Shifting sands: Companies have been adapting to the new post-revolution conditions

Aided in part by the large domestic market, a spate of new industrial facilities, competitive labour costs and increasing urbanisation, the fundamentals of the Egyptian construction market look promising, although like many other sectors it has been suffering from a certain lack of confidence after the revolution of 2011.

A variety of new projects including plans for new power plants, factories and infrastructure works, combined with a mild backlog, have helped ensure that at least some of the country’s contractors – who account for roughly 12% of total employment according to the Central Agency for Public Mobilisation and Statistics – have been able to weather the worst of the uncertainty of the past two years. Pressure for housing, as well as commercial and retail real estate, is expanding, thanks to a population that is growing in absolute terms and is seeing a gradual increase in purchasing power.

The industry also benefits from access to the largest cement and steel sector on the continent, which has helped slow the rise of prices for building materials, although the past 12 months have seen upward pressure on input costs. Against the backdrop of broader uncertainty, land issues also remain a challenge as does a large informal segment, but the long-term outlook for construction activity is encouraging.

PLAYERS: Egypt is home to a number of large construction groups, split among state-owned, privately held and Cairo bourse-listed companies. Arab Contractors is one of the largest, with activity in fields ranging from monument restoration to marine construction to technical and consulting services. For the financial year ending June 30, 2012, the group made net profits of LE505m ($71.86m), down from LE1.03bn ($146.57m) in 2011, and had 74,600 employees.

Another of Egypt’s biggest players is Orascom Construction Industries (OCI), a subsidiary of the Orascom Group which was founded in 1976 by Egyptian entrepreneur Onsi Sawiris and which has operations in construction and fertilisers in Egypt, the Netherlands, the US and Algeria. OCI is listed on the Egyptian exchange and, for the 2012 calendar year, the company registered a net loss of LE6.21bn ($883.68m) compared to a net profit of LE4.21bn ($599.08m) in 2011. The company currently employs more than 86,000 people over the 20 countries in which it operates.

Hassan Allam Holdings is another Egyptian construction group with operations in both construction and real estate development. On the construction side, the group deals with large-scale infrastructure projects and also owns ancillary industries such as steel fabrication and pipe plants. It employs more than 11,000 people but, as it is held privately, financial results were unavailable. In addition to the major domestic companies, international construction firms also have a presence on the Egyptian market.

IMPACT OF THE REVOLUTION: In the immediate aftermath of the 2011 revolution, the transitional government under the Supreme Council of the Armed Forces (SCAF) implemented a modest increase in spending in the construction sector, by way of an economic stimulus. However, as the economic outlook for Egypt has darkened over the past couple of years, the short-term prospects have become more complicated. Traditionally, the government has been the biggest buyer on the local construction market, with public spending underpinning developments in the transport and power infrastructure segments. However, a combination of policy uncertainty, dwindling reserves and a depreciating pound have reduced public sector investment since 2011. While Egypt has benefitted from cash infusions from Gulf neighbours, including most recently the UAE, Saudi Arabia and Kuwait in the summer of 2013, the state’s rate of fixed capital formation has slowed. Bassam Daher, area manager at Consolidated Contractors Company, told OBG, “In 2013 we expect very few new projects to be initiated in either the public or private sectors. All major industrial projects that were in the pipeline will be deferred until 2014 and beyond.”

DEMAND: Once these monetary issues are settled however, the underlying need for infrastructure in Egypt is massive. The country is currently suffering from a shortfall of between 1m and 3m homes, according to most estimates. At more than 92m during the 2012 census, Egypt’s population is not only the largest in the Arab world, but has also been growing by 1.7% for the last five years, according to the World Bank. Upwards of 40% of the population is under 18, so long-term demand for new units is assured.

Marriages, which also provide a useful indicator for gauging demand, paint an encouraging forecast for the coming years: in 2012, there were over 933,000 marriages. This provides a rosy long-term outlook but also increases pressure on providing short-term solutions to stem a rise in illegal construction, something that has become more complicated given that the state was previously responsible for most investment in the low-income housing sector.

As in any market, construction demand varies according to market segment. While building firms engaged in top and mid-range real estate have had a reasonably good year, construction groups involved in infrastructure have been having a comparatively harder time. Given both political and economic instability, property is increasingly perceived as a safe investment. Large infrastructure projects, on the other hand, tend to be reliant, directly or indirectly, on government spending, and issuing tenders has taken a back seat over the past two years. Moreover, given the country’s precarious fiscal position, delays in paying contractors, already an issue for the industry, have often increased, exacerbating cashflow difficulties for many firms.

NEW PROJECTS: Some of the more essential infrastructure projects continue to go ahead. For instance, electricity demand has been growing in line with population and economic growth, and as such, the country requires a new power station building programme. Tenders for three new power stations, with a combined value of LE50bn ($7.12bn), are due to be issued in 2013. The Dayrout plant is set to have a capacity of 2250 MW, while a new power station at Beni Suef with a capacity of 1950 MW and a 300 MW power plant is planned for Qena in Upper Egypt. The contracts are likely to be based around a build-operate-transfer (BOT) model. Renewables, which are to make up a sizable portion of the country’s generation mix in the coming decades, are also expected to see a spate of new developments.

Transport is another field where considerable activity is expected, particularly in the maritime and rail sectors. Already, a number of ports on the Mediterranean coast will require a deepening of their draft over the next few years, while at Safaga on the Red Sea coast, the government is planning to upgrade the existing mining jetty to create a mining, livestock and bulk cargo port. The project is to be tendered as a public-private partnership (PPP) and is estimated to be worth approximately LE6bn ($853.8m).

The Cairo Metro, the first in Africa, is currently going through an expansion programme, with a third line opening in progressive stages. The first phase was completed in February 2012, with a total cost of €235m, and a €569m second phase is currently under way that is due to be completed in 2014. Work on both phases has been conducted by a consortium including France’s Vinci Construction, Arab Contractors, Bouygues and OCI. In September 2012, Egypt and France signed a framework agreement to finance the third phase of the extension at a total cost of €980m. Upon completion of the planned fourth phase, Line 3 will reach 70 km, linking the airport to suburbs in Giza governorate on the west bank of the Nile.

PUBLIC-PRIVATE PARTNERSHIPS: In light of the urgent need for new infrastructure, the Egyptian government is aware that it is not necessarily feasible for it to undertake all the work by itself.

Under the Hosni Mubarak government, a new law governing PPPs was issued about a year before the revolution, Law 67 of 2010. The new law provides a framework for PPPs, under which the stages of the tender process are laid out in detail (see analysis).

With guidance from the International Finance Corporation, Egypt tendered its first PPP project under the new law for a wastewater plant with a capacity of around 250,000 cu metres per day in New Cairo, worth LE2.65bn ($332.31m) over 20 years. A second PPP contract was signed in April 2012 for two teaching hospitals in Alexandria. Additional tenders are either in progress or expected soon, including the Abu Rawash wastewater plant, the Ain Shams to 10th of Ramadan City railway (which will run 107 km and feature 14 stations), the Suez Canal University Hospital and the Cairo Contact Centres Park in Maadi, a business park dedicated to call centres and outsourcing companies.

LAND ISSUES: One issue for contractors is the question of who holds legal ownership to a given plot of land (see Real Estate analysis). Much of the land in Egypt, particularly desert and non-agricultural land, is in the hands of the state. Under Law 89 of 1998, when public land is released to the private sector, it should be auctioned off so as to maximise revenue to the exchequer. However, the Egyptian legal system is an amalgam of Ottoman and European codes, and a variety of land tenure systems operate in the country, with varying degrees of recognition in law.

MATERIAL PRICE: As the Egyptian pound falls, inflation is feeding into the domestic economy and many prices, including those for building materials, are going up. Estimates from Beltone Financial put the price of cement at around LE550 ($78.27) per tonne at the end of 2012, and over LE800 per tonne ($113.84) by March 2013. Although Egypt sources the bulk of domestic demand for cement and steel from local industry, a combination of rising demand and faltering supply have driven up prices. Indeed, in March 2013, a committee of the Shura Council, the upper house of the Egyptian parliament, called for the imposition of price controls on cement. In February 2013, the government raised the price of fuel oil from around $150/tonne to $220/tonne, triggered in part by supply disruptions, which lead to protests by factory owners affected by the increase, for example brick manufacturers.

“The cement industry consumes 10% of the country’s total annual natural gas supply. The industry’s effect for the year 2013 is averaged at 40%, that is why we expect the cement sector at the end of 2013 to be operating at less than 70% of its capacity,” Erdo ğan Peken ç, the CEO of Lafarge Egypt, told OBG. In June 2013, Global Cement News reported that since February 2013, cement production capacity had declined by approximately 20%, or some 3.7m tonnes.

Steel prices have also risen, partly on the back of a falling pound which makes the cost of imported iron more expensive, and partly due to a protective tariff imposed by the Egyptian government in December 2012 on rebar imports. The tariff stands at 6.8%, or a minimum level of LE299 ($42.55) per tonne. The immediate effect was to raise prices from LE4200 ($597.66) per tonne to LE4400 ($626.12) per tonne. In April 2013, Ezz Steel, Egypt’s largest producer, raised its rebar prices to just over LE5000 ($711.50) per tonne.

A further factor behind price rises is that, during the latter part of 2011 and much of 2012, consumption actually grew modestly due to an increase in informal building. Tarek Salah, managing direct of Citadel Capital, told OBG, “Demand continued to grow, even during the transition period. There has never been a case of over supply of cement in the country,” Meanwhile, the drop in the value of the pound, combined with strict capital controls, means that many Egyptians have been looking to put their money into assets, especially real estate. The result is a building boom, which has forced prices up over the short term.

LABOUR ISSUES: In light of rising inflation, many Egyptians are feeling the pinch, which has sparked labour unrest. Although the labour movement remains fragmented, there is a far greater willingness to strike, with a number of construction groups experiencing labour disputes in 2012. In October 2011, the government mandated a minimum wage of LE700 ($99.61) per month, and a draft bill was introduced to the Shura Council in February 2013 that would see the minimum wage further increased to LE1200 ($170.76). However, one of the main demands is for a minimum wage of LE1500 ($213.45) a month. Additionally, the new division of the labour movement, with newly independent syndicates sprouting up alongside or in contrast to the more established unions, has complicated issues at times since employers have not one but several labour representatives to negotiate with. Local press reports indicate that contractors are concerned over rising wages but that employers often find ways to accommodate wage demands by gaining concessions elsewhere.

FINANCE: One issue for contractors working with the government is that payment can be quite slow in coming. While government tardiness in paying contractors predates the 2011 revolution, the issue has become more severe in the immediate aftermath of the revolution which saw revenues fall, and the government has now had to commit resources to defending the value of the pound. In September 2012, the Export Council for Building Materials, Refractory and Metallurgy put the value of government arrears to construction firms at LE5.4bn ($768.42m). In December of that year, the government ordered the release of LE1.65bn ($234.8m) in late payments to contractors working for the National Authority for Drinking Water and Sanitation.

Over the long-term, as the international community puts together a support package for Egypt, and the government’s own financial position improves, there are hopes that these problems will fade. In the meantime, however, contractors who are highly dependent on government contracts continue to face serious cashflow problems. In June 2013, the Egyptian Federation for Construction and Building Contractors reported that around 77% of member firms had either gone out of business or changed careers over the previous two years. The organisation also blamed rising materials prices, in particular the cost of diesel, steel and cement, for a number of the bankruptcies.

SHIFT TO OVERSEAS: In such a climate, some of the biggest players have been looking to expand their operations overseas, as a means to protect their revenue streams. Libya, which has close ties to Egypt, and where there is a pressing need for reconstruction after the fall of Muammar Gaddafi, has already proven to be a promising source of business for Egyptian contractors. For instance, Arab Contractors in 2013 had tendered for contracts worth more than $1bn in Libya. In 2012, Hassan Allam won the buildings and civil works contract for the Qurayyah power plant in Saudi Arabia’s Eastern Province, the company’s first power plant contract in that country, as well as an oil and gas contract in Algeria. Indeed, some contractors have been expanding their activity overseas to the point where Egypt only constitutes a small proportion of their overall income. In January 2013, OCI listed on Amsterdam’s Euronext stock exchange and Egypt now accounts for only around a fifth of Orascom’s revenue base, although the company continues to be listed on the Egyptian Exchange.

FOREIGN INVESTMENT: Although foreign direct investment in Egypt has slowed to a trickle, there is noticeable overseas involvement in the Egyptian construction sector, with an increasing number of firms from other emerging markets currently active.

According to figures from the Heritage Foundation, the value of projects that are either completed or in the pipeline from Chinese firms amounted to some $3.2bn in 2012, mostly in or around the Suez Canal Zone. Chinese embassy figures estimate that Chinese investment in Egypt has risen by more than 60% since the revolution to exceed $500m.

Moreover, a number of Gulf real estate companies are involved in building new malls and mixed-use developments in the Cairo suburbs. Majid al Futtaim (MAF) Group, a UAE company specialising in retail projects, began work in 2013 on its second Cairo mall, Mall of Egypt, which covers nearly 400,000 sq metres and features 380 shops, a Carrefour hypermarket and a cinema. The construction contract, which is worth around $400m, was won by a consortium of OCI and BESIX Group, and the project is due for completion in 2015, about a year later than originally planned. Together with fellow UAE developer Emaar Misr, MAF is also developing Cairo Gate, a LE5bn ($711.5m) mixed-use site on the Cairo-Alexandria desert road.

Emaar Misr told the Cairo Cityscape expo in March 2103 that it expected the total volume of its investment in Egypt to reach LE53bn ($7.54bn) in 2013, and that during the first quarter of the year it had signed construction contracts worth LE500m ($71.15m) in total. In September 2012, Qatar said that it intended to invest $8bn in a gas, power and iron steel complex at Port Said, and to invest $10bn in a tourist resort on Egypt’s Mediterranean coast. To date however, no tenders for these projects have yet been issued.

OUTLOOK: The Egyptian real estate sector has continued to see growth, which has helped to support some contractors, but companies relying on work in the infrastructure segment, particularly those dependent on government contracts, have been suffering. This situation seems unlikely to change until the government improves its financial position, whether through loans or otherwise. While labour unrest is likely to continue having a negative influence on the sector, the growth in energy and materials costs is expected to have a more direct impact. However, the continued and long-term need for investment in housing and infrastructure means that diversified construction groups will certainly survive, if not thrive, over the medium to long term.