Planned spending by the Nigerian government set to boost construction sector

As the continent’s most populous nation and arguably its biggest economy, Nigeria offers a lot of potential for construction firms – particularly given the significant need for infrastructure work, from housing to roads. However, meeting this demand will require overcoming a number of obstacles, ranging from cash flow issues and payment delays to import of equipment and building material costs. A difficult macroeconomic environment is also constraining efforts to remedy this situation in the short term.

Size & Scope 

Nonetheless, the construction sector remains an important component of the West African nation’s economy. In the fourth quarter of 2015 it contributed 3.58% to GDP in real terms, according to figures from the National Bureau of Statistics (NBS). However, 2015 was a difficult year for the industry, and in the fourth quarter of that year the sector shrunk by 0.35% year-on-year in real terms. This represents a dramatic reversal, compared to stellar growth in 2014. Indeed, in the fourth quarter of 2015 the real growth rate of the construction industry was 13.01 percentage points lower than the same quarter a year earlier, according to the NBS. The country’s wider economic difficulties, caused by a precipitous drop in the global price of oil, have had severe ramifications for the construction sector. Contracts have dried up or been unfulfilled, and companies have had to take extreme retrenchment measures in order to survive. Estimates of job losses in 2015 due to the economic downturn range from 15,000 to 70,000.

Sector Composition 

In terms of sectoral activity, infrastructure projects account for the majority of projects. According to consulting firm Deloitte’s “African Construction Trends Report 2014”, utilities took the lion’s share of work in 2014. Water accounted for 39% of construction works, while energy and power projects accounted for 17%. Meanwhile, the oil and gas sector consumed a further 17% of work, transport took 15% and real estate contributed 11%.

This is largely in line with trends in the region in general. Across West Africa the transportation, energy, mining and water segments are the main sources of contracts. Given the nature of this work, it is hardly surprising that the public sector accounts for the largest share of projects in the region, at 68%, well ahead of third-party countries, who own a further 21% of projects, according to Deloitte. Domestic private investors can claim only 10% of projects in the region, although this is up from 8% in 2013. That may change in the coming years, with projects such as a $14bn petrochemicals and refining complex in Lagos State, backed by local industrial conglomerate Dangote Group, breaking ground.

Public Sector Constraints 

The composition of the local construction sector offers reasons for both optimism and pessimism. Given that the government provides the impetus for the growth of the construction pipeline, the current federal fiscal situation is cause for concern. On the back of a range of expansionary measures, the 2016 budget deficit is expected to reach 2.16% of GDP, or N2.2trn ($6.9bn). This will include international loans of N900bn ($2.8bn) and N984bn ($3.1bn) in domestic loans in order to fund the deficit, according to Reuters.

This precarious situation is a consequence of plummeting crude oil prices. Nigeria remains highly dependent on its hydrocarbons industry, and hence vulnerable to exogenous shocks. In 2011 oil and gas accounted for 70% of government revenues, according to IMF data. With oil prices falling by 57% between mid-2014 and the second quarter of 2016, public revenues will be under pressure in the 2015/16 fiscal year. Indeed, the government estimates oil will represent just 21% of revenues, or N820bn ($2.6bn). This is based on a crude oil price of $38 per barrel. The travails of the oil industry have had wide-ranging economic consequences, including a weakening naira, public sector payment problems and job losses.

Stimulus Spending 

However, the 2016 budget deficit is also an indication of the government’s intent to increase capital spending as a means of stimulating the economy and staving off recession. The government plans to triple capital spending in 2016. In December 2015 Nigerian President Muhammadu Buhari announced that under a three-year plan total spending – both capital and current – is set to increase to N6trn ($18.9bn). This stimulus should be good news for the construction industry.

Such government spending is necessary, not only as a means of stimulus, but also to plug the sizeable gap in Nigeria’s infrastructure. Compared to South Africa, which has a similar sized economy but a smaller population, the West African nation’s infrastructure is significantly lacking. In the transportation sector, for example, Nigeria has 200,000 km of roads and 0.004 km of rail per sq km of land, compared to South Africa’s 750,000 km of roads and 0.016 km of rail per sq km of land, according to investment advisory firm RisCura’s 2015 “Bright Africa” report. It is a similar story when it comes to utilities. Nigeria has 34 MW of installed electrical capacity per 1m people, compared to 784 MW per 1m in South Africa.

Infrastructure Fund 

Given this situation, in October 2015 the government announced plans for a $25bn national infrastructure fund. Laolu Akande, spokesperson for Nigeria’s vice-president, Yemi Osinbajo, stated that the capital required for the fund would come from the country’s sovereign wealth fund and local pension funds, as well as from international sources. Akande told Reuters, “The vice-president disclosed that other sovereign wealth funds have already indicated an interest in the fund, which would be used to address the nation’s decaying road, rail and power infrastructures.”

This would help to support some of the objectives of the National Integrated Infrastructure Master Plan (NIIMP), developed under the administration of the previous president, Goodluck Jonathan. The plan sets out a blueprint for development against which investors can assess the viability and profitability of their own projects. Buhari has stated that his intent is to support and extend this strategic plan. Under the NIIMP, the government aims to vastly improve the country’s stock of infrastructure over the next 30 years, with $3.05trn to be spent until 2043. During the first years of the plan the federal government and states are expected to provide 52% of investment against the private sector’s 48%.

Budget Execution 

The current administration’s renewed focus on infrastructure is a cause for some optimism in the construction industry. However, given the current economic situation, the funding and execution of this programme remains a key concern. The federal government’s track record on the release of budgeted funds for projects does not provide any reason to be overly optimistic about the implementation of this plan. For example, in 2015 the year’s capital spending programme was still 65% under its full allocation by the end of the third quarter of the year, according to financial services consultancy PwC. This is a recurrent problem that hampers the release of funds for construction projects.

Nevertheless, given the massive increase in projected capital expenditure in 2016 of 215.9%, according to PwC, the government is likely to substantially exceed its 2015 capital spending levels, even if it is unable to fully meet the allocation laid out in the budget. Furthermore, significant steps have been taken to reduce the mismanagement of funds throughout the federal government.

In February 2016, for example, the Federal Ministry of Justice announced that N2trn ($6.3bn) that had been grafted from the national Treasury over the past 12 years had been recovered by the Economic and Financial Crimes Commission during the course of its investigations into corruption in government. In addition, in February 2016 the government completed the transition to a Treasury Single Account, which consolidates dozens of previous independent bank accounts for ministries and agencies, greatly improving transparency. This marks an important step forward in boosting financial accountability and the disbursement of funds.

Cash Flow 

The construction industry also has a substantial debt burden and large outstanding liabilities to suppliers. Few companies have any capital reserves, and therefore most are reliant on commercial banks. Loans from such institutions come at a substantial cost, with interest rates as high as 25%.

The difficulties of Julius Berger Nigeria, one of the biggest contractors in the country, illustrate the challenges facing the sector. In June 2015 local daily The Guardian reported that the company had a debt burden of N124bn ($391.5m). This was a consequence of unfulfilled payments for contracts executed and credit held with commercial banks. The majority – N90bn ($284.1m) – was debt owed by public and private institutions for work that Julius Berger had already completed. Kayode Odesola, a corporate banking analyst at Nigerian firm FBN Merchant Bank, remained sanguine about these difficulties. He told OBG, “The bigger construction firms have weathered similar situations before, so I remain optimistic.”

However, it is clear that payment problems are compounding an already unfavourable economic climate. There is currently as much as N300bn ($947.1m) worth of outstanding debt owed to the construction industry by the federal government alone. Taking into account both local and state governments, the sum the public sector owes the contracting industry rises to as high as N600bn ($1.9bn), according to the Federation of Construction Industry.

Clearing Backlog 

In this context, the N433.4bn ($1.37bn) allocated to the Federal Ministry of Power, Works and Housing and the N202bn ($637.7m) allocated to the Federal Ministry of Transport – the two main bodies through which infrastructure contracts are distributed – under the 2016 budget are likely to clear up the payment backlog, rather than help boost new revenue streams and profitability for contractors. Indeed, moving forward payment schedules will be crucial to ensure the viability and long-term health of the sector. In terms of the regulatory environment, there are no issues. The 2007 Public Procurement Act stipulates that contractors have to be paid within 28 days of certificate, after which date they can claim interest at the monetary policy rate. Contractors also have recourse to a robust system of arbitration.

However, given the precarious nature of relationships between clients and contractors, the latter are often reluctant to push payment disputes towards a legal resolution. On the client side, a lack of available funds often renders prompt payment difficult. As such, the fulfilment of the 2016 budget will be critical to putting the industry back on track. Construction firms will be eagerly awaiting the disbursement of funds for the first half of the 2016 capital budget, as this will provide the first indication of the government’s intent to meet its spending commitments.

Input Costs 

The country’s current economic woes are not only being felt on the income side. The slide in the value of the naira following the Central Bank of Nigeria’s (CBN) transition to a free float, with the currency dropping against the US dollar, is having an impact on the operating expenses of some contractors. While firms should have access to foreign exchange (forex) from the CBN at the official rate, there is not enough available to meet demand, and capital controls are in place for a number of import segments such as ceramics and steel products.

The majority of basic materials, such as cement, steel and aggregates, can and are produced locally (see Industry chapter), which means that many contractors working on larger projects are affected less than those working in residential or finishings. Still, this has created a major headache for contractors. While contracts at the federal level often have recourse to clauses on variation of cost on basic raw materials, there is no allowance for the escalation of costs associated with the naira-dollar exchange rate and the impact that it can have on other expenses, such as spare parts and expatriate wages. As such, it is increasingly difficult for firms to accurately price risk into a contract in the current environment.

However, the economy’s exposure to forex is perhaps less worrisome for contractors than for certain companies within the country. Odesola told OBG, “Maybe 30% of a contract’s value would be in forex. Most of it would be sourced locally and most firms that require imports would do it at a fixed rate. Their exposure to devaluation risk is not as high as for manufacturers. I do not think a big construction firm would shut down as a result of forex.”

Building Materials 

Moreover, there are trends working in the favour of construction businesses. For example, in February 2016 the country’s largest cement producer, Dangote Cement, announced a reduction in the price of its cement by just under 30% (see analysis). The prices for other basic materials, many of which are also produced locally, have also remained under control. The cost of steel, for example, has been steady for several years. High-grade, high-tensile steel rebar has cost N140,000 ($442) per tonne in the local market for the last four years, according to The Guardian. Similarly, the cost of low-grade, high-tensile steel rebar has not changed in the last four years, achieving market rates of N100,000 ($315) per tonne. Sanjay Kumar, CEO of the African Industries Group, told The Guardian in October 2015 that there are over 30 local steel producers in the country, but many are struggling to remain competitive with imports and are operating at levels as low as 30% of capacity. This remains a concern for the industrial base generally, although for contracting and construction firms it currently has had only limited impact on pricing, even though forex risk has increased. “Nigeria lacks a domestic manufacturing industry for building materials because the production costs are simply too high. A better ecosystem must be put in place to spur growth in local manufacturing,” Andrea Geday, CEO of El Alan, told OBG.

Construction Costs 

The positive trends on basic materials will certainly help contractors, but the broader economic headwinds mean that margins remain tight and new projects may be limited over the coming 12 months. In spite of the high competition and the gradual easing of some material prices, the country faces high construction costs.

This, however, is nothing new. Traditionally, the cost of construction in Nigeria has been comparatively high and somewhat inflated. In 2014 Abuja ranked third highest on the continent in terms of the relative cost of construction in US-based engineering consultancy AECOM’s Blue Book, a report on the state of the global construction industry. Across a number of building types, the Nigerian capital had higher costs than every major city studied on the continent, with the exception of Kigali, Rwanda, and Luanda, Angola. For example, a prestige apartment block cost $1900 per sq metre in Abuja, compared to $1470 per sq metre in Accra and $1460 in Nairobi, the cheapest place to construct such a building in Africa. Similarly, for building a high-rise tower block and a regional shopping centre, the Nigerian capital was more expensive than most cities, costing $1360 per sq metre and $1315 per sq metre, respectively.

Housing Market 

These costs have had profound implications for the housing market. This should be an area of great opportunity for construction firms. The raw indicators point to high demand (see Real Estate chapter), with the population growing at around 2.8% a year and reaching 440m people by 2050, making it the third-largest country in the world, according to UN data. It is also an increasingly accessible population, residing in close proximity to existing infrastructure networks. As the urban population grows at 3.75% per year, Nigerians living in towns and cities will soon make up a majority of the population, according to the World Bank. This will build on what is already a massive demand for housing. The country has a current housing deficit of 17m residential units and needs 700,000 new homes each year to meet demand, according to the Federal Ministry of Finance.

The costs of construction and developer expectations have meant that much of this demand remains unmet by private sector supply, with recent projects generally focusing on the high end of the income spectrum, where margins are higher. However, a downturn in the luxury segment of the market could lead to a reassessment of business models. Odesola told OBG, “We see major players adjusting to the new reality and developing in the middle-income segment. We also see the greatest opportunities for those that are focused on delivering middle-income housing projects. If a real estate company can play in this space, they will do very well.”

Indeed, to some degree, it is simply a matter of recalculating expectations. Odesola told OBG, “Every developer has some flexibility in terms of margins, and because of the economic realities on the ground any developer realises that it will not get the margins it did three years ago. If they can accept thinner margins, they will make more revenue because of the sheer volume that they are turning out.”

This is good news for the entire construction industry. If private real estate developers move into the volume-driven segment of the market, this will open up new opportunities for contractors and decrease their reliance on government contracts. However, as with all elements of the sector, funding and financing remains a challenge. As a consequence, at the higher end of the real estate market some developments, such as Eden Heights on Victoria Island, Lagos, are beginning to offer off-plan sales as a means of self-financing projects, while other developers, such as Megamound, are beginning to focus on multi-family units. Although this trend is still in its infancy, it could present a challenge if it becomes widespread. There is currently no regulation governing off-plan sales, and therefore potential buyers and investors can be vulnerable to developer failings.

Outlook 

The long-term outlook for the construction sector is clearly encouraging, but these are still difficult days for Nigeria’s contracting firms. The ramifications of the global slump in oil prices have been severe in a variety of sectors, and this has led to a slowdown in new contracts and liquidity problems for companies. This in turn is exacerbated by the high level of public debt owed to the industry. Indeed, in the coming years, the real health of the sector will only be assured once issues surrounding payment backlogs and payment schedules are resolved.

Yet, there is encouraging momentum, following the government’s focus on helping to clear the backlog of existing projects and the emphasis on sourcing new capital to underwrite additional projects. Furthermore, if contractors can weather this current downturn, the prospects moving forward look much more exciting. The country’s rapid demographic growth and limited infrastructure offer a wide variety of opportunities for volume and value in the market.