Global infrastructure construction: a sector overview
Global infrastructure construction industry has been thrust firmly into the headlines. The award of contracts to build the first phase of HS2 (high speed railway 2) between London and Birmingham was announced this morning (17 July) by the UK transport secretary.
Infrastructure construction company and support services supplier Carillion is one of the three companies appointed by the UK government. As part of the CEK joint venture it will work with the UK's Kier Group and France's Eiffage Genie Civil.
The expected total value of this morning's contracts including both Stage 1 and Stage 2 (the full construction phase) is currently estimated to be worth £6.6 billion, said transport secretary the Right Honourable Chris Grayling MP in the official announcement.
Stage 2 will commence
Stage 2 will commence in 2019 and, along with Stage 1, is expected to support 16,000 jobs across the country. In addition, they are expected to generate 7,000 contract opportunities in the supply chain, of which around 60% are expected to go to SMEs.
Keith Cochrane, interim chief executive officer at Carillion, said: "We are delighted that our Joint Venture, CEK, has been selected to deliver two of the three Central contracts for HS2 Phase 1, reflecting the strength of our joint venture.
He took the opportunity to remind observers that Carillion is a leading global infrastructure construction vendor with top two positions in the UK rail and highways sectors, where it works in partnership with key customers, including Network Rail, Highways England and HS2.
Cochrane expects
“We expect the UK Government's objective of generating economic growth through investing in infrastructure to continue creating opportunities for us to grow our business in these core markets," he added.
The economic health of global infrastructure construction industry is dependent upon upon demand, as economics 101 will explain. But the industry, by its very nature, is unusually dependent upon government policy on underlying projects. Things are suddenly heating up.
Moody's 2017 outlook
In its 2017 construction global outlook paper, debt rating agency Moody's Investors Service writes of healthy prospects for infrastructure construction. It points to increasing traffic volumes, especially in emerging economies.
The trend towards urbanisation should lead to expansion of roads and railways, it says. Electricity Transmission and Distribution (T&D) networks should see modest growth in developed countries to improve security of supply.
In emerging countries, it expects high and growing demand from new projects. Government budget constraints, however, may limit infrastructure spending. Low prices for power, oil, gas and coal will continue to weigh on capital expenditure.
This will affect conventional power generation, upstream facilities for oil and gas, as well as mining. Renewable energies, especially wind, will continue to benefit from strong political support and efficiency improvements. Affordability is the main constraint, says Moody's.
A word from Headwaters and Catalyst
Phil Seefried, co-founder and chief executive officer of Headwaters MB, and Mark Wilson, a UK-based Partner at Catalyst Corporate Finance, issued a comprehensive note on the topic late in June.
Their observations include the suggestion that global infrastructure construction will be among the key industries to watch as the political landscape in the USA begins to settle down into the reality of the Trump administration.
They see opportunities for US and UK investors business alike. These will arise as President Trump begins to make good on his campaign pledges to deliver major programmes of public works, despite his administration’s early teething problems.
Sectors in favour include global infrastructure construction industry
Investors remain convinced that president Trump’s administration will create exciting new opportunities. Infrastructure, where the president has promised huge programmes of public works, is a key focus.
It is not only US global infrastructure construction vendors that will benefit from these drivers. International businesses, including competitors from the UK, will find opportunities in each of these sectors too, as the ripple effect continues.
British and European businesses with interests in sectors such as Infrastructure are increasingly looking to the US as an important part of their growth strategies, reflecting perceived new opportunities in these areas.
Beyond the headlines
Catalyst's Wilson said: “Looking beyond the headlines, the stable economic backdrop continues to excite investors in the US, while US investors have the strength and confidence to pursue international opportunities.
“For UK businesses, opportunities in sectors such as infrastructure and natural resources look especially enticing in a Trump context, but there will be possibilities throughout the marketplace; UK businesses can also expect to continue to be targets for US investors.”
Global infrastructure construction industry lessons from the UK
A study released recently by Dr George Inderst, an independent adviser to pension funds, institutional investors, and international organisations also considers global infrastructure construction industry and what lessons the UK experience have for other countries.
In a nutshell, he notes, the UK has for some time been living on the combination of an ageing infrastructure, weak spending by the state (and taxpayers) and strong private sector involvement in infrastructure finance.
The country’s creaking infrastructure needs more investment when public budgets are already stretched. The question is, he suggests, whether private capital will be as easily available in future as in the past, especially from trusting institutional and foreign investors.
Major positive lessons from the UK experience include
- Importance of a stable political system and macro economy
- Solid institutional and legal environment, clear property rights
- Highly developed capital markets, with a strong and diverse investor base
- Open borders for overseas infrastructure developers, operators and investors
- Strong private sector involvement in infrastructure, both via privatisations and PPPs (public private partnerships)
- Proven regulatory system for utilities, telecoms, and other infrastructure sectors
- Long experience with PPPs, especially in social infrastructure with availability payments; PPPs in particular require time and a high degree of trust to succeed
- Financial centre with high private sector capacity and international expertise
I'm from the government; I'm here to help
For what it might be worth, a national technology roadmap that will support the growth and technical capabilities of the UK construction and infrastructure sector was launched by Lord Prior on 11 July at a meeting of the Construction Leadership Council (CLC).
The roadmap, produced by the Infrastructure Industry Innovation Platform and the Manufacturing Technology Centre (MTC), outlines the critical challenges which need to be addressed in order to meet the targets set in the Government’s Construction 2025 Strategy.
These include
- 33% lower costs
- 50% faster delivery
- 50% lower emissions
- 50% increase in exports.
The roadmap articulates key technologies – from augmented and virtual reality to autonomous sites – that will enable the industry to address its challenges.
It has been aligned around the CLC’s three strategic themes: Digital Transformation, Manufacturing Construction, and Lifecycle Performance.
The news, though, that the government is here to help is enough to send a chill down the experienced spine. The heart of anyone old enough to recall the late Harold Wilson's white heat of technology speech in October 1963 will surely sink. Does one laugh or does one cry?
What affects the sector’s share prices?
The strength of demand for infrastructure construction services. The availability of sufficient funds to pay for those services. The quality of management in the deployment of cash and other resources to meet contractual requirements and make a profit.
Global infrastructure construction contractor's development of revenues. Moody’s states that a company with shrinking revenues will typically show increasing contingent liabilities to revenues, until existing projects are completed and related guarantees expire. An increase in the order backlog.
Tradition, perspective and habit. George Inderst notes that most domestic UK institutional investors have traditionally been keen investors in listed utility stocks and bonds. They have been relatively late in seeking investment opportunities in the unlisted market sector.
The country has, so far, been seen as one of the most attractive investment targets by international investors. This is mainly due to an open, investor-friendly environment with clear property rights, a working judiciary system, and a relatively stable political framework.
Brexit could be negative
Brexit could be negative for constructors due to reduced European Investment Bank (EIB) funding, skills shortages, raw material price inflation and reduced foreign direct investment. So says broking firm Liberum in a recent paper on support services and special situations.
“We have already seen delays on Infrastructure projects (like HS2), but regional has been surprisingly resilient,” say Liberum analysts. “At the contractors, order books also reflect the adverse impact of delayed decisions.”
What can make one company buck the trend?
Recovery potential. An undervalued current share price. The ability to undertake work for a government keen to invest. Low wages, for although the so-called national living wage is now in force in the UK there are increasingly strident calls for it to be frozen (from bosses).
Good spread of sources of profitable business. Exposure to the railway sector where the UK government is pledged to spend more than £100bn in rail projects across the country, dominating the transport pipeline, as Liberum puts it.
Affordable housing and regional building are working well for Kier, the broker adds, saying that it also sees Morgan Sindall as a beneficiary of a commitment to the housing sector. Costain has strong positions in the key regulated markets, most notably highways and rail.
Liberum identifies Babcock as the key beneficiary of the Hinkley nuclear power plant project. It singles out Balfours as likely to secure the greatest overall revenue from HS2. Most UK contractors and consultants should benefit from Heathrow's third runway project.
What can make a company’s share price fall?
Ask Carillion. There could scarcely be a better text book example of how what can go wrong will go wrong. The company generates around 70% of its revenues from support services, estimates Liberum.
But as HS2 shows it remains involved in infrastructure construction. The company lost most of its value in two days of trading this month. The Times cited a succession of botched projects which forced it to take £845m of provisions against a market value around £830m).
The level of debt and possible pension problems also quickly became issues of concern. By the end of the week the share price was less than one-fifth of its year's high and it had appointed HSBC as an adviser, to help repair its finances as the Financial Times put it.
Carillion seeking apprentices...
A debt-for-equity swap looked certain to dilute existing shareholders heavily. Rank bad management was the root cause, it would seem. Yet still it wins contracts.
What should I look out for in company accounts?
Pension obligations: does the company have a pension deficit? If so how is it tackling that deficit? Can it close the deficit? Are the plans realistic? Is it an infrastructure construction company or a pension fund with an infrastructure construction business attached?
Sales and the direction of sales. Costs and the direction of costs. New business being acquired: is it keeping pace with business completed? How strained is the balance sheet?
What else is there to watch out for?
Is the company over-indebted? Is management remuneration controversial or a non-issue? How aligned are the interests of the management with the separate interests of shareholders, staff and other interested parties?
Moody’s points to contingent liabilities. Global infrastructure construction contractors typically have to provide a certain percentage of a project’s contract amount as security. This varies project to project. In its rated universe in Europe, this ratio is typically 0.5-1.0x. However, it can vary.
Global infrastructure construction vendors bidding for public contracts in certain jurisdictions may be required to post performance bonds of up to 100% of the contract value, irrespective of their credit standing.
Project finance cost a factor
The project finance cost for the client is another factor monitored by Moody's. Many large infrastructure projects have their own project financing. Financing cost will depend, among other things, on certain security provided by the contractor to minimise credit risk.
The contractor’s size and scale and its general credit quality are also pertinent. The lower the credit quality the higher the amount of security requested by clients. Higher-rated companies like Vinci SA (A3 stable) and Petrofac Limited (Baa3 negative) are at the low end.
Lower-rated companies like Obrascon Huarte Lain SA (OHL Caa1 negative) have relatively high contingent liabilities. At the same time, highly rated companies might be more generous with providing bonds, given the relatively low cost related to them.
A track record in terms of execution of other projects matters. Global infrastructure construction contractors with a relatively limited track record - especially if they are or expanding in new markets and regions - will typically be required to provide more security and guarantees than well-established ones.
The earlier the stage that projects are in, the higher are the execution risks.