Construction: Hostage to poor planning
The many factors conspiring against infrastructure spending do not bode well for SA’s listed construction players
Murray & Roberts’s decision to exit SA infrastructure and building markets has shown up large cracks in the economy.
It comes despite government plans to spend R4trillion on 18 categories of strategic infrastructure projects over 15 years, of which hundreds of billions have already been spent.
The exit excludes the company’s shareholding in Gautrain operating companies that, according to Murray & Roberts CEO Henry Laas, are still in "fierce" litigation with the Gauteng provincial government. It also excludes projects being wound up in the Middle East, where no new business will be pursued.
The decision by one of SA’s top construction and engineering groups may provide a significant opportunity for black economic empowerment. But what it really shows is that civil infrastructure development, such as in the mining and steel industries, is being held hostage by poor government industrial policy design and implementation, amid the fury and chaos of national politics.
The infrastructure and building segment of the construction industry undertakes large civil engineering and earthworks projects — constructing power plants, dams, major roads, bridges, pipelines and large buildings, and also facilities such as the City of Tshwane’s Zeekoegat waste water treatment plant.
"In SA, the civil engineering and construction market is not strong and has not returned to the levels it should be at," Laas says.
There has been no fulfilment of government undertakings for big civil engineering projects, though he says the SA National Roads Agency (Sanral) has come to the party.
Murray & Roberts says its "new strategic future" lies in three multinational business platforms providing services to selected oil and gas, metals and minerals, and power and water markets.
The domestic civils industry has languished since the end of the 2010 Soccer World Cup. Megaprojects such as the Gautrain and Sanral’s Gauteng freeway improvement projects, along with soccer stadiums, have not been replicated.
But now that a major JSE-listed SA construction and engineering group is in the process of selling up a core business, it is worth looking at what this means.
One hint comes from Buildmax, a much smaller listed group that casts itself as a leading empowered opencast mining contractor, and one of SA’s biggest in the coal-mining niche.
The company also provides bulk earthworks and construction materials to the mining and construction industries. It says trading conditions in these sectors are dismal. But apart from slowing growth in China and poor demand in Europe for mining commodities, it says Eskom’s poor management of coal off-take, coupled with the utility’s pressure on mines and service providers to be 50% plus one share black owned, have stymied capital projects.
"The market for opencast mining services has diminished, triggering an oversupply of services, increased competition, lower prices, cautious lenders, bearish investors, labour and community unrest, and a general liquidity crunch in the sector," Buildmax says.
The same could be said of the general construction and engineering industries for the past six years. The lousy trading environment has been made worse by a global surplus of second-hand plant and a substantial drop in second-hand values.
Combined with a weaker rand, there has been a huge increase in the cost of new plant, which constrains companies from replacing and financing equipment. This in turn has deeply hurt JSE-listed companies such as Eqstra, which provides earth-moving machinery.
On the positive side, there has been evidence of public-sector spending on much smaller-scale projects, including for human settlements and associated infrastructure. This includes the building of schools, clinics, hospitals, and also the roads, water, electricity and sewerage systems that serve them. Much of this is in rural areas.
This has benefited smaller JSE-listed building and materials groups, and thousands of "bakkie and spade brigade" outfits.
But it remains to be seen if there are costly comebacks in future, similar to widespread quality concerns over low-income housing developments that resulted in remedial actions costing billions of rand a few years ago.
Parliament was told in reports from the National Home Builders Registration Council, the Construction Industry Development Board, and the public protector that flawed procurement processes and corruption were major causes of shoddy work in the construction of reconstruction & development programme houses for the poor.
Now, amid allegations of the capture of state-owned entities, and with memories of the Marikana massacre of mineworkers by police still fresh, SA’s economy is hurting.
Mining is in crisis, along with SA’s steel sector, and parastatals ranging from SA Airways to PetroSA have lost many billions of rand.
Projects such as Eskom’s Medupi and Kusile power stations are plagued by cost overruns due to often violent labour unrest and long technical delays. The ANC has also been seen to have unduly benefited from its past relations with Japanese contractor Hitachi on such projects, to the tune of billions of rand.
Meanwhile, the intrigues encompassing the Passenger Rail Agency of SA (Prasa) and state arms manufacturer Denel are a long way from the austere public interest that is mandated for the running of state enterprises.
Bad blood between government and the construction industry spilt over at the end of the 2010 Soccer World Cup.
The state felt it was being ripped off by collusion among contractors — including cement and steel producers — over its plans for infrastructure development.
This eventually resulted in about 15 large and lesser-known construction and engineering groups agreeing to pay a collective R1.5bn in penalties to the competition authorities.
Some of these groups continue to deny some charges.
Subsequently, SA’s largest steel producer, ArcelorMittal SA, also agreed to pay a R1.5bn fine for monopoly pricing.
Infrastructure takes up about 50% of steel production in SA. In simple terms, it is made up of construction and building segments, where confidence has been low in recent years.
At the same time ArcelorMittal SA has been pressured into a long-delayed black economic empowerment transaction.
The deal comes after many years of state pressure on the group over mineral rights and the pricing of flat steel products used in infrastructure development.
A previous Gupta-related empowerment deal for 26% of the steelmaker resulted in criminal charges being laid, until it was ultimately nixed in the constitutional court.
Such is the construction industry’s decline since then that the value of the proposed deal was worth nearly the same as ArcelorMittal SA’s total market capitalisation now — about R10bn.
The ill feeling between the state and the construction sector is continuing in the form of potentially costly civil litigation by provinces, cities and other parties.
These include the Construction Industry Development Board and black business organisations that want a much larger slice of the lucrative state infrastructure pie.
There are still outstanding claims and counter-claims from the 2010 Soccer World Cup over the Gautrain project and for Sanral’s roads networks. These run to more than R1.2bn. This is normal for large and complex construction and engineering projects. But when mixed with politics they can become far more potent.
State spending on infrastructure comprises about 70% of the total value of the construction and building industries in SA. Between the private sector and government this is worth about R460bn a year.
Construction companies have experienced some punishing losses in recent years, many of which come from divisions involved in infrastructure work.
Both Murray & Roberts and Aveng have also been trying to dispose of their steel manufacturing and services businesses, classifying some as discontinued operations.
Despite recent evidence of some renewed state tender activity, many of the biggest JSE-listed construction groups now derive the bulk of their profits from Australasian and European operations. Along with infrastructure-related steel and cement companies in SA, many have also flirted with becoming penny stocks.
Meanwhile, Evraz Highveld Steel & Vanadium, once SA’s second-largest steel producer that made structural steel for infrastructure that no-one else could make, is in liquidation.
Group Five CEO Eric Vemer says the engineering and construction markets are "very challenging". The group’s engineering and construction cluster contributed 85% of group revenue in the year to June, but saw an operating loss of R237m.
This was before a R365m provision made for a "problematic debtor" in the civil engineering segment, which itself made an operating loss of R381m.
The day was saved by a R917m operating profit from the group’s largely overseas-based investments and concessions business, helped by a weak rand.
This state of affairs has hollowed out such companies. They have been geared up for state infrastructure spend on 18 strategic integrated projects, and hundreds of subprojects, which are supposed to have started, over a period
of 15 years.
These projects include human settlements, coalfield railways, and proposed economic and industrial zones such as the Ekurhuleni OR Tambo Aerotropolis in Gauteng. The Presidential Infrastructure Coordinating Commission (PICC) says priority projects include mining towns, rapidly growing urban areas and municipalities in distress.
But instead of spending money on large infrastructure projects such as railways and mass water supply and treatment facilities, government has focused on manufacturing locomotives and coaches, and on finishing Eskom’s long-delayed power stations. Amid the crunch in financing, progress on such projects remains slow.
Cabinet ministers have been tasked by the PICC, which resides in the economic development department, to unlock everything from green energy to rural and agricultural infrastructure, water and sanitation, public transport, development corridors, mineral belts, and also the MeerKAT and Square Kilometre Array telescopes.
The state says that, given its limited finances, private-sector funding will be needed for some of these investments. This has taken place in SA’s renewable energy sector, to international acclaim. But there has been precious little private-sector participation across the spectrum of national infrastructure development, from planning to implementation.
Eskom CEO Brian Molefe, before his resignation, threatened to compromise R200bn of investments in renewable energy projects, most of it from the private sector. He said electricity supply from renewable energy is too erratic and too costly.
Policy uncertainty of this sort comes amid a lack of transparency over a potentially huge nuclear build in SA, and enormous uncertainty over the future of mining in the country.
Most recently, this has led to private-sector funding being withheld from state-owned enterprises, amid a frenzy of media speculation that SA’s sovereign credit rating would be downgraded by international ratings agencies.
While government has tightened regulation around the construction industry to get more bang for its buck, its stated desire to further stimulate market competition and promote affordable access to quality services has, in many ways, backfired.
The slow process of creating capacity in government departments and regulatory institutions has been made worse by the state not inviting the private sector to be involved in infrastructure development from the get-go.
Despite some contact between business and government — and also labour — there remains a seemingly insurmountable gulf between government’s desire for a "developmental state" and private-sector drivers of the economy.
Major state enterprises are on the verge of bankruptcy as large and politically controversial construction projects remain on the drawing board, including PetroSA’s proposed Mthombo refining facility at the Coega industrial zone in the Eastern Cape and Durban’s proposed dig-out port project.
With proposed costs collectively running into hundreds of billions of rand, infrastructure projects on such a scale need to be publicly scrutinised in the full glare of parliament.
This is not happening.
Some major construction groups, such as WBHO, have benefited from state and private infrastructure spending on human settlements and new offices being built in Sandton and elsewhere in Johannesburg. But 60% of group turnover and about one-third of profits now come from Australia, says CEO Louwtjie Nel. Revenue in the group’s civils business is down 40% in the year to June, while the roads and earthworks segment is down 18%.
Other major construction groups, including Aveng, Murray & Roberts and Group Five, are much more geared for heavy engineering work. This includes projects in water, ports, railways and mining. However, individual state infrastructure contracts have rarely exceeded amounts of R400m over many years.
Large construction and engineering companies want projects worth billions. With an increasing focus on rural development, many big players have been left out in the cold, with major infrastructure development languishing.
The 2016 budget review indicates that public-sector spending on infrastructure has risen from nearly R50bn/year in 1998/1999 to R260bn in 2014/2015, an average annual increase of 7.5%, discounting inflation.
State-owned companies such as Eskom, Transnet, the Central Energy Fund, Sanral and Prasa have been the biggest contributors to spending.
National treasury says provincial departments and municipalities have also significantly increased infrastructure spending to construct schools, hospitals, clinics and community-related infrastructure.
It says economic infrastructure accounts for 75% of total public-sector infrastructure spending, mainly by state-owned companies.
The funds are used to expand power-generation capacity, upgrade and expand transport networks, and improve sanitation and water services. Meanwhile, social services infrastructure accounts for 22% of total public-sector infrastructure spend, including for communications technology, with education and health spending accounting for 6% and 3%.
Industry group Consulting Engineers SA says at least 30% of all funds spent on infrastructure needs to be spent on maintenance. But it is difficult to see this happening, especially in dysfunctional municipalities.
What it means: Civil infrastructure development is being held hostage by poor policy design and implementation