The Motley Fool

Thinking of Investing in Construction Companies? Think Again

Construction companies have been hogging the limelight in the last few months as the Singapore government has unveiled plans on land usage as part of the URA’s Draft Masterplan 2019. These include plans to build more homes in the Central Business District and Marina Bay areas so that residents can live closer to their workplaces and amenities (which reduces time spent commuting as well as strain on commuter infrastructure). Familiar areas such as Orchard Road, mature towns, and major recreational corridors will also be rejuvenated.

However, investors may wish to think twice before investing in construction companies, even though the sector is getting a major shot in the arm as a result of the government’s plans. I looked at three companies in the sector and analysed three aspects for each of them.

The companies are:

  • BBR Holdings (S) Ltd (SGX: KJ5), one of Singapore’s leading construction and specialised engineering groups.
  • CSC Holdings Limited (SGX: C06), a leading foundation and geotechnical engineering specialist, and also a ground engineering solutions provider for private and public sector work.
  • Yongnam Holdings Limited (SGX: AXB), a steel fabrication specialist involved in infrastructure and construction projects.

1. Gross profit margin

The average gross margin is low for the three companies within the industry for both fiscal years. Yongnam even reported negative gross margins (i.e., a gross loss) for two consecutive fiscal years. Poor gross margins indicate that the companies do not have pricing power, and though their contracts may be large, this means they end up being price-takers and are held hostage to their costs of materials.

2. Cash and debt positions

All three companies are in positions of net debt, and the construction industry is known for its large projects where companies need to gear up in order to pay for the construction and materials. High debt levels increase the risks for the companies as a sudden downturn or a dry-up in contracts may result in insufficient cash-flow generation to service the finance costs, and it may also affect the companies’ ability to pay off their loans.

3. Free-cash-flow generation

Free-cash-flow generation was generally negative for all three companies over two fiscal years, with only CSC generating positive free cash flow in FY 2017. The capital-intensive nature of the industry ties up significant amounts of working capital, which then leads to negative operating cash flow. Coupled with significant capital expenditure requirements, it comes as no surprise that construction companies need to rely on a lot of financing in order to operate smoothly.

The Foolish conclusion

The evidence above points to significant risks associated with construction companies, as their poor gross margins, high net debt positions, and constant lack of free cash flow make them vulnerable to economic stress should the industry turn down. Investors need to be mindful of these risks and ignore the hype generated by news outlets as they report on large-scale infrastructure and construction projects.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Royston Yang does not own shares in any of the companies mentioned.