*** It’s time to bury the Middle East construction myth!

From Gareth Stokes, MoneyWeek editor, SA

Dear MoneyMorning reader

If you flip through a recent annual report of any of South Africa’s heavyweight construction companies you’ll probably stumble across a chapter titled “Project Middle East.” Through 2007 and 2008 chief executives smiled broadly as they added lucrative Middle East tenders to their order books. They were banking on transforming arid desert landscapes in the region to billions on the annual profit and loss statement. But things don’t always go to plan.

Countries in the region have suffered two major blows in recent months. The global financial crisis is one. Capital for massive private infrastructure projects has all but disappeared – leaving private and public sector developments high and dry. And the second setback is even more damaging. Dubai, Saudi Arabia, Qatar and the UAE are heavily dependent on oil revenues. As Brent crude plummeted form highs of around $147 per barrel to below $50, governments in the region have had to make serious adjustments to their expansionary budgets. What does this mean to South Africa’s construction giants?

Can companies like Murray & Roberts (M&R), Group 5 and Aveng report record profits against the backdrop of falling Middle East order books? We’ll look at Murray & Roberts because they’re in the news right now. The company announced yesterday it would lose its 33% share of a joint venture contract to construct the Tameer Towers in Abu Dhabi. The decision to cancel the construction project will wipe R5bn from M&R’s forward order book. At this point any ‘ordinary’ company would be panicking. But M&R management hardly batted an eyelid. They point to their previous caution on “volatility in the Middle East market as a result of the global financial crisis, and in particular, the alliance nature of the contracting arrangement on the Tameer Towers project!” They’re confident the cancellation will have no impact on the group’s financial performance. Should we believe them?

This is not the first contract to fall by the wayside in recent times. In the last four months M&R has seen two other projects go up in smoke! A joint venture with Bahrain’s Nass to build a $545m luxury resort near the Bahrain Formula 1 track was canned in January. And it learnt in December that the Trump Towers Dubai project was cancelled too. Even if the company receives compensation for work done to date it cannot continually look to the domestic market to replace projects of this magnitude. At some point ‘something’ has got to give!

For M&R the saving grace is the heavy sell-off we’ve witnessed in construction stocks in recent times. At 4200c the company is trading on a forward price-to-earnings ratio (to June 2009) of around 6.15 times. It offers a dividend yield of 4.58%. And try as we might we cannot think the loss of value from order books will impact the company’s profitability in the near term… If government wasn’t pumping more than R700bn into local infrastructure projects it would be a different story. Once the good sentiment around bank, financial and resources shares filters to the construction sector we think the heavyweight construction stocks will correct nicely. At current valuations you can definitely include M&R in your portfolio on a three to five year view.

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Turning to the markets...
 
The JSE all share index closed up 0.71% yesterday. The gold mining index gained 2.4%. Resources tumbled 0.04%. Banks and financials shot up 4.11% and 2.76% respectively. Industrials rose 0.68% and the platinum mining index gained 2.25 %.

London’s FTSE100 closed down 0.29%. The Dow Jones increased 1.17% and the Nasdaq shot up 0.82%.

Tokyo’s Nikkei closed 0.75% up. Hong Kong’s Hang Seng climbed 2.25%.

Brent crude is currently trading at $52.45 per barrel.

Spot gold’s trading at $933.15 and platinum was last quoted at $1,120.

And here’s how the rand is performing against the major currencies:
R/$ 9.49
R/£ 13.82
R/€ 12.90

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Copyright (c) 2009 Fleet Street Publications Pty (Ltd)

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