Construction sector in UAE faces rising challenges

The UAE construction industry, which has been witnessing unprecedented growth in the past few years, is facing increasing challenges such as getting foreign workers into the country as well as rising cost of raw materials, including cement and steel, according to a new report.

In the past few years, the UAE's efforts to diversify away from oil has fuelled a massive growth in buildings and investment in the country, with the construction sector emerging as an important economic driver.

In 2006, the construction industry recorded a real growth rate of 19.7 per cent year-on-year, while the sector is expected to expand at a slower pace of 10.4 per cent from 2008 until 2012, said Al Mal Capital, a UAE-based investment bank, in its report.

The importance of the construction industry can be seen by the country's project value relative to its GDP. The value of projects in the UAE in 2008 is 4.6 times the estimated GDP value in 2007, compared to just 1.3 GDP in Saudi Arabia and 2.3 in Oman.

Real estate has been a driving force in the construction boom in the UAE. Since 2002, the UAE's population has grown at more than seven per cent CAGR and is projected to grow at around five per cent over the next five years, from 5.19 million in 2007 to reach 6.88 million in 2011. As the population increases, so too the demand for housing.

According to the report, real estate demand in the UAE currently outweighs supply by more than 101,000 units and supply is not predicted to surpass demand until at least 2010. The increase in construction of infrastructure, hospitals and schools go hand in hand with a growing population.

But the report says one of the bigger dangers facing the industry is the increasing cost of labour, and the ability to attract and retain workers. In the mid-1970s, the Gulf saw a large number of foreign workers, who were attracted by higher salaries than they could earn in their home countries.

The UAE is home to 3.11 million foreign workers, accounting for more than 90 per cent of the private sector workforce. There are about 1.5 million Indians and a large number of them work as contract labourers in the construction industry.

Approximately 43 per cent of all foreign workers in the UAE are Indians, making the Emirates particularly vulnerable to fluctuating currencies and rising wages in India.

In the last few years, Asian countries, in particular India, have seen rapid economic growth, improved career opportunities and higher wages. According to Hewitt Associates, salaries in India in 2007 grew at 14 per cent, with a similar rise in 2006. The UAE, in comparison, saw an increase of 10.7 per cent in 2007, a small rise from 10.3 per cent in 2006.

"Based on estimates, in 2005 an Indian worker earning Rs3,000 to Rs5,000 (Dh255 to Dh424) in the Gulf could earn twice as much as he could at home by signing up to a three-year contract in the GCC. In 2008, the same worker could earn Rs10,000 a month in India, while wages in the GCC have been fixed at the original contracted amount, thus reducing the incentive to work overseas," the report argues.

Essentially, the wage gap between India and the Gulf is closing as the declining value of the dirham against Indian rupee is compounding the issue. The US dollar has depreciated against the rupee by 16 per cent between 2002 and 2008.

"Regional and international competition is also making it difficult for construction companies in the region to find workers. Though the depreciating value of the dirham has a more marked impact on workers from Asia, it is also impacting expatriates from South Africa, Australia, Canada and Europe," the report said.

"Labour costs may go up in 2008 and 2009, says the report, adding that labour accounts for about 15 to 20 per cent of project-related costs. "Labour shortage is more of a capacity constraint rather than a financial one. A lack of appropriate staff may impede a contractor's ability to take on new projects and carry out expansion plans outside the UAE."

Another important factor affecting the sector is prices of cement and steel, which together accounts for 30 per cent of construction costs. And rising prices are putting contractor's margins under pressure, said the report.

The UAE produces its own cement – 15 companies together produce 13.2 million tonnes of cement per annum. However, production has fallen short of demand since the beginning of the construction boom in 2003. The difference is met by imports – which has soared 74 per cent from 1.70 million tonnes to 2.96 million tonnes in 2007. And this shortage of local supply has driven cement prices in the UAE from Dh150 per metric tonnes in 2003 to an unofficial rate of Dh400 per metric tonnes this year.

There has been speculation in the cement industry, with traders and producers blaming each other for the hike. In May, the UAE Ministry of Economy signed an agreement with cement producers to increase daily production of 50kg cement sacks from 150,000 to 250,000 and cap prices at Dh340 per metric tonne.

The report expects cement prices to ease in 2009 with supply outstripping demand in 2010. "Cement consumption is expected to grow in line with the growth of the construction industry. Until the UAE has the storage and handling facilities to cope with importing larger volumes of cement, future pricing is dependent on the ability of local cement companies to roll out their expansion plans," the report said.

At the same time, the steel market has also seen increases in selling prices in the last 12 months due to greater shortages in the Middle East. Steel consumption in the region has outpaced production and has pushed prices up by 33 per cent this year.

A tonne of rebar now costs Dh4,500, up from around Dh3,294 in March 2008. In 2007, the UAE imported nine million tonnes of steel, an increase of 36 per cent from 2006.

"Rising material costs and an alarming shortage in labour is partly responsible for project delays and cancellations in the UAE. There are currently more than 160 projects facing delays; we expect this number to fall as industry bottlenecks are addressed. However, it is important to note that while the number of projects planned or underway in the GCC has reached the $2 trillion landmark, only 24.7 per cent of them are actually under construction," it said.

Purchasing off plan is common practice in the region. High liquidity and negative interest rates in real terms has lowered borrowing costs and increased off plan real estate investment. However, escalating construction costs have meant planned developments sold two or three years ago are no longer profitable to develop.

Currently there are projects worth more than $2trn planned or underway in the GCC, which is more than double the GDP of the six GCC economies combined. The construction sector, including air and sea ports, real estate, civil engineering, railways and roads, account for 60 per cent of the total and is valued at $1.17trn. The UAE is home to 38 per cent of projects planned or underway in the GCC.




Arabtec – Attractive valuation


Arabtec, the only 'pure play' construction company listed on the DFM, has an impressive order backlog of Dh36 billion, of which the UAE market comprises two-thirds with a project value of Dh24bn.

Al Mal Capital in a report on the company gave the share price an 'outperform' rating. "We initiate coverage with an outperform rating and a price target of Dh26.7. Arabtec offers investors 51.2 per cent upside on the current price. It is trading at a low in 2008 with estimated P/E of 12.7 compared to an average industry comparable of 14.5.

Arabtec Holding, was incorporated in November 2004 as a special-purpose vehicle to acquire Arabtec Construction, a leading contractor, which has been operating in the UAE since 1975.

In 2005, Arabtec listed 55 per cent of its shares on the DFM, and to date is the only publically listed contractor in the UAE.

Arabtec is one of the largest construction firms in the Middle East and is open to GCC and foreign investors.

However, in line with the DFM regulations, non-UAE nationals are allowed to own only up to 49 per cent of the outstanding shares.

According to the report, short-term catalysts would include penetrating the Saudi market, further acquisitions, a proven track record of successful overseas projects and the reclassification of GCC citizens in foreign ownership calculations.

"Arabtec has forged relationships with Emaar, which represents 11 per cent of the current backlog. Arabtec is currently working alongside Emaar to build Burj Dubai."

In addition to this relationship, Arabtec may penetrate other markets such as Saudi Arabia and India. "We see Arabtec's relationship with Emaar and penetration of the Saudi market as a huge growth potential for Arabtec," said the report.

International expansion is of strategic importance for Arabtec with one-third of its order backlog currently outside the UAE. In May, Arabtec won its largest contract, worth Dh10bn, to build the Okhata Centre in St Petersburg.

Projects in Qatar, Pakistan, Jordan and Syria have reached Dh2bn, accounting for 5.5 per cent, said the report.