Down to delivery: Government projects will give the sector a boost, if they go to plan

Infrastructure development has been placed at the heart of South Africa’s new economic transformation plan. For the National Planning Commission, it is seen as a silver bullet that will get the economy moving once again and create jobs in a country that historically suffers from chronic unemployment. However, the response thus far has been muted. It seems that a raft of postponed government projects and diminishing spend on infrastructure over the past three years has left most contractors cautious about a rapid turnaround.

MULTIPLIER EFFECT: In February 2012, Pravin Gordhan, the minister of finance, announced the medium-term budget policy statement in parliament, which calls for approximately R845bn ($107.5bn) of spending on infrastructure over the next medium-term expenditure framework (MTEF) period to improve market access and reduce costs in the economy.

The hope is that this counter-cyclical spending can have a multiplier effect on economic growth, pushing up GDP and reducing the high levels of unemployment, which stood at 23.9% in the fourth quarter of 2011, according to Statistics South Africa. Gordhan said that public sector infrastructure spending for the MTEF period ahead would reach R262bn ($33.3bn).

However, many contractors operating within the sector are sceptical about the potential positive impact this will have on the construction industry as a whole. Ed Jardim, the spokesperson for Murray & Roberts, one of South Africa’s biggest construction contractors, told The Mail and Guardian in September 2011, “We believe that even if the South African government put projects out to tender now, construction would not start this year and the benefit of these contracts would only be seen in the group’s 2013/14 financial year.”

Murray & Roberts has targeted R10bn ($1.2bn) worth of public infrastructure contracts in the near term. Wilson Bayly Holmes Ovcon (WBHO), another top-five contractor in South Africa, is also setting its sights on government tenders, estimating that R13bn ($1.6bn) of its R23bn ($2.8bn) development pipeline will come from government projects specifically in social infrastructure and public-private partnerships (PPPs).

CONTRACT DELAYS: The expectation of government contracts is exacting a heavy toll on many of the country’s leading contractors, however. Companies that have built capacity around the expectation of tenders, and that have spent significant funds on them, are now beginning to see an erosion of their margins as tenders are delayed and their additional capacity, particularly in terms of labour, goes unused.

According to the Nedbank capital expenditure project listing report, there has been a significant decline in the number of projects actually announced by the government, falling from R42bn ($5.1bn) in 2008, to R19bn ($2.3bn) in 2009 and R4.2bn ($514.1m) in 2010. As a result many companies are becoming disillusioned, particularly with the PPP process. According to Neil Cloete, the group CEO of Liviero, “If PPPs are the way to go, we are not setting a good example to follow.”

IMPACT: Basil Read, one of the big five construction companies in the country, has spent R50m ($6.1m) on bidding for PPPs between 2009 and 2011 and has no contracts to show for it. Postponed and cancelled projects have already had a significant impact on the industry, with the first contractor retrenchments beginning in 2011. Group Five, the fourth-biggest contractor, slashed 500 jobs in the five months to December 2011. This may not be a big loss for a company with 12,000 employees, but the industry as a whole had lost more than 80,000 jobs since 2008 by the third quarter of 2011.

Group Five’s retrenchment was, at least in part, a response to losses through delayed government tenders. In 2011, the company threatened to take legal action against the Department of Correctional Services for the costs incurred by the company after the cancellation of a tender for a PPP project for the design, construction and management of four new prisons in Paarl, Nigel, East London and Klerksdorp. The tender was cancelled after it was established by the department that the PPP model was at odds with the policy stipulating that security and custodial services could not be handed over to third parties.

CONTRACTOR CONFIDENCE: Such developments have knocked the confidence of contractors that the government can reliably deliver on its project pipeline. The First National Bank/Bureau for Economic Research Civil Construction Confidence Index stood at 26 at the end of 2011, suggesting that almost three-quarters of respondents were dissatisfied with the current business conditions. The government is likely to take some solace from the marginal improvement of five index points from the third quarter of the year.

The South African government, on the other hand, is projecting confidence in its overall ability to meet its spending projections for infrastructure development. Indeed, President Jacob Zuma has got fully behind the plan, establishing a Presidential Infrastructure Coordinating Commission in July 2011 to coordinate and monitor the implementation of this strategy. According to the 2012 budget policy statement, just under R300bn ($38.2bn) will be invested in the energy sector, another R262bn ($33.3bn) is slated for the transport and logistics industry, while an additional R12.3bn ($1.57bn) will go to health care infrastructure and a further R207bn ($26.36bn) is allocated to education.

BIDDING ROUNDS: Nonetheless, these areas are likely to transform into a significant source of work for both local and international contractors over the coming years. In February 2012, Mike Upton, the CEO of Group Five, told Bloomberg that the company plans to bid for the country’s renewable energy projects by the March and August deadlines. The Department of Energy put out a tender for the first 3725 MW of renewables capacity under the Integrated Resources Plan in August 2011. This capacity is expected to be delivered by 2016 and draw local and international investment of $ 10bn12bn. In December 2011, the energy department announced the preferred bidders for this phase of development. In a statement to the press, the department said, “From phase one of the large-scale renewable project, 53 bids amounting to 2128 MW were received across wind, solar photovoltaic, concentrating solar power (CSP) and small hydro. The evaluation resulted in 28 bids with a total MW of 1416 being selected as preferred bidders.” There are five deadlines for the renewables programme, which is expected to contribute some 17,800 MW, or 42%, of generating capacity by 2030. The next bids will be received in 2012.

As part of this process, the South Africa government signed a $250m loan deal with the World Bank in November 2011 to support the construction of CSP and wind power plants. The funds will be directed through the state-run utility provider Eskom as part of its Clean Technology Fund and will go towards developing a 100-MW CSP plant and a 100-MW wind plant.

THINKING NUCLEAR: In October 2011, The Mail and Guardian newspaper reported that the government might issue a R1trn ($122.4bn) tender for the construction of six nuclear plants by 2030. According to Cloete, “Nuclear power would be very important for the construction industry. This would be South Africa’s single-biggest infrastructure investment ever. Everything else would pale into insignificance. When this happens, we will see a revitalisation of the construction sector, opportunities for localisation and employment.”

There has already been significant interest from international firms, with the French company EDF telling the Reuters news agency in February 2012 that it was preparing to submit a bid for the tender, which is expected in June. “We are in a position to either offer a fully French technology, such as the EPR [next-generation nuclear reactor], or a Franco-Chinese technology in partnership with Areva and China Guangdong Nuclear Power Corp,” CEO Henri Proglio said.

TRANSPORT & HEALTH: These headline projects will be supported by a number of smaller projects in both the transport and health sectors. In the latter segment, there has already been some movement. In July 2011 President Zuma announced plans for a new R250m ($30.6m) hospital in Limpopo to help resolve rural health challenges in the province. The hospital is expected to be built in phases over three years.

This was followed in November 2011 by the announcement of a further R50m ($6.12m) for reconstruction of KwaZulu-Natal Children’s Hospital. The project is expected to be complete by the beginning of 2015. The provincial department of health has a R2.2bn ($269.3m) slate of ongoing projects to overhaul its health care infrastructure, including the expansion or upgrade of five hospitals throughout the province.

This suggests that a steady stream of projects is beginning to flow into the sector and, more importantly, the country as a whole. While smaller firms may have their sights set on the municipal projects, the big players will be looking toward the realisation of transport and energy developments. Although confidence remains low among contractors, a number of larger tenders seem to be materialising. This should begin to buoy a fragile sector, and if the government can deliver on its pipeline projections, 2012 could well be the year when the industry begins to emerge from its current slump.