How did GCC's construction sector fare in Q3 2016?

Developers flourished during the third quarter of 2015, but a number of large UAE contractors suffered significant setbacks

Client comfort: the current market is favouring developers like Aldar, which is responsible for Yas Mall.
Client comfort: the current market is favouring developers like Aldar, which is responsible for Yas Mall.

Alarm bells began to ring in the UAE late last week as Dubai’s bourse dropped 3.7%. On 15 November, Dubai Financial Market (DFM) closed at its lowest value since December 2014, driven primarily by the weak performance of several locally-listed construction firms.

Drake & Scull International (DSI) surpassed DFM’s maximum daily fall limit of 10% to an all-time low as it reported a third-quarter net loss of $268.18m (AED985m).

The contractor reported a 28% decline in its revenue for the first nine months of 2015, dropping from the $980m (AED3.6bn) figure achieved in 2014 to $762m (AED2.8bn).

Though DSI’s order backlog of 160 projects stood at $3.3bn (AED12.3bn) as of 30 September, 2015, the company recorded a net loss of $258m (AED951m) for the year’s first nine months. A stark contrast to the $26m (AED97m) figure of the corresponding period last year.

Elsewhere, Burj Khalifa-builder Arabtec recorded a $257m (AED945m) net loss during Q3 2015, compared to a net profit of $18.7m (AED69m) for the same period of 2014. The contractor’s quarterly revenues from continuing operations declined by 24% to $435m (AED1.6bn) from $571m (AED2.1bn) in Q3 2014.

Arabtec’s results came despite progress on two $272m (AED1bn) projects, which include 601 villas in Arabian Ranches 2’s Rosa, Rasha, Yasmeen, and Lily communities.

Outside the UAE, Saudi Arabian contractor, Abdul Mohsen Al Khodari and Sons, recorded a $3.81m (SAR14.3m) loss during the third quarter. New contract awards for the firm slumped to $8.26m (SAR31m), a stark contrast to the $147m (SAR554.6m) work secured in the same period last year.

Though their losses were significant, DSI, Arabtec, and Abdul Mohsen Al Khodari were by no means the only contractors to feel the pinch in Q3 2015. Interestingly, the region’s developers appeared to emerge largely unscathed.

Developer finances buoyed the UAE’s construction market during the quarter. DFM-listed developer Damac posted a net profit of $1bn (AED3.6bn) for the first nine months of 2015, an increase of 43% from the same period of 2014. The luxury developer recorded revenues of $1.8bn (AED6.7bn) in the year’s first nine months. Commenting on the results, Hussain Sajwani, the firm’s chairman, said: “We believe Dubai is well set for continued growth, and we expect the city [to] outperform established metropolitan centres around the world.

“This outperformance is underpinned by a stringent and efficient regulatory framework which supports the government’s vision to create a sustainable city,” he added.

In the UAE’s capital, Aldar – listed on Abu Dhabi Securities Exchange (ADX) – reported a 9.4% increase in net profits for Q3 2015. It recorded a profit of $172.7m (AED634.3m), compared to $157.7m (AED579.6m) in Q3 2014. Responsible for Yas Mall, the firm also recorded a quarterly gross profit margin of 47%, up from 26% year on year.

The vastly contrasting results posted by construction firms operating within the same geography serve to illustrate just how turbulent the UAE’s construction market has become. In this climate, it is difficult to predict how listed construction firms in the country – many of which work directly or otherwise on government-funded developments – will realign their strategies for the coming year.

Companies will have to find ways to reduce costs and increase productivity if they are to overcome this year’s challenging economic conditions, which many predict will continue into 2016.

Arabtec has implemented cutbacks to its operations amidst “difficult regional market” conditions. These measures have caused the company to take charges against “a limited number of challenging projects”, thus reversing $103m (AED279m) in claims. This strategy, the firm stated, has increased its direct costs, leading to a gross loss of $168m (AED617m) for the third quarter of 2015, compared to a $73.2m (AED269m) gross profit for the corresponding period of last year. Consequently, Arabtec has now assumed a “more selective approach to project targeting”, and is keen to focus on markets where it has a “clear competitive advantage”, added the contractor.

In a statement to DFM, Arabtec said its internal restructuring and cost-reduction programme is also in effect, and has resulted in annual savings worth $25.8m (AED95m) for the company so far.

Similarly, DSI claims the decline in its revenues is partly due to the adjustments it has made for uncertified variations orders and disputed time claims extensions.

It appears that the Middle East’s already cut-throat construction market is being hampered by payment deference and delays by clients and developers, which DSI said has negatively impacted finances in key markets across its 160 project-strong backlog – two of which are Saudi Arabia (32%) and the UAE (20%).

The UAE-based contractor’s response to these externalities has, unsurprisingly, involved cost-cutting measures, and the company admits it has had to “take a more conservative approach to its financial position”.

Khaldoun Tabari, chief executive officer and vice chairman of DSI, explained: “As the current regional construction sector remains extremely challenging, we have taken a pre-emptive and prudent view of our exposure related to key projects and have introduced cost-efficiency measures to preserve cash and initiatives to reduce debt.”

These strategies also led DSI to account for “one-off provisions” for its ongoing arbitration and legal cases in the UAE and Saudi Arabia, as well as adjustments for revenue and gross profit related to claims, disputes, and accrued certified work.

“[In the] longer-term, we remain confident about the prospects for the company,” Tabari continued. “Regional government diversification programmes and infrastructure investments remain a significant tailwind in the GCC, but our clients [are] committed to funding and completing their ongoing projects.”

But for Tabari to have it his way will require that GCC governments pay heed to the warning signs of a market downturn.

On 8 November, 2015, Christine Lagarde, managing director of the International Monetary Fund (IMF), warned of a slowdown in regional growth as the region’s fiscal and current account balances deteriorate. “At the moment, a large share of fiscal and export revenues in the GCC come from oil,” she said, adding that public spending on megaprojects might have to be scaled back in order to compensate for significantly reduced state incomes.

Only time will tell whether Q4 2015 results will bear the brunt of reduced public spending in the region. An altogether less controversial assertion is that finances within Gulf construction are likely to remain delicately poised for the foreseeable future.

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