Source : The Business Times, June 30, 2008Tiptoeing gingerly around the sector, think specialised, short and selectiveTHEY say there's no business like show business; right now, they are also saying there's no worse business than the construction business.
The construction industry is being battered from every angle: margins are being squeezed; sand, concrete and steel prices have been taking turns to take off; and residential property sales have turned anaemic.
Steel suppliers further tightened the screws by cutting the lock-in period for steel prices from six months to three months early this year, leaving contractors even more vulnerable to price fluctuations.
It isn't surprising then that some pundits are ironically predicting the destruction of the construction business.
'This is a very bad time to be looking for bargains in the construction industry. It's in bad shape and is the worst hit by inflation,' says an analyst who does not want to be identified.
Other analysts, however, are decidedly bullish on the industry and insist that all builders cannot be tarred with the same brush.
'Investors are not able to differentiate between specialised and integrated construction firms. The former have a lower risk profile,' explains CIMB analyst Lawrence Lye.
Investors should bear in mind the three S's when tiptoeing around the minefield of construction stocks: think specialised, short and selective.
Specialist companies involved in specific parts of a construction project may be better placed to stay out of the crossfire between suppliers and the main contractors that attempt to do everything.
'We would recommend investors reduce their exposure to integrated construction companies,' Mr Lye says. 'These companies have large order books and stand a higher risk of margin erosion.'
Instead, he suggests specialist firms with low exposure to construction material costs, like Tat Hong and Tiong Woon, both of which are crane-leasing companies.
With commodity prices being contractors' Achilles heel, firms with shorter- term contracts are better bets, like foundation engineering firm CSC Holdings, according to Mr Lye.
'CSC's average contracts are short at three to six months, which limits its exposure to fluctuating prices,' he says.
And while trite, it pays to remember the adage, 'location, location, location'. Selective locations, in particular.
'Wealthy buyers tend to be more discriminating, and they will be looking for property in areas like Districts 9, 10 and 11 which are not overbuilt,' says Mr Lye.
Contractors with projects in such areas will be safer bets, as prices are expected to remain relatively higher.
BBR, a contractor working on a development in Nassim Hill, would appear to fit the bill, especially since the estimated benchmark sale price of a similar unit was $2,200 per square foot in June, far exceeding BBR's breakeven price of $1,304 psf on the project.
One particular firm that has struck out on all three counts is Lian Beng Group, a main contractor saddled with a large order book of $800 million extending till 2010 and unsold residential properties.
Order books provide an indication of both future revenue and costs. The larger and longer a firm appears to be committed to an order, the larger and more risky its exposure to raw material price increases.
While Lian Beng's latest projects in Bukit Timah and Emerald Hill are estimated to have higher gross margins, its overall development portfolio remains a risky bet.
'We are cutting our FY08-10 forecasts for Lian Beng by 11-60 per cent to account for risks in its property development profits, which stem from projects such as Lincoln Lodge and Kovan Road, where benchmark transacted prices have fallen below breakeven costs,' Mr Lye said in a report this month that downgraded Lian Beng from 'outperform' to 'neutral'.
Kim Eng analyst Wilson Liew begs to differ on Lian Beng, citing the contractor's advantage in controlling raw material costs because it owns a batching plant for ready-mixed concrete, and maintaining a 'buy' recommendation.
Even so, the writing on the wall cannot be ignored. The valuation of the company has been lowered from $1.12 to $0.68 per share by Mr Liew, based on an expected shrinkage of all-important margins.
In addition to its three strikes, Lian Beng also falls into a category of firms that now fancy themselves as property developers as well.
This category also includes the likes of investment holding company Eastern Holdings and is dismissed by CIMB's Mr Lye as 'Johnny-come-lately firms that snapped up land in the middle of 2007 when property prices had peaked, right before the meltdown in July'.
'Reduce exposure to contractors that have turned opportunistic property developers late in the cycle,' he says. 'These are likely to be saddled with unsold inventory or expensive land.'
And if you must invest in a giant, go for one that has fluctuation clauses to manage raw material prices, like main contractor Chip Eng Seng.
'Gross margins for public projects are likely to remain stable at around 5 per cent, as increases in raw material prices will be protected by fluctuation clauses,' Westcomb analyst Wong Say Tian said in a report this month on Chip Eng Seng. 'We estimate that public projects account for about 60 per cent of the group's existing order book.'
While the bottom line may take a beating for some builders this year, it is still clear: investors should avoid construction companies built on sand if they want a solid portfolio.
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They will comprise 1,587 premium flats - 55 three-room, 1,222 four-room and 310 five-room flats.
