Most indicators suggest significant slowdown in activity in 2011-12. There is one anomaly. The Centre for Monitoring the Indian Economy (CMIE) claims projects worth over Rs 4 lakh crore (a record) were completed in 2011-12. It should have translated into high growth in the construction sector and substantially higher offtake of cement and steel.
But steel and cement more or less stagnated. The construction industry’s growth rate dropped. The Economic Survey estimates the construction sector grew at 4.8 per cent in 2011-12, compared to 8 per cent growth in 2010-11. One possible answer to the puzzle is the methodology ‘rear-loads’. That is, even if a project was, say 90 per cent complete before 2011-12, the entire project value would still be counted in the fiscal of completion.
The constraints for the construction industry included slowdown in real estate, shortage of skilled labour, high interest rates, slow environmental clearances and so on. This was reflected in poor performance of various listed companies in the construction space in the first three quarters of 2011-12.
Construction is among the more cyclically sensitive industries. Activity depends on activity in real-estate and on the creation of physical infrastructure (roads, bridges, dams).
This service industry absorbs huge, albeit fluctuating labour forces at varying levels of skill from the utterly unskilled to the highly sophisticated. It is a major consumer of steel, cement, specialised machinery, and so on. It is also capital intensive and has a long gestation. Finally, it is vulnerable to shifts in political alignments and policy change. Suffering can be caused by poorly framed contracts that result in interminable legal disputes.
If the economy is depressed, the construction industry can actually shrink with startling rapidity. Conversely, if the economy booms, it can show accelerated growth. Unfortunately, it is prone to bubbles. In 2007 and 2008, nations like Ireland, Spain and Iceland, for example, saw construction contributing 15-20 per cent of GDP. China and Japan have also seen massive construction booms. When the real estate sector collapsed after the subprime crisis, construction went bust as well.
Booms in construction can however, be sustainable for longer periods if the construction activity is driven by infrastructure creation. In India, construction contributed roughly 8 per cent of GDP in 2011-12 and it offered employment to around 33 million, more than any sector aside from agriculture. Roughly 55 per cent of construction revenues come from infrastructure, while industral construction contributes another 35 per cent with the rest coming from household and small commercial developments.
The industry contribution to GDP is down from 12 per cent in the boom period, between 2004-08. But it’s still pretty substantial and in absolute terms, the industry has grown. The sector is very fragmented. There are hundreds of mid-sized and small unorganised players as well as a handful of really big players. The big ones (L&T, HCC, GMR) have become developers rather than remaining contractors.
Projects worth an estimated Rs 140 lakh crore are estimated to be in various stages of the pipeline according to CMIE. The Twelfth Plan alone is supposed to contribute Rs 41 lakh crore worth of infrastructure creation with about half coming from the private sector. Urban development, private sector projects, and so on, make up the rest.
This project flow should sustain the construction industry over the next five years at the least, unless the current slowdown persists for an unprecedented period. However, the historic growth rate for the construction industry is around 9 per cent CAGR and it underperformed GDP in the past three fiscals. To fully capitalise on the opportunities, growth would have to accelerate till around 15 per cent CAGR. That implies construction growing at almost twice the GDP rate.
It probably cannot ramp up to those levels of efficiency. The structural problems won’t sort out easily though financial liquidity should ease as the business cycle turns. However, an investor with a long timeframe should see acceptable growth rates.
The key question here is, will things get much worse for the construction industry before they get better? If they do, share prices should drop. If we’re at the bottom of the cycle, this is a good time to buy into construction.
The macro-economic situation suggests that there will be a bottoming out over the next two or three quarters. Shareprices may drop quite a bit from here. But there is enough long-term earnings visibility to keep people interested. This sector could be a reasonable target for averaging down.
