the construction sector. Moreover: “There has been an increase in payment delays for construction assembly work, similar to August. Construction company directors are anticipating a reduction in recruitment levels, similar to the forecast made last month,” he adds.

Artur Popko, the CEO of Budimex, seems, however, rather more sanguine about the current situation. “For large construction companies, the situation is not too bad at the moment,” he claims, “and it will especially be those companies that have a diversified business and a large order book that will be able to cope in both the short and the long term. There could be problems for companies that operate only on the housing or rail infrastructure markets, since their financial liquidity could come under pressure. This could be a particularly pressing issue for smaller developers,” he suggests. Budimex’s CEO seems, if anything, on the whole optimistic: “In the long term, the situation looks good for all construction companies. The government and the private sector are planning construction projects worth up to one trillion złoty in various sectors of the economy over the next ten years. In such a situation, every company, regardless of what it specialises in, will have the opportunity to carry out its specific scope of work,” says Artur Popko. This is not the only boon that he can see arising from the present situation. “It’s also worth bearing in mind that the potential investments related to the reconstruction of Ukraine in the future could have a significant impact on the state of the industry,” he adds.

Inflation, inflation, inflation

“Inflation has become a key factor determining the financial situation of the construction sector. The exceptionally steep rise in construction material prices, fuel prices and financing costs over 2021 and 2022, which have resulted from both the post-pandemic boom and the conflict in Ukraine, have considerably increased construction costs. Even though construction material prices have started to stabilise, they have nonetheless settled at a considerably higher level than two years ago,” according to a statement by PwC prepared for ‘Eurobuild CEE’ by Kinga Barchoń, the partner responsible for real estate at PwC, Natalia Łyko, a director at PwC Polska, and Tomasz Kępa, the manager of the real estate M&A team at PwC.

Jakub Jędrys of Savills also feels that inflation is a major concern: “In recent times, inflation has significantly impacted the profitability of the construction sector in Poland. According to data recently published by GUS, there has been a marked deterioration in the profitability of construction firms, largely attributable to the unprecedented surge in construction costs over the 2021–22 period. In 2022, the net profitability of large construction companies declined by more than one percentage point to app. 5.5 pct. In contrast, the profitability of small and medium-sized enterprises (SMEs) saw a reduction of around 0.4–0.7 percentage points, settling within a range of 7.5–8.5 pct,” he says. But the bad news doesn’t just stop there. “Escalating prices for construction materials coupled with the upward trajectory of labour costs are expected to erode profit margins further in the next few months. Nonetheless, the residential construction sector is showing a more optimistic outlook owing to robust demand outstripping the supply,” he adds.

When it comes to the construction engineers themselves, they are not entirely cheerful about the prospects, either: “Although the prices of building materials are no longer rising so sharply – in some cases, there has also been a correction and their availability has improved – but their manufacturers are still under pressure. The costs for the energy used in the production of building materials certainly remain a challenge – and in some cases these can account for up to a third of all costs,” admits Artur Popko of Budimex. However, he doesn’t just see dark clouds on the horizon. He points out that the slowdown has resulted in many subcontractors offering lower prices and that many contracts are inflation-indexed.

Saved by indexation

Indexed contracts, however, have not proven to be any kind of panacea. “In the public sector, wage indexation mechanisms exist to partially compensate companies for the extraordinary price increases. However, for certain contracts (e.g. roads and railway projects), the cost escalation limits are low. Once these limits are exceeded, the increased costs diminish the profit margins that were initially projected. Such a scenario played out for many of the contracts acquired between 2021 and 2022,” points out Jakub Jędrys of Savills.

Artur Popko of Budimex admits that there is a problem, but lays some of the blame at the feet of those construction firms that priced their work too aggressively: “For some time now, in contracts with the GDDKiA [the General Directorate of National Roads and Motorways in Poland], the remuneration has been indexed, but it cannot exceed 10 pct of the value of the order. There are contracts where the increases have breached this limit – mainly those signed just before the Russian invasion of Ukraine and the surge in costs that resulted from it. As an industry, we are talking about increasing this limit to 15 pct – this is fair, but there are some companies that would also like to increase the limit for contracts signed after the outbreak of the war. In this case, however, the problem arises from overly aggressive calculations. Since the first day of the invasion, we have even turned down contracts that were worth PLN 3 bln, knowing that they would be unprofitable. This is because indexation is intended to mitigate extraordinary cost increases, rather than to reward those who risk low prices in their bidding,” argues Artur Popko.

However, according to PwC, this isn’t the only reason for the lack of profitability from public contracts. “Currently, general contractors are concentrating their activities mainly on road construction. This is, above all, due to the slowdown in other construction sectors. According to the GDDKiA’s estimates, the planned investment costs for roads will rise by around PLN 15.5 bln in 2023 to over PLN 25 bln in 2025. Even though there have been no cases where new road investments have ceased, problems still exist with the profitability of the contracts already signed and due to the increased competition for new contracts. Local authority investments have also shown relatively good results, but they have also run into difficulties over costs. The rail infrastructure market, which is largely based on EU funding, has been struggling with an investment deficit due to delays in the payment of EU funds. The prefinancing mechanism that is intended to compensate for the lack of funds from the National Reconstruction Plan [KPO] has not proven to be as effective as was envisaged. For these reasons, public procurements are not compensating construction companies in full for all their costs, and so the question of profitability remains one of the biggest challenges for the sector,” claim Kinga Barchoń, Natalia Łyko and Tomasz Kępa of PwC.

Everyone wants a piece

It should also be borne in mind that despite the difficulties currently faced by the industry, Poland remains an interesting market for foreign contractors. “Predominantly, the leading construction companies operating in Poland have foreign capital in their share structures, especially from the Austrians and the Germans. However, investors from Spain and Scandinavia are becoming increasingly active, all of which have a global reach. These foreign construction companies utilise capital from their countries of origin. Being part of the European economic area grants them unfettered access to the Polish market. Moreover, the relatively low salaries in Poland in comparison to countries with established market economies allows them to offer competitive rates in Poland while maintaining their usual levels of profitability,” explains Jakub Jędrys of Savills.

PwC, however, does not seem to consider foreign competition to be a major threat to the Polish market. “The main challenge for Polish construction remains the price competition between home-grown firms, particularly when it comes to road tenders. The huge potential for the growth of the Polish construction sector over the coming years means that there is enough space for both national and foreign firms. Attempts to open up the Polish construction market to companies from outside the EU will probably not have any meaningful effect, because there is a lack of Polish subcontractor companies in the market anyway. The history of failed attempts by foreign firms to expand into Poland is also not doing anything to encourage new initiatives of this kind,” argues the consultancy.

Artur Popko of Budimex also emphasises the massive potential of Poland’s construction sector and believes that many of these forays into the country by foreign competitors have often been unsuccessful due to their inadequate knowledge of its business climate. “Poland is still very much one huge construction site due to its rapid development. Not many other countries have so many investments of this kind. That’s why many international companies are submitting bids in Poland at very low prices, below the direct costs. These companies have yet to take on board exactly what the requirements of the contracting authorities are. This can lead to situations where they have a huge problem terminating such contracts. And this has been a very noticeable phenomenon. At the moment, there are a dozen or so bids for each tender, both for road and rail. These lowest bids are often below the direct costs, which is a very worrying trend for the entire industry,” argues the CEO of Budimex.

Energy for growth

Having painted such a dark view of the situation faced by the construction sector, the question has to be asked: what are the bright spots? Which segments are showing the greatest potential for growth and profit? For Bartłomiej Sosna of Spectis, the answer is clearly energy and renewables. “Over the coming decade, the industrial and power construction sectors will see massive growth, as can be seen from the largest projects planned. Renewables and nuclear power are going to play an increasingly significant role in the power construction sector over that period. There has also been considerable interest in large-scale solar and wind energy projects, both from private investors and state-owned companies. For the RES (Renewable Energy Sources) investment sector, offshore wind farms will generate the largest volume of work over the next ten years. Moreover, two nuclear power plants are planned to be built in Poland. Under Poland’s nuclear power programme, the construction of the first reactor is expected to commence in 2026 and is scheduled to come into service in 2033,” points out Bartłomiej Sosna.

Artur Popko also sees huge potential in the renewable energy sector and advocates for more diversification: “Through segment diversification and strengthening our position in the hydrotechnical and military segments, as well as expanding into foreign markets, we will be able to maintain our long-term trend of growth for our order books and revenues in the construction segment while maintaining stable profitability. We hope that additional growth in construction will come from our own RES projects,” believes Budimex’s CEO. PwC also remains cautiously optimistic for the future of the sector: “The evident slowdown in the construction industry has been severe, but signs of a promising future can be seen – mainly due to the major infrastructural investment on its way, including in rail and energy as well the Central Communication Port (CPK) intermodal transport hub. These investments will most likely strengthen the recovery of the commercial sector, particularly logistics,” argue Kinga Barchoń, Natalia Łyko and Tomasz Kępa of PwC.