Thailand’s Engineering and Construction Industry in 2017 and Outlook
Executive Summary
TRIS Rating believes that intense competition in the engineering and construction (E&C) industry will continue through 2018 as private sector investment plan remain flat. Many E&C companies will try to participate in public sector projects despite the higher funding needs. More E&C companies will diversify to other line of business in order to secure long-term, stable source of recurring income. TRIS Rating expects to see higher leverage of the large E&C companies focusing on big infrastructure projects. Financial flexibility, good relationships with creditors, and a defendable competitive edge are the key success factors over the medium term.
Sluggish private investment and fewer construction projects
In 2016, the value of total construction in Thailand equaled Bt1,224,327 million, or about 8.5% of gross domestic product (GDP). The aggregate value grew 8.1% in real terms in 2016, slower than 15.7% growth rate recorded in 2015. During the past decade, construction activity accounted for 8%-9% of the country’s GDP. This level is lower than before 1998, when construction activity surged together with the property sector boom. Before 1998, construction activity accounted for over 10% of GDP.
TRIS Rating expects that public sector construction projects will continue to drive the industry in 2017-2019. In 2016, spending on public sector construction projects grew 14.0% in real term. Though high, the growth rate is lower than in 2015.
Role of public sector construction in driving the industry has increased since 2015. Public sector construction spending grew by 32.5% in 2015 from a year earlier. In contrast, private sector construction expenditures barely grew during the same period, rising by merely 1.1%. Private sector construction expenditures accounted for less than 50% of total construction expenditures from 2015 through the first quarter of 2017.
TRIS Rating believes that the slowdown in private sector construction during the past two years was primarily due to the lack of investor confidence in the domestic economy. Economic growth has slowed as the real growth rate slipped below 4% since 2013. This rate is lower than the average annual growth rate of 4.6% achieved during the past decade (2002-2012). In addition, we believe that private sector construction, which mainly derived from residential property, was affected by a slowdown in demand for housing. The number of new registered residential property grew by merely 0.6% in 2016 after a drop of 5.8% a year earlier. Between 2014 and 2016, the value of construction of residential properties declined marginally in real terms, slipping by 0.20%.
The government has laid out plans to invest in several public projects, including a number of very large transportation infrastructure projects, worth Bt2.3 trillion. The major infrastructure investment projects included the expansion of the mass transit system in the Bangkok metropolitan area and the construction of railways to link a number of provinces across several regions of the country. We expected these public sector construction projects will generate more private sector investment, in property development for instance, alongside the areas of the new infrastructure projects. The public sector investment will also stimulate economic activity in other segments. In 2017, the Office of National Economic and Social Development Board (NESDB) forecasts government investment will grow by 12.6%, up from 9.9% a year earlier. NESDB also projected private sector investment would rise by 2.0% in 2017.
As of July 2017, TRIS Rating announced the ratings of seven domestic E&C companies. The ratings of the E&C companies range between A- and BBB-, as summarized in Table 1.
Heightened competition squeezes margins
Consistent with the construction industry, TRIS Rating observed the slowdown in the E&C industry and higher competition. Revenues of 18 major E&C companies included companies rated by TRIS Rating and non-rated companies declined between 2015 and the first quarter of 2017.
Operating profit margins of most rated E&C companies ranges from 6%-10% between 2012 and 2016
The contractor business by nature has a low level of leverage, as contractors typically fund a portion of the construction activity with cash advanced by project owners. The ability to generate a profit relies largely on the contractors’ ability to control the costs and the construction period according to the items in the construction contract. Some companies in the E&C industry are especially proficient at this and the operating profit margins reflect this skill. For example, Sino-Thai Engineering & Construction PLC (STEC; issuer rating A-/Stable) earned an operating profit margin of 8.7% in 2016 and Syntec Construction PLC (Syntec; issuer rating BBB/Stable) recorded an operating margin of 16.2%.
Some E&C companies make long-term investments, causing leverage to rise before the returns are realized. The returns from the long-term investments generally will not be recognized during the early stages of the projects while the financial burden remains pressuring profitability. E&C companies that have large investments in long-term projects, such as CH. Karnchang PLC (CK; issuer rating A-/Stable), Italian-Thai Development PLC (ITD; issuer rating BBB-/Stable) also recorded higher debt levels.
Higher leverage at E&C companies holding long-term contracts for big government infrastructure projects
Large public sector construction projects cause E&C companies to carry a higher financial burden during construction period
TRIS Rating expects that government projects will continue to drive the construction industry over the next few years. Consequently, E&C companies with a good track record that specialize in government projects will be in good position to increase their construction backlogs and the investment opportunities. However, participation in large scale government projects will increase the debts of the project developers and contractors until the construction processes finished and the projects earn income. Government policies to provide concessions to project developers, based on public-private partnerships (PPP), will encourage private sector companies to participate in public sector projects. One example of a PPP project is the concession recently granted to BSR Joint Venture (BSRJV). BSRJV was awarded a contract to construct and operate the Yellow Line and Pink Line electric rail routes in Bangkok. The construction cost of approximately Bt45,000 million each will be initially borne by BSRJV. Based on this example, E&C companies that aim to bid for mega infrastructure projects should have a capital structure strong enough to carry a sizeable debt for at least a few years.