Friday, April 21, 2017

Review of Singapore's Construction Sector - Part 1

Dear Readers,

I am continuing my search for, what Warren Buffett will have exclaimed – the next “wonderful company at only fair prices”.

Therefore, to search for this company, I decided to try searching within the construction industry.

The interest in construction industry was triggered due to a few reasons such as:
  1. This video via Flyinpeach – Singapore continuous infrastructure development for the next 2 to 3 years will continue to provide projects for the construction industry, especially those in the civil engineering sector. 
  2. The recent purchases for land at high prices via SP Sertia and Sing Holdings.
  3. The continued urbanization of the world, especially within South East Asia.
Before we start, do note Companies that are within the construction industry but also within these areas of business will be ignored:
- Companies earning more than 50% from Overseas. (I may not have the knowledge to fully understand these companies’ revenue stream. Ex. Civmec)
- Furniture/Maintenance companies (Ex. Design Studio, Nobel Design, ISO Team).
- Equipment Rental/Soil Investigation companies (I generally believe they are in a very bad business environment right now. Ex. Tritech, Tat Hong, CSC Holdings).
- Companies that intends to be delisted (If I come across…)
- Industrial Conglomerates (Ex. Keppel and Sembcorp)

Without further ado, lets understand the Construction “Food” Chain 1st. 

Developers and owners (including HDB and Stat Boards) are deem to have the biggest chunk of profit or the biggest say at the pricing of the projects. Contractors will need to bid for the projects and normally the “best” deal will get the project (Do note that currently for Singapore Government, lowest bid for project may not necessary get the deal). Thus, I deem them to be at the top of the food chain.

Contractors are next in line. They have the right to choose whom are their sub-contractors or from whom will they get the construction materials.

Finally, it is the Sub-contractors. This category of companies includes the building products distributor, the pre-cast manufacturer, the steel fabricator, etc. I believe they do not have much say in the project and their net profit are strongly linked with raw materials prices.

With that, I have gathered a list of companies specially selected due to their involvement within the Singapore construction industry as per Stockfacts segments – Building Products, Construction and Engineering, Electrical Equipment, Industrial Conglomerates and Trading and Distribution. 

I have proceed to break them into 5 different categories:
  1. Civil (Including Stat Board) 
  2. Industrial/Commercial 
  3. Residential (Including HDB) 
  4. Sub-Contractors
  5. Materials
Civil (Including Stat Board)


Civil construction includes tunneling, drainage work, roads, MRTs, desalination plants, Changi Airport Terminal, sea ports, bus terminal, bus stop etc.

I believe this is where more projects will be revealed over the next few years. Although the margin may not be amazing, since most of the requirement comes from stat boards, but the margins will be higher than the next group I am going to talk about.

These companies will be included in my research for part 2.

Industrial/Commercial

For companies in this group, I don't have a good feeling about them. They tend to evolve into industrial/Commercial owners eventually. These companies will then need to be responsible for occupancy rate. If the occupancy rate is low, it will be money wasted on the development. Furthermore, their competitors are the REITs which are so much better at achieving higher occupancy rate.

If not, they may tend to divest into other areas which they may not have experience in. This will incurred additional initial cost and negatively affect their net profit margins.

So I will ignore this group of companies.


Residential (Including HDB)

My belief is that for this group – the future is bleak UNLESS THERE ARE INNOVATIONS involved.

My reasons are simple. 

If you look at the recent award of the lands to SP Sertia and Sing Holdings, the land price is $939 psf and $517 psf respectively. If the land prices are already so high, at what price psf will the property be sold at?

I have talked to a valuer previously and he stated the high land prices are a result of foreign companies also bidding for the land in Singapore. In the past, local developers can expect a 15% to 20% of net profit margin. But when these foreign developers came into the scene, they started overbidding the land prices. These foreign companies is willingly to stand by lower margin of 5% to 10%, in view that they get the project. Thus, the local developers must also up their bid prices, resulting in the high land prices when they are awarded to the developers.

On the other hand, this will also mean that the high property prices may never go away and the government will have to continue to implement stop gap measures to protect the property bubble from bursting. Therefore, this also meant that developers, such as Bukit Sembawang Estates, holding onto huge plots of land will be in a more advantageous position in future.

With the above information, lets' estimate that Singapore’s property price has continued to rise over the next year and SP Sertia is able to sell the property at $1800 psf (Do note that based on URA Cavaet, the property prices in Toh Tuck Road area is about $1500 psf to $1800 psf currently).

In addition, lets assume the developer will need to achieve a 35% gross profit margin (Have not considered the overhead cost, ABSD and the extra QC charges) in order to achieve just a small 5% net profit margin. Thus, the gross profit will should be about $630 psf ($1800 x 0.35).

Based on this formula: 
Property Selling psf - Land purchase psf - Construction Cost psf = Expected GROSS PROFIT for the Developer.

$1800 - $939 – Construction Cost psf = $630. So the maximum Construction Cost will be $231. 

Based on the latest BCA estimate, the construction cost for a standard high rise apartment is about US$1300 to US$1500 per metre square. This works out to be S$196 psf (1500 x 1.4 / 10.764). In view of inflation and potential rising material cost, we deem that the overall cost to be 10% higher at $215.

Therefore, we can deem that the GROSS PROFIT the Construction company is about 7%. This exclude the taxes, the overhead charges, the financing cost and the director salaries. THAT IS HOW BAD THE SITUATION CAN BE FOR A CONSTRUCTION COMPANY IN THIS SECTOR.

We can always argue that the figures above are based on very exaggerated assumptions. But what I am demonstrating here is that construction companies within the residential segment will be squeezed very badly by the developers. 

This maybe another reason why construction companies involved in the residential projects, such as Keong Hong or KSH, take on a minority percentage in the development in order to supplement their lower net margin in the construction segment.

For those who believe that helping HDB build housing might provide a better margin for the construction firms – In my opinion, you are wrong. Remember the "lower" prices HDB have to price their BTO at?

Regardless, construction companies that worked on HDB projects will still have an assured source of cashflow to allow the company to operate consistently. However, in future if they do not engage in more advanced way of building flats, the companies will become irrelevant.

Therefore, in my opinion, the only way that these companies can progress forward is through innovation and technology - such as Prefabricated Pre-finished Volumetric Construction (PPVC).

From the list of companies that are intending to get PPVC Manufacturer Accreditation Scheme as per BCA, only the following have applied:

  1. BBR Holdings Ltd (Moderna Homes Pte Ltd)
  2. Tiong Seng Holdings Ltd (Tiong Seng Contractors Pte Ltd and Steeltech Industries Pte Ltd)
  3. Chip Eng Seng Corporations Ltd (SPP System Pte Ltd)
Therefore, I will only be adding these 3 companies into the research I will be doing in the next post.

Sub-Contractors

These sub-contractors are mainly involved in the M&E segment. As per my personal view, I feel this segment is too competitive and the net profit margin maybe too low. Other than the 6 companies listed above, there are still a lot of other M&E companies! Furthermore, their low margin may affect the future dividend payment (Remember the "Food" Chain?).

However, I must say there are still "wonderful" companies in the above list, such as Tai Sin Electric Limited.

But based on an overall segment category, I will be ignoring this group of companies.

Materials

For this final group, the companies can be sub-categorized as "Cement", "Steels" and "Parts of Homes" segment. Generally, this group of companies may seem to be squeezed for margins, but it may actually be one of the most special group. This is because their products are not restricted to a single segment of the construction industry and at times, they maybe the price setter of the whole project. This is because without them, some of the projects may not be able to proceed.

Cememt:
Pan-United Corporation Ltd
Transit-Mixed Concrete Ltd

Cement should be deem as the raw material for many construction projects. Thus, I will be looking into them.

Steels:
BRC Asia Limited
Hupsteel Limited
Asia Enterprises Holding Limited
HG Metal Manufacturing Limited

Next, I will definitely be ignoring the steels segment. I used to be significantly vested in the steel segment. However, I feel that this group of companies are supported mainly via its inventory. Furthermore, in my opinion, their value-added services, such as fabrication, seems "too common", resulting in low barriers of entry.

Parts of Homes:
KLW Holdings Limited
Hor Kew Corporation Limited
GDS Global Limited
Hafary Holdings Limited

Parts of Homes segment includes companies that manufacture doors, windows or provide tiles. These are the basic requirements for residential, commercial or industry buildings. This is an interesting group. The main issue is to find out the barriers of entry to this group of companies. I will be adding them into my research for part 2.

In Short

In conclusion, the above are only my thoughts about the current construction industry. This will be the end of part 1 of my review. For part 2, I will be looking deeper into each respective segment and shortlist a few of the counters for an extensive review for part 3.

Do note that there might be some missing companies, such as LTC Corp and Ocean Sky International, that are not included in the grouping due to their categorization of Stockfacts.

Nevertheless, I believe the above companies will be enough "work" for me to research on for my trilogy on the construction sector.

For those interested in understanding a bit more of my Contrarian Approach, I will be having a short paid seminar on 28th of April. Do click on this link to know more on the seminar! Thanks for your support!

Oh... and do remember, please like our Facebook page (T.U.B Investing) and follow me on InvestingNote.

4 comments:

  1. Thanks - good informative post, enjoyed the read. Looking forward to parts 2 and 3.

    ReplyDelete
    Replies
    1. Hi Dan O,

      Thanks for stopping by and commenting.

      Regards
      TUB

      Delete
  2. very good post indeed. Can I check when will part 2 and 3 be out?

    ReplyDelete
    Replies
    1. Hi Ys,

      Part 2 and 3 are already out!

      http://tubinvesting.blogspot.com/2017/04/review-of-singapore-construction-sector.html

      http://tubinvesting.blogspot.com/2017/05/review-of-singapores-construction.html

      Here you go.

      Regards,
      TUB

      Delete