Recovery Report, Part 1: Money talks

Is the GCC construction sector prepared for economic recovery?

Ziad Makhzoumi: Arabtec's chief financial officer says management needs to be more dynamic.
Ziad Makhzoumi: Arabtec's chief financial officer says management needs to be more dynamic.
Before the financial crisis, there were many more commercial high rises and real estate towers being constructed in Dubai.
Before the financial crisis, there were many more commercial high rises and real estate towers being constructed in Dubai.

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Nine months into 2010, and there is a sense in parts of the region that the industry may be through the worst of the economic downturn.

New markets have been a huge focus for most companies, with more Dubai-based construction firms looking across the GCC for opportunities.

But for contractors to win new business, it is not only important that the projects are available, but that the contractors themselves have the necessary funding to bid for them.

Given today’s highly competitive market, which includes an influx of international players, they are seemingly under more pressure than ever to ensure the appropriate funds are immediately accessible.

“The key to taking advantage of the opportunities which the GCC countries offer the industry is to be suitably positioned to seize the opportunity,” explains Arabtec’s chief financial officer, Ziad Makhzoumi, who is working hard to ensure his company stays at the forefront of new and existing GCC markets by maintaining strong control of cashflow.

“Working capital is rarely a top priority for operating managers, but at times like these, it should be a high priority on the corporate agenda.”

ALEC’s financial director Greg Walsh agrees. “There’s a saying in the construction industry. ‘If you win a tender, you’ve made a mistake or forgotten to price something correctly!’ Clearly, remaining competitive in today’s market is no mean feat considering the portion of provisional sums that make up any tender. It’s getting to the stage now where tenders are won based on who is the bravest and how good your last contract was,” he says.

Challenging times
Certainly one of the biggest symptoms of the global financial crisis within the construction industry has been a difficulty to manage cashflow in the wake of a non- and late-payment period.

As cash-strapped developers struggled to stay afloat, payments to contractors either slowed down or stopped completely in some quarters, causing some contractors to walk off-site.

After months of speculation about whether or not struggling contractors would ever receive payment, and in turn, what would happen to these delayed and abandoned projects, some positive steps towards resolving the payment issues began to occur towards the end of the second quarter of 2010.

The question being asked today is: does this mean that contractors now have enough capital to compete for new projects in the event of an upturn? Have the last six months helped them to access the appropriate funds to facilitate their movement into new markets, which for some is critical for their survival?

“From my point of view,” says Walsh, “the UAE construction market is facing very challenging times in 2010 compared with 2009. As construction projects generally span more than a 12-month period, most of 2009 was spent completing projects that were already in the contractors’ order books, which gave some stability to the industry. Now, many of these projects are completed and handed over.”

Makhzoumi agrees that the construction industry is not out of the woods yet, but attributes the problems more to a lack of payment resolutions.

“In Dubai, although Nakheel has come up with a solution and has started payment, other developers have not sorted their cash situation and have therefore not started making substantial payments yet,” he says.

Exacerbating problems, are the current payment terms being negotiated with clients and the availability of funding from the region’s financial institutions.

The fact that pricing tends to be agreed and finalised at the end of a project, for example, continues to create difficulties for contractors who have borne the brunt of initial project costs.

“This again has an impact on cashflow as the work is not certified along with the original contract value in spite of it being done,” says Makhzoumi.

“Over the last few months, this has meant that many contractors have essentially funded these variations, which in some cases have been significant.”

" Also in the last nine months we have witnessed clients asking to re-price contracts for projects that have not yet commenced but are planned to go ahead,” he adds.

Limited access to finance meanwhile is, according to Walsh, adding to the mounting pressure on contractors and making it difficult for them to compete with global firms that have the advantage of being international.

“When it comes to facilities from financial institutions, there is either nothing on offer or rates that are unaffordable, especially for the second tier contractor,” he says.

“In my personal opinion, the targets and tight timeframes the central bank has set have resulted in the majority of institutions changing their business models, with some opting to stay clear of the construction industry.”

These problems in mind, both experts believe that only the bigger contractors are really prepared to take on new projects.

“Contractors that are under-capitalised, have restricted bank facilities and outstanding receivables are stuck and will suffer most, because they do not have the money to expand into new markets or fund new projects,” Makhzoumi explains.

“On the other hand, companies that can survive this deep recession will not have a problem raising funding when there is an upturn. That said, initially, the cost of funding will be high, and they will need to manage their cash aggressively.”

Similarly, but without claiming to know for sure how the industry is coping currently due to a lack of listed companies and financial reporting, Walsh believes that the coming months and years will be a test for the Middle East building sector.

“The drastic reduction of liquidity across the construction industry has put huge strain on the supply chain and this is going to be a real litmus test during any future upturn or sudden shift in the market. The major contractors will manage to ride out the storm, especially those that are diversified, but a major portion may not survive.”

Moving forward
With many new projects and government investment schemes this year, from Saudi Arabia and Azerbaijan to north African states such as Egypt and Libya, 2010 is no time for contractors to give up.

Irrespective of being the largest construction contractor in the UAE, Arabtec is also going through some challenging times. The company’s most recent financial results for Q2 2010 for example, showed a 23% fall in after-tax profits from AED393.3 million for the same quarter last year to AED301.7 million in 2010.

That said, the company continues to surge ahead, committed both to diversifying its markets and taking a somewhat strategic approach to cash management.

Likewise, Walsh explains that ALEC is focusing on new sectors, and on reinforcing win-win relationships with stakeholders, suppliers and subcontractors, as well as financial institutions.

“I believe we face a recession which is expected to be severe and prolonged, combined with exceptional stress in the financial system,” says Makhzoumi. “Even as funding opportunities begin to re-emerge, it will be essential to maintain financial strength and independence, and to keep tight control of finances.”

Among his many tips for struggling companies, this year, Makhzoumi advises that all contractors make it their focus to understand how refinancing needs to evolve, and that they develop contingency plans to prepare for future funding gaps.

He also suggests that firms manage their company receivables effectively so as to limit expensive and increasingly risky trade credit, and implement strict spending controls internally with a view to improving their financial strength during rocky economic times. He maintains that there needs to be a shift to a more dynamic management approach in a more complex and unpredictable environment.

“This should include restructuring balance sheets, business models and overall business strategies. At the same time, it is important to remember that the mid- and long-term implications of these measures need to be evaluated, especially because the current climate offers the chance to pursue capital investment opportunities at a lower than normal cost.”

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