Large E&C Companies to Benefit from Public Infrastructure Projects. Summary. CH. Kanchang PLC (CK) Sino-Thai Engineering & Construction PLC (STEC)

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1 Construction Industry Large E&C Companies to Benefit from Public Infrastructure Projects Summary 15 May 215 Rapeepol Mahapant Auyporn Vachirakanjanaporn Suchada Pantu, Ph.D. TRIS Rating expects the construction industry to expand in 215, a welcome change from last year s contraction. Public works projects will be the key growth driver, given the number of government-sponsored infrastructure projects in the pipeline. As a result, this year should be a better year for contractors which concentrate on public sector projects. Construction in the private sector is also expected to grow, but at a slower rate. A slowdown in the domestic economy has made some entrepreneurs reluctant to make huge investments, while weaker demand for residential property has caused some property developers to delay the launches of new projects. These actions may pressure the financial performances of contractors which concentrate on private sector work, particularly condominium projects. Despite the tepid outlook for these contractors, their financial performances are expected to stay at acceptable levels, supported by their sizable backlogs. The pressures from the cost side should alleviate this year. Construction material prices and labor costs are relatively stable, and interest rates remain low. The financial performances of most contractors rated by TRIS Rating remained acceptable in 214, despite unfavorable market conditions. As of 3 April 215, TRIS Rating rated seven contractors, as shown in Table 1: CK, STEC, TTCL, ITD, NWR, PREB, and SYNTEC. Nearly all of the seven contractors posted growth in revenues, while about half reported steady or improved operating margins in 214. However, the combined net profit of these seven contractors slumped after CK experienced a dramatic drop in its extraordinary income. Leverage stayed at the same level as in 213 for the seven contractors, except for TTCL and PREB. The debt to capitalization ratio of TTCL soared because it changed its business model. TTCL became a project owner rather than acting purely as a contractor. PREB s leverage increased because it entered the residential property development business. The credit profiles of most rated contractors remained stable in 214. Their ratings ranged from A- to BBB-. In 214, TRIS Rating upgraded the rating of CK to A-/Stable from BBB+/Positive as a result of its stronger business platform and its improved financial flexibility. The ratings of the other six rated contractors remained unchanged. TRIS Rating expects the ratings of most rated contractors to remain stable in 215. Their sizable backlogs and reduced pressure on the cost side will limit the downside risk. Table1: List of Rated Contractors Company CH. Kanchang PLC (CK) Sino-Thai Engineering & Construction PLC (STEC) TTCL PLC (TTCL) Italian-Thai Development PLC (ITD) Nawarat Patanakarn PLC (NWR) Pre-Built PLC (PREB) Syntec Construction PLC (SYNTEC) Source: TRIS Rating Rating/Outlook (As of 3 April 215) A-/Stable A-/Stable BBB+/Stable

2 Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 Industry Research Market Recap In 214, the construction industry continued to slow down, reflecting a weaker domestic economy and the follow-on effects of political turmoil. According to the Office of National Economic and Social Development Board (NESDB), the value of all construction activity (in real terms) fell by 3.4% year-on-year (y-o-y) in 214. Private sector construction, which made up about 55% of all construction activity in the year, decreased by 3.7% y-o-y. Public sector construction, which accounted for the rest, declined by 3.1% y-o-y. However, the quarterly data has telegraphed signs of a recovery since the second quarter of 214. The value of construction rose by 3.6% y-o-y in the fourth quarter of 214. Public sector construction rose by 5.1% y-o-y. Private sector construction also increased, but at a slower pace of 2.4% y-o-y Chart 1: Construction Growth Rates % yoy Private Construction Growth Public Construction Growth 25 Total Construction Growth 2 Source: Office of National Economic and Social Development Board The construction work performed by the 17 contractors listed on the Stock Exchange of Thailand (SET) is just a small portion of the total value of all construction activity in Thailand. The NESDB reported that the total investment in construction activity in 214 equaled Bt935 billion. For comparison, revenues of the 17 SET-listed contractors amounted to Bt199 billion or just 21% of the value of construction activity nationwide in 214. ITD, CK, and STEC are the three largest contractors, accounting for about half of the revenues of the 17 SET-listed firms. The remainder of the market is more fragmented, shared by many contractors. Revenues of the seven publicly rated contractors, ITD, CK, STEC, TTCL, NWR, SYNTEC, and PREB, were not noticeably affected by the unfavorable market conditions in 214. Nearly all of them, except STEC, posted higher revenues in 214. The aggregate revenue of the seven contractors rose by 7.3% y-o-y. The firms sizable backlogs, with remaining lives of less than one year to four years, helped smooth their revenue streams. The combined backlog of these seven contractors stood at approximately Bt412 billion at the end of 214, compared with Bt313 billion at the end of 213. Table 2: Sales Performance of Rated Contractors Sales (Btmn) % Change ITD 36,76 44,247 46,291 43,913 47, CK 8,586 1,96 2,824 32,677 32, STEC 9,291 14,815 19,872 22,294 21, TTCL 5,259 8,896 11,358 15,441 19, NWR 3,935 4,57 6,74 6,727 7, SYNTEC 5,3 4,723 4,857 6,199 6, PREB 1,933 3,128 4,89 6,7 6, Total 7,83 9, , , , Sources: ITD, CK, STEC, TTCL, NWR, SYNTEC, and PREB TRIS Rating Co., Ltd 2 15 May 215

3 Market Outlook TRIS Rating expects total construction spending to grow in 215, compared with last year s contraction. Public works projects will be the key growth driver, considering the number of government-sponsored infrastructure projects in the pipeline. The Bank of Thailand (BOT) projected government investment to grow by 8% y-o-y in 215, up from a minus growth of 6.1% y-o-y in 214. Private sector construction spending is also expected to grow, but at a slower rate. A slowdown in the domestic economy has made some entrepreneurs reluctant to make huge investments, while weaker demand for residential property has caused some property developers to delay the launches of new projects, especially condominiums. The BOT projected private investment to grow by 3.1% y-o-y in 215, up from a contraction of 1.9% y-o-y in 214. As a result, 215 should be a better year for contractors which concentrate on public sector work, such as ITD, CK, and STEC. Contractors which concentrate on private sector work, particularly builders of condominium projects like SYNTEC and PREB, are likely to face a drop in the value of new contracts they sign during the year. However, both firms have sizable backlogs, which will cushion any negative effects on their financial performances. TTCL, which specializes in power, petrochemical, and chemical projects, is expected to be less affected by the weak domestic economy as most of its revenues are from overseas projects. The pressure from the cost side is expected to alleviate in 215. Construction material prices and labor costs are relatively stable, and interest rates remain low. Key Factors for the Next 12 Months Positive Factors A number of government infrastructure projects in the pipeline. After a new Cabinet was formed in the second half of 214, many infrastructure projects have moved forward. The Mass Rapid Transit (MRT) Green Line (Mo Chit-Kukod), worth about Bt29 billion, was the first mass transit project opened for bidding after the political impasse ended. The MRT Orange Line (Cultural Centre-Minburi), the MRT Pink Line (Khae Rai- Minburi), and the MRT Yellow Line (Ladprao-Samrong), worth more than Bt2 billion in total, are expected to be open for bidding during In addition to these four electric train projects, other large infrastructure projects are planned. The projects in the pipeline include double track railway projects, road and motorway projects, and airport expansion projects. These large infrastructure projects will boost public sector construction spending from 215 onwards. Demand for residential property along the mass transit routes is expected to increase, and thus buoy private sector construction spending over the medium to long term. Sizable backlogs. The combined backlog of the seven rated contractors stood at approximately Bt412 billion at the end of 214, up from Bt313 billion at the end of 213. ITD s backlog surged as it was awarded two large concession contracts in Mozambique, worth about Bt112 billion in total. Moreover, the company had another concession contract under negotiation: the Dhaka Elevated Expressway PPP, worth Bt38 billion. These three concession contracts boosted ITD s backlog, and increased the combined backlog of the rated contractors in 214. In fact, the backlogs of most of the rated contractors declined from the previous year. Many contractors saw drops in the value of contracts they signed during 214. The drops in the backlogs reflected a contraction in total construction spending. However, most of the rated contractors backlogs were considered high. TRIS Rating Co., Ltd 3 15 May 215

4 Chart 2: Backlogs of Rated Contractors Btbn ITD CK STEC TTCL NWR SYNTEC PREB Total Sources: ITD, CK, STEC, TTCL, NWR, SYNTEC, and PREB Construction costs and labor costs stay under control. The costs for construction materials and labor were relatively stable during the last two years. The slowdown in the domestic economy and the global economy caused the prices of steel and cement to decline. The sharp drop in oil prices also helped lower the production costs of several key raw materials used in construction. In addition, some contractors have partially replaced their workers with machines. As a result, concerns over the industry-wide labor shortage have subsided somewhat. Low interest rates. Because of the weak economy, the Bank of Thailand (BOT) decided to lower its one-day policy rate twice during the first four months of 215. The first rate cut was on 11 March, when the Monetary Policy Committee decided to lower the rate by.25% to 1.75%. The second rate cut was on 3 April, when the one-day policy rate was lowered by another.25% to 1.5%. Following the rate cut by the BOT, several commercial banks lowered their minimum lending rates (MLR) by basis points. The MLR now ranges between 6.625%-6.975%, based on the rates of Thailand s five largest banks. The consecutive rate cuts indicate the BOT s attempt to keep borrowing costs low. Low borrowing costs will benefit contractors which have relatively high levels of leverage. Negative Factors A slowdown in the domestic economy. The economic sentiment in the first four months of 215 was not good. The sharp decline in the export sector has raised concerns over the ability of the country to achieve the 4% gross domestic product (GDP) growth target. The BOT lowered its GDP growth forecast from 4% for 215 to 3.8% on 23 March 215. However, GDP may grow more slowly than the current forecast if the prices of major agricultural products stay low and if the domestic economy and the global economy recover more slowly than initially forecasted. The cooling economy has caused entrepreneurs to delay investment projects. Many are keeping their eyes on the government s economic stimulus program and policy moves before making investment decisions. A slowdown in the residential property market. Due to weaker demand for residential property, inventory levels at property developers have kept rising. The overhang of unsold units is expected to discourage property developers from launching more new projects. The excess supply will adversely affect contractors which concentrate on residential property projects, especially condominiums, like SYNTEC and PREB. Property developers are generally more concerned about unsold condominium units than unsold units in low-rise housing projects. Still, both SYNTEC and PREB have sizable backlogs, which can lessen any negative effects on their financial performances in the short term. However, if the slowdown in the residential property market TRIS Rating Co., Ltd 4 15 May 215

5 continues, the financial performances of these companies will inevitably be hurt in the next one to two years. Both firms have many short term construction contracts. Chart 3: Number of Condominium Units Launched, Sold, and Ending Inventory in Bangkok and the Vicinity 1, 8, 6, 4, 2, Units %YoY Newly launched Sold Ending Inventory % growth of inventory (RHS) Source: Agency for Real Estate Affairs (AREA) Political instability and rising public debt. After a Cabinet was formed in the second half of 214, the political situation has improved steadily. Nevertheless, the political outlook in Thailand is still highly uncertain in TRIS Rating s view. Political losers may stir up trouble if a new election occurs. In addition, fiscal discipline is another lingering concern. Due to rising public debt, it is possible that the government may have to delay or even forgo some planned infrastructure projects. According to the Public Debt Management Office (PDMO), public debt as a percentage of GDP has risen continuously since 211. It stood at 4.8% at the end of 211, and increased steadily to 46.8% at the end of March 215. However, the level of public debt as a percentage of GDP stayed below 6%, the threshold level based on the Thai fiscal sustainability framework. The ongoing political concerns and the public debt constraint may cause contractors backlogs to grow more slowly than expected. Changes in Ratings/Outlooks Despite the weaker economy, the credit profiles of nearly all of the rated contractors remained stable in 214. Their ratings ranged from A- to BBB-. Most of the rated contractors financial performances in 214 were in line with TRIS Rating s expectations. In 214, TRIS Rating upgraded the ratings of CK to A-/Stable from BBB+/Positive as a result of its stronger business platform and its improved financial flexibility following successive business reorganizations. The ratings of the other rated contractors remained unchanged. In 214, four out of the seven rated contractors reported steady or improved operating margins, compared with their margins in the previous year. ITD, CK, and TTCL showed weaker profitability. CK s net profit slumped by 7.1% y-o-y due to a dramatic decline in its extraordinary income. Due to its size, CK is a large contributor to the combined net profit of the seven rated contractors. As a consequence, the combined net profit of the seven firms plunged by 51.4% y-o-y in 214. Leverage stayed at the same level as in 213 for most contractors, except TTCL and PREB. The debt to capitalization ratio of TTCL soared to 53.6% from 13.6%, because it changed its business model. TTCL is now a project owner rather than purely a contractor. PREB s leverage increased to 27.9% from 8.7%, as it entered the residential property development business. The leverage levels varied widely among the rated issuers, given the differences in their business models. Leverage levels are particularly high at contractors which invest in long-term projects, such as ITD, CK, and TTCL. TRIS Rating Co., Ltd 5 15 May 215

6 TRIS Rating expects that financial performances of most rated contractors will remain stable in 215, implying their ratings should remain stable. The slowing demand for residential property may pressure contractors which specialize in residential property projects, but their sizable backlogs will limit the downside risk. Table 3: Profitability and Leverage Levels of Rated Contractors Operating Margin (%) Change ITD CK STEC TTCL NWR SYNTEC PREB Average Net Profit (Btmn) % Change ITD 298-1, CK ,674 2, STEC ,96 1,733 1, TTCL NWR SYNTEC PREB Total 1, ,987 11,37 5, Debt / Capital (%) Change ITD CK STEC TTCL NWR SYNTEC PREB Average Sources: ITD, CK, STEC, TTCL, NWR, SYNTEC, and PREB TRIS Rating Co., Ltd. Office of the President, Tel: ext 5 / Silom Complex Building, 24th Floor, 191 Silom Road, Bangkok 15, Thailand Copyright 215, TRIS Rating Co., Ltd. All rights reserved. Any unauthorized use, disclosure, copying, republication, further transmission, dissemination, redistribution or storing for subsequent use for any purpose, in whole or in part, in any form or manner or by any means whatsoever, by any person, of the credit rating reports or information is prohibited. The credit rating is not a statement of fact or a recommendation to buy, sell or hold any debt instruments. It is an expression of opinion regarding credit risks for that instrument or particular company. The opinion expressed in the credit rating does not represent investment or other advice and should therefore not be construed as such. Any rating and information contained in any report written or published by TRIS Rating has been prepared without taking into account any recipient s particular financial needs, circumstances, knowledge and objectives. Therefore, a recipient should assess the appropriateness of such information before making an investment decision based on this information. Information used for the rating has been obtained by TRIS Rating from the company and other sources believed to be reliable. Therefore, TRIS Rating does not guarantee the accuracy, adequacy, or completeness of any such information and will accept no liability for any loss or damage arising from any inaccuracy, inadequacy or incompleteness. Also, TRIS Rating is not responsible for any errors or omissions, the result obtained from, or any actions taken in reliance upon such information. All methodologies used can be found at TRIS Rating Co., Ltd 6 15 May 215