Construction Part 2 - Engineering construction

August 2012 Publication No. 12-04 Contents

Construction industry overview 1 The construction industry has grown by 3% pa over the past five years although this general growth rate masks divergent growth rates between sectors.

Engineering construction 2 Engineering construction has risen to prominence in recent years on the back of unprecedented private sector investment by the resources sector and public sector investment in major infrastructure projects.

Non-residential building construction 3 This sector has had mixed fortunes. Demand for commercial and industrial construction plummeted in the wake of the GFC, but fiscal stimulus measures drove significant growth in school construction.

Residential building construction 4 Despite strong population growth, residential construction has declined in recent years due to prevailing economic conditions and a winding back of government subsidies for home buyers.

Construction industry outlook 5 The outlook for the construction industry is difficult. Whilst residential and commercial construction activity is forecast to return to grow modestly, the end of the BER stimulus will drive institutional building activity down. Demand from the mining boom will continue to underpin engineering construction activity but there is some uncertainty over the value of new mining projects due to come on stream. 2 Engineering construction. Engineering construction is an $81 billion division representing 32% of the overall construction industry. It has risen to prominence in recent years on the back of unprecedented private sector investment by the resources sector and public sector investment in major infrastructure projects such as highways and water pipelines. Engineering construction (comprising heavy industry and other 4 non-building construction and road and bridge construction) has grown by 8.3% pa over the past five years. This is well above the overall construction industry growth rate of 3.0%.

Engineering construction revenue.

$81 billion Road and bridge Revenue (2011/12) construction $18b

Heavy industry and $81b other non-building 14.6% construction

Profitability (2011/12) $63b 8.3% Annual growth (2007-12) Source: IBISWorld. Engineering construction revenue.

32% Heavy industry & other non-building Road & bridge Overall construction industry $100b

75 Heavy industry and non-building 50 revenue by sector. 25

Minerals $16b 25% 0 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

Oil $13b 20% Source: IBISWorld.

Electricity $11b 18%

Water, sewerage $7b 12% and drainage

Railway $5b 8%

Telecommunications $5b 8%

Other $6b 9%

Source: IBISWorld. With the exception of demand from manufacturing, the key 5 demand drivers of engineering construction have been strongly positive over the past five years.

Private engineering The commodities boom has driven record Strong investment into the construction of mineral and construction energy infrastructure. Growth

The construction of energy, water and sewerage Demand from water infrastructure accounts for around 30% of the Strong sector’s revenue. Activity has been high due to a and energy sectors focus on alternative energy supplies and improving Growth ’s water security.

The Federal Government stimulus funding of Capital expenditure by infrastructure projects such as water pipelines Strong the public sector and roads has been a key driver of growth in Growth recent years.

Net population growth has exceeded 400,000 per annum over recent years, which is almost twice the long-term average. This has driven Moderate Population growth demand for the construction of infrastructure to Growth meet Australia’s population and industrial development.

Demand from Demand from manufacturing (excluding that Moderate associated with the commodities boom) has manufacturing been subdued in the wake of the GFC. Decline The mining boom has fuelled substantial growth in private sector 6 engineering construction.

Mining industry growth. Engineering and building construction.

$250b $300b Engineering 280 200 260 240 150 220 100 200 180 Building 50 160 0 140 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 120 100 Source: ABS. Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec 06 07 07 07 08 08 08 09 09 09 10 10 10 11 11 11

Source: ABS.

The commodities boom has driven a massive Over the past five years engineering construction increase in privately funded investment into activity has almost doubled, and is now the largest mining and oil related engineering projects sector of the Australian construction industry. and related railway and pipeline infrastructure.

Public and private investment. Public and private funding.

Public Private Publicly funded and privately constructed $300b 13% Publicly funded 250 and publicly 14% constructed 200 Privately 150 funded and 73% privately 100 constructed

50

0 Source: ABS. Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec Apr Aug Dec 06 07 07 07 08 08 08 09 09 09 10 10 10 11 11 11

Source: ABS.

Public sector funding accounts for only 27.5% of current engineering activity, down from around 75% in the early 1990s. This reflects the privatisation of public assets during the 1990s and early 2000s, coupled with a massive surge in private sector investment in mining and energy construction projects on the back of the commodities boom. Mega infrastructure projects have also driven demand. 7

Growth in infrastructure markets.

Electricity Water Energy & minerals

160% 160% 160%

140 140 140

120 120 120

100 100 100

80 80 80

60 60 60

40 40 40

20 20 20

0 0 0

-20 -20 -20 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012 2007 2008 2009 2010 2011 2012

Source: IBISWorld. Source: IBISWorld. Source: IBISWorld.

HIGH HIGH HIGH Growth Growth Growth

The past five years have The recent persistent The China-induced seen a notable increase in drought led to a number of escalation in global construction of electrical major water infrastructure demand pushed up mineral power projects. These projects designed to and energy commodity include the development of improve Australia’s water prices and supported the Coffin Bay-Elliston wind security. These include the unprecedented growth in farm in South Australia and Gippsland Water Factory in construction of mine the Tomago gas-fired power Morwell, Victoria, the developments, mineral, plant in New South Wales. $1.1 billion gas and oil processing Desalination Plant, the facilities and transport $560 million Western infrastructure. These Sydney Water Recycling included the Baya-Undan Scheme and the Field stage two production $400 million Goldfields facility and pipeline, the Water Project in Western Burrup Peninsula Ammonia Australia. Plant and the Loy Yang A Power Plant upgrade. Engineering construction competitive landscape. 8

Most Engineering Construction projects are complex and of a large scale. As such, the pool of competitors tends to be fairly low and the basis for awarding tenders is weighted toward a range of factors including reputation, expertise Competition and perceived ability to complete the project on Medium time and on budget, rather than price alone. It is not unusual for market participants to form consortiums to tender for larger projects in order to meet the requirement for specialist skills.

The size and track record of existing larger firms acts as a deterrent to potential newcomers. The Barriers to entry tendering process focuses on reputation and Medium track record and newcomers often lack the credentials to effectively compete.

Planning and regulation typically involves many tiers of governments and a range of statutory bodies. Industry participants are required to Regulation comply with a multitude of regulations, ranging Medium from OH&S and safe work place conditions, to building standards, pollution and competing land usage legislations.

Global mergers, joint ventures and the establishment of strategic relationships between local and overseas firms have driven structural change. This has resulted in the emergence of larger multi-disciplinary firms that are capable of being involved in all phases of construction, including design, procurement, operation and funding. Firms such as Leighton Holdings, Downer EDI, UGL Limited, Lend Lease Group, Concentration McConnell Dowell Corporation and MacMahon Low Holdings compete across a range of construction sectors and have the resources to tender for mega projects. The four largest firms account for around 25% of industry revenue and the 50 largest firms account for around half of industry revenue. By contrast, 88% of firms employ fewer than 20 employees and compete in very narrow geographic or expertise niches.

Source: KordaMentha, IBISWorld. Walter Construction - managing peformance bond recovery. 9

Appointment issues. Walter Construction overview. • 18 of 21 Construction and Civil contracts were • 5th largest builder in Australia with cashflow negative to completion. Accordingly, approximately $500 million turnover. most projects were abandoned and performance bonds called. • Loss making since 2000. • Significant contract disputes with project • 950 staff. principals (especially in Walter Mining). Debtor • Owned by German parent, Walter Bau. book difficult to recover, with significant • Divisions: counterclaims. − Construction and Civil: 21 contracts • Insolvency prevented ‘sale’ of contracts. worth approximately $970 million, • Project principals assumed control of most average completion of 80%, 550 projects and joint ventures collapsed. employees. − Mining: seven contracts worth • Project principals and joint venture participants approximately $76 million, profitable took on subcontractors and in some cases and growing business, 360 employees. paid past debts to ensure projects were completed. • Placed into Voluntary Administration in February 2005 following collapse of the • Project principals generally called bonds German parent. immediately. Costly to seek injunctions. Difficult to recover bonds, even after defect liability period had expired.

Walter Construction Performance Bond recoveries.

Total loss Total loss Total recovery Total recovery

Total $25m Construction 20 $14m $8m 15 $44m $20m Bond exposure $12m 10 $30m

5

0 FY05 FY06 FY07 FY08 FY09 FY10 FY11 Mining Civil Source: KordaMentha. $3m

$4m $8m $16m $4m

$13m

Source: KordaMentha. Contacts

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