U.S. Markets Construction Overview. Industry Focus. Powerful Results.

Transcription

1 U.S. Markets Construction Overview Industry Focus. Powerful Results.

2 FMI Contributing Authors: Michael D. Clancy Principal Ryan R. Howsam Sabine H. Hoover Steven J. Isaacs Scott L. Kimpland Bryan S. Kucinski Brian A. Moore Lee D. Smither Philip E. Warner Scott B. Winstead Consultant Content Manager Division Manager, Architecture and Engineering Director Consultant Principal Managing Director Research Consultant President, Management Consulting Published by: FMI Corporation 5171 Glenwood Avenue Suite 200 Raleigh, North Carolina Editor and Project Managers: Sarah E. Avallone Sallyann Hulick Karen Newcombe FMI Capital Advisors, Inc. Contributing Authors: Russell H. Clarke Analyst W. Chris Daum President and Senior Managing Director R. Huntley Davis Managing Director Scott C. Duncan William G. Hill Timothy D. Huckaby Vice President D. Alex Miller Associate John F. Steinegger Randal G. Stutzman Timothy R. Sznewajs Porter L. Wiley Senior Managing Director Managing Director Associate Managing Director Senior Managing Director Managing Director Layout and Design: Erda Estremera Departmental Editors: W. Chris Daum President and Senior Managing Director Hank M. Harris, Jr. President and Chief Executive Officer Scott B. Winstead President, Management Consulting Proofreaders: Jeanette R. Albright Mary L. Bjelica Elaine J. Bowen Denise D. Danisewich Denise M. Gonzalez Pamela C. Nettles CONTACT US AT: Copyright 2014 FMI Corporation. All rights reserved. Published since 1985 by FMI Corporation, 5171 Glenwood Ave., Suite 200, Raleigh, N.C Printed in the United States of America. Notice of Rights: No part of this publication may be reproduced or transmitted in any form, or by any means, without permission from the publisher: To order additional copies of this book, please call or complete the order form at the back of this publication.

3 Introduction FMI, a leader in management consulting, investment banking and people development for the engineering and construction industry, is pleased to present the 2015 U.S. Markets Construction Overview. This publication offers insights into some of the construction industry s most complex business challenges. FMI publishes the U.S. Markets Construction Overview annually. The Overview includes a comprehensive report on current and emerging construction trends and forecasts the growth or decline in each market segment, noting both short-term and long-term considerations. We hope this document provides you with a thorough understanding of economic and other major issues affecting the industry and serves as a starting point for your company s strategic planning efforts. However, we must caution that major decisions should not be made without additional investigation and research of your own specific geographic and construction market segments. We welcome your comments and questions. Your feedback is important and helps us to improve our service to you. Please us at outlook@ fminet.com to give us your input about the Overview and to reserve a copy of next year s issue. Investment banking services provided by FMI Capital Advisors, Inc., a registered broker-dealer and wholly owned subsidiary of FMI.

4 Table of Contents SECTION 1: Energy Trends Executive Summary... 2 Energy Outlook: Key Trends Impacting the Construction Industry... 5 SECTION 2: Stakeholder Trends The Labor Shortage: Impacts Across the Industry Engineering and Construction Firms General Contractors Heavy Civil Contractors Construction Materials Engineering and Architecture Industrial Contractors Oil and Gas Industry Utility Transmission and Distribution Trade Contractors Energy Services and Cleantech Industry Building Product Manufacturers and Suppliers Private Equity Surety SECTION 3: Construction Outlook Construction Forecast Residential Construction Nonresidential Buildings Nonbuilding Structures Construction Put in Place Regional Summaries... 71

5 Energy Trends SECTION 1

6 Executive Summary 2 Executive Summary As we go to press with this year s U.S. Construction Industry Overview, it is late in the third quarter of 2014, and the United States construction industry is showing strong signs of recovery. The recovery still has an uneven nature to it and is somewhat erratic, however, construction over the long haul only grows at an inflationary rate. The current growth rates of 7% to 8% are a definitive sign that we are in recovery, as well as the fact that we are in the up cycle portion of what is ultimately a cyclical industry. This particular recovery is the first in the modern history of the United States not to feature housing as the recovery leader. That in itself is unusual and may be part of the reason why this recovery is so irregular. Housing is, of course, recovering, but at a slow rate and from a very low base. The erratic nature of this recovery means that some geographies are doing much better than others, as are certain vertical markets. Being in the right place at the right time is an important part of capitalizing on this part of the cycle. The good news for the construction industry in the U.S. is that almost all of the major market sectors have a strong amount of pent-up demand. The corollary is that there are funding constraints in almost all of these sectors as well. The geopolitical realities of our world today translate to a federal government that is fiscally underwater and to hesitancy among those who wield private capital. This is expressed by choppiness among capital expenditure programs. While funding issues keep the short-term picture somewhat murky, we believe that the intermediate- to longer-term implication of our situation is generally good. Infrastructure funding is so necessary and, at this point, is so far behind that the political will must be found. Americans have shown strong tolerance for putting up with transportation problems. However, we do not believe that the American public will withstand a lack of water. Other vertical markets, like health care, simply must be funded over the intermediate term due to demographics. Amid a reasonable intermediate-term outlook for most conventional forms of construction, the U.S. is also experiencing a booming oil and gas phenomenon, which is creating much positive momentum. We believe that the LNG export market will be favorably resolved. With the unstoppable linear trends of growing middle classes in Africa, India and China, and the U.S. in position to be the No. 1 energy exporter in the world, this will be a strong and positive economic driver for the economy and for our industry does not seem so long ago, but the reality is that it has been six years since the construction industry saw one of its worst economic crises looming on the horizon. At that time, executives in our industry and in others came back to their offices from the 2008 holiday season and proceeded to dramatically reduce overhead and expenditures. In early 2009, many companies were going about the business of getting smaller in preparation for a difficult period. For many of them, that was the right response at the right time. However, CEOs and senior managers must now turn their thinking in the other direction. Now is the time to be taking advantage of the industry s re-emergence. Senior managers are now focusing on where to place their bets in the markets, how to orchestrate brand positioning in the marketplace, and how to pursue the right projects in the market mix. Senior managers are also looking at reinvesting in the human capital programs requisite to accomplish all the work to be done.

7 3 The 2015 U.S. Markets Construction Overview As executives turn their attention toward a renewed growth agenda, we have asked ourselves how this publication can best help. While one publication cannot possibly solve all questions in one of the country s largest and most fragmented industries, we do think that we can serve as a springboard for strategic thought among the industry s executives. Our aspiration is that the content here is foundational material for strategy development in a variety of industry organizations. Part of what we attempt to demonstrate each year in this publication is that, once defined, markets can be researched. Every going concern in the industry must ultimately define its market space, whether that is geographic, vertical or some combination. Once defined, those markets can be examined for in-depth information that enables senior managers to plan and execute effective penetration strategies. Demographics, demand drivers, customer buying practices and preference, market size, growth trajectory and many other factors that can help senior managers craft these approaches are all ascertainable with the right work. Of course, all companies must make their strategic choices at a micro-market level. In this publication, we write at the macro level, but we do so in the hope of demonstrating that good facts can support good executive decision-making. Strategy development may be thought of as somewhat of a telescope. Therefore, starting out with a macrolevel picture provides context from which to begin subdividing the market. Firms may then begin applying a similar level of trend and market trajectory assessment to target segments. In today s market, doing this well is perhaps more important than it has ever been in the industry s history. Many service providers in the industry are now effectively in the position of having to win the work at least twice, and sometimes even three times. Many firms depend upon their brand and the value promise of that brand to get them to a shortlist opportunity. However, everyone on a shortlist is qualified to do the work at hand. So, the right diligence on project pursuit is required to actually win at the point of sale. For some companies, bid protests make it necessary to have to return to the fray and win again. Add to that the growth in large projects, both in infrastructure and building, and the growth of complex and expensive delivery proposals, and you have a situation where the efficiency of market and project targeting is extraordinarily important. Any of our readers who happen to remember marketing classes from their school days will perhaps remember the Four P s of marketing. Applied to our industry, they can be thought of as follows: Product What is the actual product or service that your firm is taking to the market, and is there any way that it is unique? Place Where are you in the food chain of the design and construction process? Promotion How are we able to package the right expertise and get it in front of the right people in order to win? Price How big of an issue is this, and will it prevail above all else? If you know this industry reasonably well, then you know that some firms will invariably choose new market entry by simply pricing themselves lower than anyone else for a project. In effect, they will ignore three out of the four P s of marketing. They will pay dearly for a project in order to gain new market experience. While this is one way to do it, it is an extraordinarily risky and expensive method. Doing the research, crafting the right strategy, amassing the right resources and perhaps having the right partners will produce a much better return on investment scenario in new market entry when all things are considered.

8 Executive Summary 4 Economic cycles in our industry are inevitable. By definition, they imply change. CEOs and senior managers in the industry have the difficult job of orchestrating that change within their organizations. In considering those changes and the implications for their organizations, it is often useful for senior managers to pause and reflect. What are the trends that will impact the context of the industry going forward, and how might individual firms respond? What are the changes in the competitive landscape? What do clients really want from their service providers under the new conditions? Where is construction spending headed, and how do service providers get ahead of the curve? Do we have the right strategy and the right organizational approach necessary to capitalize on the market resurgence? We hope that this publication will help you as you pause to consider these issues. Thank you for including us in your time to read, reflect and consider our industry going forward. As always, please let us know if we can directly help you in any way. Sincerely, Hank M. Harris, Jr., cmc President and Chief Executive Officer

9 5 The 2015 U.S. Markets Construction Overview Energy Outlook: Key Trends Impacting the Construction Industry By Sabine H. Hoover alone could put constraints on the rebirth of residential and commercial construction across the nation, as contractors scramble to fill positions particularly in hot energy markets such as North Dakota, Pennsylvania, Texas and Colorado, to name a few. Every second of the day, Americans rely on energy from oil and natural gas to maintain their daily lives. By taking advantage of advances in horizontal drilling and hydraulic fracturing techniques, energy companies are making unprecedented investments to develop unconventional oil and gas resources trapped within shale formations. The trend is expected to continue over the next two decades. By 2035, in fact, the oil and gas industry is expected to make more than $5.1 trillion in cumulative capital expenditures. [1] This high level of activity will translate into significant opportunities for the U.S. design and construction industry nationwide and will have far-reaching global implications. Following are some key trends associated with the new energy revolution that will have a ripple effect on the U.S. design and construction industry for decades to come. Energy Industry Drains Construction Talent The fact that many construction employees have gravitated to the growing oil and gas sector should come as no surprise. In 2008, just 3.8% of the total construction workforce was engaged in direct oil and gas construction. That number almost doubled by 2012, when 6.4% of that workforce was engaged in direct oil and gas construction. One of the main reasons for this shift is that during the construction downturn following the Great Recession, the high level of shale activity and oil and gas production lured construction workers away from depressed markets, offering ample opportunities to increase their incomes by thousands of dollars. According to FMI s estimates, by 2017 nearly 10% of the total U.S. construction workforce will have moved over to this burgeoning segment of the industry (Table 1). [2] Growth, of course, is good. However, this particular expansion could come at the expense of other construction sectors that are now experiencing their own recoveries and subsequent growth. The expansion could also impact the oil and gas industry, where the sector s share of total workers continues to increase despite concurrent double-digit growth in the U.S. residential sector. This fact Jerry Nevlud, president of the Associated General Contractors Houston chapter, stated, The construction that s anticipated to be built in the Houston area over the next few years is pretty impressive. Many subcontractors are going to have a hard time manning up the numbers to accommodate the volume of work projected. [3] Raising the Stakes To compete effectively with the energy sector and to attract and retain new talent, contractors in other construction sectors must be prepared to offer competitive base salaries and implement effective incentive compensation programs that include higher bonus payouts. Consequently, owners will likely face rising construction costs and possible project delays, as contractors struggle to staff their projects. Under this unprecedented labor pressure, industry participants must acknowledge that not all previous forms of labor models and business approaches will continue to be appropriate during these transformational times. The changing competitive landscape, combined with emerging technologies and ideas about how to ramp up and organize companies, has become a real force influencing today s construction industry particularly in the oil and gas sector. As such, we will likely see more union labor re-entering high-growth markets like the Gulf Coast area, just as owners scramble to get projects off the ground. As one industry executive points out, There s a reluctance on the part of the owners to bring back the unions into the market (in the Gulf Coast area), but that needs to be transcended with the pragmatic reality that you cannot get these facilities built all open-shop or all union. It s going to take a combination of the two. As competition for limited resources intensifies, labor and talent management are quickly becoming key differentiators in company performance and value. Companies seeking to build a presence in the energy market need systems and processes in place that maximize productivity and retain top talent. As the energy sector continues to draw a larger share of the available construction labor force, contractors across all sectors will be forced to do the same. 1. America s New Energy Future: The Unconventional Oil and Gas Revolution and the U.S. Economy. IHS Global Insight. October Energy Industry Drains Houston s Construction Talent; Impacts Project Costs, Timelines. Shaina Zucker. Houston Business Journal. May 3, For a full overview on predicted labor shortages, see: Skills Shortages in a Booming Market: The Big Oil and Gas Challenge. FMI. April 2014.

10 SECTION 1: Energy Trends 6 Table 1. Total Construction Employment Demand Oil and Gas Segment Estimated for the United States Thousands of Full-Time Workers September E 2014 E 2015 E 2016 E 2017 E Carpet, Floor and Tile Installers and Finishers Sheet Metal Workers Brickmasons, Blockmasons and Stonemasons Roofers General and Operations Managers Cost Estimators Drywall Installers, Tapers, Ceiling Tile Installers Construction Managers Cement Masons, Concrete Finishers and Terrazzo Workers Painters and Paperhangers Engineering and Design Occupations Construction Equipment Operators Helpers, Construction Trades Pipelayers, Plumbers, Pipefitters and Streamfitters First-Line Supervisors/Managers Electricians Carpenters Construction Laborers TOTAL % Change from Prior Year 6% 5% 7% 10% 11% 14% 17% 16% 14% Estimated Composition of Engineering and Design Demand E 2014 E 2015 E 2016 E 2017 E Petroleum Engineers Other Engineering and Design TOTAL Estimated Composition of Pipelayers, Plumbers, Pipefitters and Steamfitters E 2014 E 2015 E 2016 E 2017 E Pipefitters Welders Other TOTAL Source: FMI Projections

11 7 The 2015 U.S. Markets Construction Overview U.S. Energy Market Fuels Midstream Infrastructure Build-out With major pipeline projects currently underway and in the planning stages, North America s oil and liquids gas transport infrastructure is in high demand. Experts predict significant expansion in the coming years. North America leads the world in pipeline construction, with 41,810 miles of new or planned lines for oil and natural gas, according to Pipeline & Gas Journal s 2013 Worldwide Construction Report. For example, the newly completed southern leg of the Keystone Pipeline route (aka the Gulf Coast Pipeline) is now carrying over 700,000 barrels of oil daily from Cushing, Okla., to Nederland, Texas. This new conduit is relieving what once was a significant bottleneck between oil produced in Oklahoma and refineries located on the Gulf Coast. However, in other regions of the U.S., such as the Eagle Ford, Bakken and Marcellus formations, gas gathering and pipeline infrastructure build-out is lagging up to two years behind well development despite attractive pricing. According to a recent study commissioned by the Interstate Natural Gas Association of America (INGAA) Foundation, energy companies will need to invest $641 billion in midstream energy infrastructure through 2035 to keep up with growing oil and gas production. [4] The largest share of regional midstream infrastructure investment is expected to occur in the Southwest (New Mexico, Texas, Oklahoma, Louisiana and Arkansas) and will total more than $220 billion between 2014 and [5] With midstream oil development infrastructure increasing in the region, and with more than half of the U.S. refineries situated there, investment in gas-related infrastructure is expected to increase too. The key drivers for this growth are continued expansion in gas production and load growth at petrochemical and liquefied natural gas (LNG) export facilities. Canada, the Central U.S. and the Northeast are also on track for significant growth in new midstream infrastructure particularly gas-related infrastructure to support the growing production of shale resources and facilitate pipeline transport to markets and export facilities. Concurrently, the abundant supply of low-cost and low-emission natural gas is expected to drive an accelerated decline of coal-fired generation plants combined with an increase of gas-fired generation plants. This trend will ultimately lead to more pipeline construction as well. 4. North American Midstream Infrastructure through 2035: Capitalizing on Our Energy Abundance. An INGAA Foundation Report. Prepared by ICF International. March 18, While pipelines move most U.S. crude oil, limited capacity is leading to growing competition from trucks, railroads and barges throughout Canada and the U.S. Between 2011 and 2013, the number of barrels of oil transported to U.S. oil refineries by rail, truck and barge increased by almost 60%, with rail shipments increasing the most. [6] By leveraging rail companies, producers can select target markets without worrying about long-term commitments to specific destinations. Should projects like Keystone XL, Northern Gateway or Energy East pipeline not come to fruition, rail will become even more essential to the industry. Oil and gas producers high demand on rail is also starting to affect other industries, including coal and agriculture. According to latest news reports, some power generators claim that they can t stockpile enough coal for the coming winter due to freight slowdowns and backlogs. In a recent Senate Committee Hearing on Commerce, Science and Transportation, U.S. Department of Agriculture Deputy Administrator Arthur Neal testified that railroad service to grain shippers may not recover in time for the 2014 crops harvest. Should this happen, grain elevators could run out of storage capacity, grain stored on the ground would run the risk of spoiling, and the costs of inadequate rail service would continue to accrue, Neal stated. [7] Sprawling Energy Hot Spots Traditionally centered in U.S. and Canadian hubs (e.g., Houston and Calgary, respectively), energy job growth is beginning to spread to second-tier energy hubs like Dallas, Fort Worth, Edmonton, Denver and Pittsburgh, where strong economic activity is creating new opportunities for energy companies and causing a ripple effect across all construction sectors. The following provide examples of energyrelated construction activity in the commercial and industrial sectors, specifically: 1. Commercial. Many of the shale zone communities, such as the Bakken in North Dakota or Eagle Ford in Texas, are illequipped to accommodate the growing populations in these areas. For example, the average retail square footage per person in the U.S. is 23.8 square feet; that number is nearly 50% less (12.02 square feet) in North Dakota. [8] Over the next six years, roughly $80 billion in annual investments com- 6. Refinery Capacity Report. U.S. Energy Information Administration. June Rail Deliveries Impact U.S. Power Plants Coal Stockpiles for Winter. Industrial Info Resources (IIR). September 29, Energy Outlook. North America. JLL Ibid.

12 SECTION 1: Energy Trends 8 bined with rapid population expansion (and associated high spending capacity!) is expected to spur the construction of local infrastructure and real estate development in these areas, turning small settlements into genuine boomtowns. Chris Daum, senior managing director with FMI Capital Advisors, Inc., confirms this trend: A tremendous amount of new drilling activity in the Niobrara Basin in Colorado s front range will drive significant commercial activity north of Denver. According to the Metro Denver Economic Development Corporation, the Niobrara region serves as a hub for integrating traditional fossil energy and cleantech. [9] A good example is the proposed Niobrara Data Center Energy Park, a 662-acre micro-grid energy and technology park located in Weld County, that will serve as a hub for cloud data centers, energy storage, renewable and fossil power generation, and multiple high-technology uses. These developments will create opportunities for new clusters to emerge, further driving local job growth and economic activity. Meanwhile, investors have been tracking these industry changes too and secured $254 billion for commercial real estate construction and development starts during the first half of Projects include everything from Class A office space, to manufacturing facilities in energy hubs, to multifamily properties in thriving markets. Lenders are more than happy to oblige. Goldman Sachs, for instance, has set its sights on construction and development lending, according to Fortune, and has issued more than $500 million in construction loans in 2014 (up from just $50 million in 2013). 2. Industrial. The shale gale s ripple effect is also influencing the industrial construction sector and driving construction of access roads, site preparation, storage ponds and pipes; petrochemical, power and steel plants; and fueling stations. LNG export terminals, both in the U.S. and Canada, are expanding too, even though these projects dwarf the financial outlay and labor demands of all the midstream pipeline construction activity, stated Daum. As an example, federal regulators just approved plans for Dominion Resources $3.8 billion Cove Point LNG project in Calvert County, Md., the closest one to the Marcellus Shale region. Construction to convert the existing import terminal into an export facility is expected to begin in early Cove Point is one of four LNG export projects to receive final approval. The other three include the Sabine Pass LNG Terminal in Cameron, La.; the Cameron LNG project in Hackberry, La.; and the FLEX/Freeport LNG project on Quintana Island in Texas. Meanwhile, 14 other projects are still awaiting federal approval, most of which will be located in the Gulf Coast area, in addition to a few projects in the Pacific Northwest. All combined, these activities and changes are further increasing the strains on labor capacity and affecting anticipated project costs. In some cases, large capital projects have already been delayed or canceled (see Shell s Louisiana GTL plant as an example) due to rising costs and questionable long-term profitability projections. With America s natural gas prices hovering at historic lows, however, international companies such as South Africa-based Sasol, an integrated energy and chemical company, are moving in, despite the high risks associated with costs and labor availability. Sasol s new $16 billion to $20 billion ethanol plant in Westlake (Lake Charles, La.) is expected to start construction in late Local construction companies are afraid that such colossal projects will lure skilled labor from the area and put them to work on industrial construction projects. As one executive with a Lafayettebased general contractor stated, We are worried. We are primarily in the commercial building construction industry, and we have concerns about our resources being pooled into other markets such as industrial construction markets, which is a valid concern. While these new industrial construction projects are keeping thousands of construction and engineering companies afloat, a parallel construction boom is taking place and is being spurred by federal pipeline integrity and safety regulations to inspect, repair or replace the aging transmission system. State and federal regulators alike are investigating pipeline systems and adopting cost-recovery strategies to help modernize and expand current facilities. Government oversight will likely increase as the oil and gas industry continues to expand. This will create more opportunities for pipeline and engineering firms that specialize in design, operation and corrosion control for gas transmission and distribution lines as well as liquid-petroleum pipelines. 9. ENERGY: Metro Denver and Northern Colorado Industry Cluster Profile (Prepared by Development Research Partners, Inc.). Metro Denver Economic Development Corporation. January 2014.

13 9 The 2015 U.S. Markets Construction Overview The Road Ahead A real energy revolution is underway. Led by increased production of both shale oil and shale gas, the U.S. is finally reversing an energy production decline that spanned more than three decades. With the demand for infrastructure expected to grow dramatically over the next decades, significant increases in midstream pipeline construction as well as expanded rail and road construction for energy transport are in store. Concurrently, each of these transportation segments will likely see more stringent laws and regulations around safety and environmental impacts, as infrastructure systems at the local, state and national levels adapt to a new energy revolution. At the same time, the U.S. oil and gas industry is on the brink of its largest human capital shortfall as it faces one of the most significant expansion periods in its history. Fierce competition for talent in this sector is already driving energy infrastructure construction firms to rethink their human capital needs and optimize access to and retention of qualified and experienced workers. This perfect storm of sorts will present both challenges and opportunities for construction and engineering firms across a broad range of markets. By shoring up their stables of experienced, skilled workers now rather than later and exploring the various strategic opportunities that exist, firms will find themselves well equipped to tackle the oncoming challenges and to leverage extraordinary opportunities. Sabine H. Hoover, Content Manager, at or via at shoover@fminet.com

14 SECTION 1: Energy Trends 10

15 11 The 2015 U.S. Markets Construction Overview Stakeholder Trends SECTION 2

16 SECTION 2: Stakeholder Trends 12 The Labor Shortage: Impacts Across the Industry By Michael D. Clancy, R. Huntley Davis, Scott C. Duncan, Steven J. Isaacs, Scott L. Kimpland, Brian A. Moore and Randal G. Stutzman For years industry experts have predicted a workforce shortage spanning the design and construction industry, from engineers to skilled labor to firm leadership. Some have argued that there is no such deficiency, particularly in STEM-related disciplines, but in 2014 the real shortfall of qualified talent became apparent. It will be a major trend in 2015 and for several years as the marketplace seeks viable solutions. Availability of Labor at All Levels is a Major Concern The shortage of skilled labor at all levels is no surprise. The construction industry first recognized the declining supply of construction labor as early as the mid-1980s. Organizations, including the Associated Builders and Contractors, Construction Industry Institute, Business Roundtable, Construction Users Roundtable and others, began warning the industry of the inevitable shortage of not only skilled craftsmen but also project managers, estimators, superintendents and senior managers. Now that the industrial segment is expanding, the issue has become critical. A 2012 report from FMI stated that two million jobs disappeared from the design and construction industry during the downturn that followed the Great Recession. This accounted for about 20% of all jobs lost during that period. There have been many reasons for this reduction: During the recession, many in the industry found careers in other sectors and have no desire to come back to the construction field. As younger workers encountered the cyclical nature of the industry for the first time during this recession, many opted to seek employment in other industries less impacted by economic cycles. Proposing Entity Immigration Policy Proposal (Self-Described) Likely Industry Impacts if Adopted Obama Administration Enforcement: focused on those entering to commit additional crimes/terrorist acts Employer verification and compliance-driven Legalizing DREAMers, guest visas for migrant farm labor, increased H1-B visa availability Immediate legal status contingent on registration, background check, tax and penalty payment; back of the line and English language requirement for citizenship Immediate availability of Hispanic labor Increased e-verify requirements Wage stagnation may end as legal status allows workers to demand more Senate Requires enforcement, in particular at high-impact crossing areas, certified by DHS Secretary Provisional legal status not granted until enforcement certification provided by DHS Use of e-verify system Double or triple number of H1-B visas Create new W-visa for low-paid workers, capped in the early years Increase in wages as W-visas capped at only 20,000 in year one More verification and enforcement requirements House No House bill has emerged from subcommittee yet Unknown

17 13 The 2015 U.S. Markets Construction Overview Baby boomers are retiring at an astounding rate. Approximately 10,000 baby boomers are retiring each day and members of this group heavily populate most industrial, engineering and construction firms. Boomers represent 26% of the U.S. population. While the loss in numbers of workers within this group is significant, the loss of experience, knowledge and leadership is more alarming. Fewer young workers are entering the industry, both in the field and in management. The U.S. has fewer construction and engineering graduates than at the peak just six years ago, with many construction management and civil engineering programs running below maximum enrollment. Additionally, fewer young people are entering the skilled trades. The industry, particularly at the craft level, is highly dependent on Hispanic labor. This demographic has historically deep roots in the industry, and with typical values such as a strong work ethic and pride in craftsmanship, this is not surprising. The growth of Hispanic workers is projected to be about three times that of all other workers. This drives the need for bilingual personnel at all levels. The current immigration policy (or some would argue, the lack of a policy) has clouded the ability to fully predict what ongoing impact Hispanic labor will have on the segment. Current proposals, and their likely effects, are all over the map. With no immigration reform proposal becoming law before the 2014 midterm elections, immigration will likely be a key campaign element of the 2016 presidential race. Contractors looking to Washington for clarity on this issue will have to wait a few more years. Oil and Gas Construction Feeling the Strain The petrochemical industry is experiencing rapid growth as more oil and natural gas reserves are found in the U.S. Getting these resources out of the ground, moving them to refineries in different areas of the country, and transporting the resulting products to end users have created an unprecedented construction boom in the midstream segment. The strains on labor capacity in oil and gas construction markets worldwide continue to affect projected project costs, with large capital projects, particularly on the Gulf Coast, facing cost pressures as a result of rising labor prices and questionable long-term profitability projections. As demand continues to increase in the face of the liquefied natural gas (LNG) export gold rush, construction firms are faced with unprecedented pressures to retain and grow talent. To keep up with this extremely dynamic and competitive if not unprecedented business environment, oil and gas construction firms need to develop a robust talent pipeline to tackle the industry s many business challenges in the coming years. In 2008, just 3.8% of the total construction workforce was engaged in direct oil and gas construction. By 2012, 6.4% nearly double 2008 s number of that workforce was engaged in direct oil and gas construction. According to FMI s estimates, by 2017 nearly 10% of the total U.S. construction workforce will have moved over to this burgeoning segment of the industry. FMI expects these strains to continue. In response, successful companies are thinking long term and building new talent pipelines, developing targeted interventions, assessing the business impact of skills shortages and considering the options available to build competency. Engineering and Architecture Firms Battle for Limited Talent Pool Design firms have anticipated with great concern the impact of talent drain on the profession. Just as with construction, a plethora of experienced individuals departed the profession during the Great Recession and, having taken up other work, are unlikely to return. With new projects becoming available and those long on hold starting up again, the need for talent has returned. Many engineering and architecture firms anticipated the seriousness of this issue and have established strong programs for recruiting. With a limited pool of talent available, many of these programs focus on acquiring experienced staff from competitors. Design firms that looked ahead to this day have already established robust engagement and retention efforts to protect current staff. Firms that remained cautious about hiring must now quickly take a defensive position and beware of losing key staff to competitors. With the pipeline of future college graduates, especially in engineering disciplines, insufficient to supply the entire industry, all firms must find ways to improve effectiveness for the long term or face an erosion of capacity over time. Trade Contractors With the building sector already facing significant shortages of talent, the industrial construction boom will further exacerbate severe shortages among several trades in the building markets. This trend is of even more concern when considering that the oil and gas companies are typically able to afford higher wages than other sectors. For tradesmen capable of working in either of the industrial or building sectors, the wages and opportunities being created by the oil and gas industry may be too attractive to pass up.

18 SECTION 2: Stakeholder Trends 14 In addition to a significant shortage of trade and craft workers in the field, most trade contractors are finding it equally difficult to find, attract and hire professional and management-level talent. Finding talented project managers, operations managers and successors for aging presidents and CEOs is as challenging as finding talent in the field. As a result, the companies that implemented aggressive and ongoing internship and college recruiting programs five to seven years ago are finding it considerably easier to fill midlevel and senior project management positions today. Having a system that injects new young talent into the firm every year is proving to be a more successful approach than trying to hire a qualified project manager or operations manager off the street. For many trade contractors that did not pursue a talent and leadership pipeline strategy years ago, the options for finding and hiring management succession candidates are limited. The marketplace is resilient, and solutions will emerge over time. For the short term, responses to the worker shortage may be twopronged. First, as firms return to more normal work levels, they will seek new methods of increasing efficiency and productivity to better leverage existing teams; second, firms will enhance recruiting and retention efforts to keep top talent in-house and lure desirable workers to the firm. Michael D. Clancy is a principal with FMI Corporation. He can be reached at or via at mclancy@fminet.com. R. Huntley Davis is a managing director with FMI Capital Advisors, Inc., FMI Corporation s registered Investment Banking subsidiary. He can be reached at or via at hdavis@fminet.com. Scott C. Duncan is a vice president with FMI Capital Advisors, Inc., FMI Corporation s registered Investment Banking subsidiary. He can be reached at or via at sduncan@fminet.com. Steven J. Isaacs is the division manager for architecture and engineering services with FMI Corporation. He can be reached at or via at sisaacs@fminet.com. Scott L. Kimpland is a director with FMI Corporation. He can be reached at or via at skimpland@fminet.com. Brian A. Moore is a principal with FMI Corporation. He can be reached at or via at bmoore@fminet.com. Randal G. Stutzman is a managing director with FMI Capital Advisors, Inc., FMI Corporation s registered Investment Banking subsidiary. He can be reached at or via at rstutzman@fminet.com. Engineering and Construction Firms By R. Huntley Davis and Lee D. Smither Large engineering and construction (E&C) companies intend to offer fully integrated design-build or EPC (engineering, procurement and construction) platforms, and they intend to do it globally. In some sectors industrial, oil and gas the owner is demanding this approach. In other sectors, firms are combatting slow growth in their core business by moving either up or down the supply chain in order to take a bigger piece of the project. Despite the end market, owners see benefits from the increased speed of delivery and total project control offered by an integrated firm. Michael Burke, AECOM president and CEO, said it best when he referred to the firm s core strategy as being to create the premier fully integrated infrastructure firm in the world. [1] As URS CEO Martin Koffel said recently in reference to a combined AECOM / URS, It s one-stop shopping. [2] In order to build these global, fully integrated platforms, firms are seeking acquisitions that will help fill voids whether they are geographic, end market or competency. Three transformational deals announced in the first half of 2014 are examples of this trend: AMEC s announced intent to acquire Foster Wheeler SNC-Lavalin s announced intent to acquire Kentz AECOM s announced intent to acquire URS 1. Ronald D. White, AECOM overseeing infrastructure projects from conception to completion, LAtimes.com, 8/25/2014, 2. Caelynn Barr, Beth Jinks, Matthew Monks, AECOM Technology Agrees to Buy URS for About $4 Billion, Bloomberg.com, 7/14/2014, news/ /aecom-technology-agrees-to-buy-urs-for-about-$4-billion.html

19 15 The 2015 U.S. Markets Construction Overview Each of these deals will provide the buyer with further exposure in the oil and gas sector and offer global expansion as well as other benefits. Foster Wheeler provides AMEC additional capacity in both oil products and petrochemical, including access to the Middle East. Kentz, which AMEC also looked at before moving on to Foster Wheeler, provides SNC exposure to liquefied natural gas (LNG) and unconventional oil and gas shale and oil-sands production, while also expanding the firm s oil and gas capabilities into Australia, Asia and the Middle East. Finally, URS will provide AE- COM significant additional oil and gas capabilities and increased global scale. Of nearly equal importance to expanded capabilities and résumé in the oil and gas sector, these acquisitions also provide the buyers with a larger pool of labor and talent resources. As noted in the article The Labor Shortage: Impacts Across the Industry, increased construction activity in the oil and gas sector is causing a significant strain on labor capacity, and the competition for talent at all levels craft, management, executive is becoming a key driver of acquisition activity. The trend of globalization also continues to influence the strategic direction of leading E&C firms. While there have been several examples of U.S.-based companies expanding overseas, many non-u.s. firms are showing a desire to either enter or expand their operations in the U.S. (and perhaps all of North America) both organically and through acquisition. The U.S. market is attractive for international E&C firms, particularly for those that can provide funding support and guidance to the civil-related building segments. Infrastructure projects continue to struggle to attract the necessary capital, and few industry stakeholders will argue against the immense need in this country to improve the national infrastructure. The problem facing many public owners is in financing these projects. One potential solution is for private entities to become more involved on the front end of potential revenue-generating projects and assist in the development of Public Private Partnerships (P3). As has been the case in other nations, such as the United Kingdom and Canada, this model will gain more traction in 2015, with international E&C firms, in addition to some U.S.-based companies, leading the charge. The wave of consolidation will continue in the E&C sector through 2015, as firms wage an arms race for capabilities, labor and talent resources and geographic and end market share. The large deals discussed above, as well as the pending sale of Parsons Brinckerhoff, will shift the E&C landscape, and other firms will seek to increase scale in order to compete. Additionally, as the federal and state markets have reduced funding, firms that traditionally rely on U.S. public spending will continue to chase growth by acquiring firms in more attractive markets, whether they are international or tied to the domestic oil and gas boom. This will undoubtedly cause some turmoil that embedded companies will have to respond to strategically. As this increased merger and acquisition (M&A) activity continues, firms must be intentional in managing the conflicts of interest that exist in an integrated platform. Many firms see the value of integrating vertically, yet worry that having a proprietary design group or a proprietary construction group will hurt the chances of working with firms that view the internal group as a competitor. Some conflicts should be avoided, but sometimes there are conflicts worth having and intentionally managing. History has shown that building an integrated firm solely through acquisition can be a risky proposition, given the inherent culture clash and conflicts of interest. This is often especially true of large contractors acquiring engineering capabilities without first having engineering capabilities in-house. In 2014 we saw another example of this, as Balfour Beatty announced it is divesting Parsons Brinckerhoff only five years after acquiring the firm. While the Balfour Beatty/Parsons Brinckerhoff transaction may be an outlier in its result, experience with clients has shown that acquisitions are most successful when the firm first builds the complementary practice organically in-house and then supplements it through acquisition. At the very least, firms must be intentional and methodical about their approach. AECOM, for example, meticulously sought out a target to take it into the construction space, culminating in the acquisition of Tishman in AECOM is currently seeking to repeat this success with the recently announced acquisition of Hunt Construction Group Inc. to augment construction capabilities. Perhaps the most crucial element in the success of an integrated E&C firm is the intentional creation of a culture that embraces this integration. While maintaining a unified culture is difficult for any size firm, larger firms with multiple disciplines, locations and services must be especially intentional about reinforcing core values. Some companies began as integrated firms and have maintained a culture of integration from day one. A CEO of one of these firms recently told FMI that its in-house design group will not work for external clients, as it gets beat up pretty badly. The culture of collaboration is such a fundamental shift in how the company s employees approach a project that its internal design team is not accustomed to the typical struggles that often occur when design and construction do not embrace an integrated approach.

20 SECTION 2: Stakeholder Trends 16 Other firms were founded as pure-play engineering or construction firms and were forced to build or buy the other capabilities in order to offer an integrated platform. This strategy requires an intentional effort to create a successful culture. Obviously, this riskreward tradeoff is difficult for some firms to accept, and many will choose to stay firmly rooted in either the design or the construction world. However, as design firms get more comfortable with risk, the consolidation of E&C will continue, particularly in certain markets. While FMI recognizes the benefit of an integrated platform and sees the trend continuing, current pure-play firms considering integration should study the cultural divide and meticulously plan an approach before proceeding. Whether E&C firms were founded as integrated platforms or have shifted that way over time, it is clear they have fully embraced the approach. As these firms look to expand, both domestically and internationally, the industry will continue to see consolidations in the near future as a strategy for market entry and expansion, as well as for securing capabilities, labor and executive talent. R. Huntley Davis is a managing director with FMI Capital Advisors, Inc., FMI Corporation s registered Investment Banking subsidiary. He can be reached at or via at hdavis@fminet.com. Lee D. Smither is a managing director with FMI Corporation. He can be reached at or via at lsmither@fminet.com. General Contractors By Timothy R. Sznewajs and Scott B. Winstead As Reagan said in his famous 1980 campaign speech, It s morning in America again. The industry is recovering, and while many general contractors have not returned to peak levels, most are feeling more optimistic about future prospects than at any time during the last five years. FMI s Nonresidential Construction Index (NRCI), which gauges contractor sentiment, currently reads 62.5 and has been in positive territory for 18 quarters in a row, dating back to Q The most recent AIA Architecture Billings Index (ABI), which serves as a useful leading indicator for general contractors, tells us that new architectural design contracts have risen sharply in each of the past three months, and the pace of growth in June was the fastest in the roughly four years that the AIA has collected this data. This improvement seems to be reaching more balance across regions and across the major construction sectors. With the June ABI figures, firms in three of the four major regions of the country are reporting billings gains. [3] Megaproject Proliferation and the Trend Toward Joint Ventures Even with this positive news, the industry overall remains cautious about celebrating the recovery too soon. With prospects for contractors improving, a look inside the numbers indicates some trends worth noting. From 2005 to 2009, there were only 87 projects over $1 billion in size in the U.S. versus the 2010 to 2014 period, which saw 336 projects over $1 billion. Conversely, nonresidential putin-place spending from 2005 to 2009 totaled more than $3 trillion versus $2.8 trillion for the 2010 to 2014 period. In other words, as the overall market was shrinking in size, the number of megaprojects was exploding. Since the vast majority of contractors lack the size or scale to compete for these megaprojects (which therefore go to megafirms and large joint ventures), the implication is that many firms were fighting for fewer and smaller projects. As projects grow larger and owner demands become more complex across the general building market, partnering and joint venturing have become much more commonplace. Once the preserve of only the largest contractors and the largest projects, cross-firm collaboration has now become firmly entrenched in the lower and middle end of the construction market. Whether due to the social goals of public agencies (in meeting set-aside requirements), environmental and conservation requirements of private owners (LEED, etc.), the rapid expansion of subcontractor default insurance or a myriad of other factors, projects in today s construction market require a greater level of cross-firm collaboration. In this environment, the skill sets of successful contractors must be augmented with a new set of competencies. In particular, partner selection and project execution with partners must be a core skill of tomorrow s successful general building contractor. Partnering and joint venturing are familiar concepts in the construction industry, but history is littered with failed efforts. Firms must develop a new set of evaluative tools to assist executives and project personnel to define the appropriate criteria and to measure successful outcomes. Successful firms learn from the mistakes of others and proactively employ strategies to ensure they can take advantage of the opportunities available through cross-firm collaboration. 3.