From Gareth Stokes, MoneyWeek editor, SA

Dear MoneyMorning reader

The South African construction industry is in the doldrums. Most shares in the sector have fallen by more than 50% since August 2008– and by more than 60% since their all-time highs Q42007. The slump has left shareholders slightly bemused. How can companies with full order books (running into billions of rand) and geographically diverse operations fall out of favour so quickly?

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We can answer this question by taking a look at construction projects worldwide. On the domestic front we’ve just heard that new building plans passed have slumped to the lowest level since 1986. It’s a statistic that seems to contradict the news flow from the industry. As we mentioned earlier, most of the country’s construction firms have long ‘to do’ lists – enough major projects to keep them busy for the next three to five years. And finance minister Trevor Manuel has once again committed government to massive infrastructure expenditure in his 2009 Budget. Who should you believe?

We’d believe everyone. Yes – building plans passed are at the lowest level since 1986. Yes – government remains committed to major infrastructure upgrades. And yes – the construction companies’ order books are full. The bubble is going to burst when these projects get canned! This scenario has already played out on the international construction front. As the sub-prime contagion washes over the Middle East – particularly Dubai – a number of multi-billion dollar projects are being delayed or shelved. And companies like Group Five Holdings (JSE: GRF) which tendered for and won a number of projects in the region, have watched a huge chunk of their offshore order book evaporate.

Commenting on the groups latest interim results, chief executive Mike Upton say the group “substantially replaced the R4bn orders cancelled in Dubai with South African public works! The company has a secured order book of “R13bn as at 16th February 2009, with further awards of almost R2bn imminent.” In the six months to December 2008 Group Five increased revenue by 33% to R6bn with 60% earned in South Africa. Operating profit for the period was R377m and both earnings and headline earnings per share were considerably higher. At 2700c per share the company boasts a price-to-earnings ratio (to June 2009) of 5.76 times and a dividend yield of 4.61%. Can we ignore construction stocks at current valuations?

You have to make the decision on the balance of facts. If you believe the long-term order book won’t be further affected by cancellations and delays, then you’d be crazy not to get involved. But the more prudent investor will know that the construction stocks haven’t seen the worst yet. For example, Group Five witnessed a 62% contraction in its property development revenue on the back of a weak residential market. The group says it will shift focus from residential to commercial developments; but we’re concerned the shift might coincide with a recession-led commercial collapse. Under existing conditions it may be safer to play a ‘wait-and-see’ game.

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Turning to the markets

The JSE All Share Index closed down 0.45%. The Gold Mining Index slipped 0.26%. Resources lost 1.11%. Banks and Financials closed in the black 0.72% and 0.42% respectively. Industrials decreased 1.13% and the Platinum Mining Index gained 3.45%.

London’s FTSE 100 closed negatively 0.68%. The Dow Jones is up 0.04% and the Nasdaq is down 0.18%.

Tokyo’s Nikkei gained 0.76% and Hong Kong’s Hang Seng closed down 0.41%.

Brent crude is currently trading at $39.98 per barrel.

Spot gold’s trading at $977.71 and platinum was last quoted at $1079.00.

And here’s how the rand is performing against the major currencies:

R/$ 10.17
R/£ 14.48
R/€ 12.79

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