Residential demand to offer a lifeline; Infrastructure and projects to see a late-cycle pick up

The construction sector is poised for a limited rebound in 2020—fueled by sharp tax cuts—following the two-year slack in activity which drove down profitability. This rebound is primarily driven by the residential segment. Over the past two years, the construction sector saw record level borrowings—the highest over the past decade—and a sector-wide liquidity issue. Therefore, the expectations of a bounce-back are moderated by the overhang of pre-existing sector-wide challenges.

Asia Securities, the leading investment services firm in Sri Lanka, hosted the latest in its Wealth Insights Series of investor events, titled ‘The Construction Sector: Setting Sights on a Residential Thrust’ on Thursday, 20 February 2020. The event saw the launch of a comprehensive sector research report of the same title by Asia Securities. Key industry experts, Suresh Rajendra, President – Property Group, John Keells Holdings PLC, and Chairman, Condominium Developers’ Association; Praveen Gnanam, Director – Innovations, Tokyo Cement Company (Lanka) PLC; and Mega Kularatne, Director Finance and Planning, Maga Engineering (Pvt) Ltd, joined the event as panellists for a discussion on the trends and outlook for the construction sector.

As a prelude to the panel discussion, Asia Securities Research’s construction sector research analyst Naveed Majeed presented the key findings from newly published sector research report. He highlighted that the recent consumer-centric tax cuts will bring about a rebound in the residential development market. The uptick in residential market’s medium-term growth is due to (i) falling interest rates, (ii) lower cost of construction due to VAT and NBT reductions, and (iii) a boost in disposable income levels as a result of higher PAYE thresholds.

In contrast, Majeed noted that the infrastructure development is likely to slow down as the government attempts to bridge the budget gap left by the recent tax cuts. Commenting on the apartments and hotels segment, he noted that while tepid demand will persist for the next two years due to oversupply, the recent VAT reductions may accelerate absorption. He also highlighted that while companies can expect a sharp pickup in Return on Equity (ROE) in the coming year, the sector’s high dependence on raw material imports could pose a risk to profitability due to the projected 4.4% depreciation of the Sri Lankan Rupee.

Suresh Rajendra offered an optimistic outlook for the apartment segment in 2020, stating “We have seen a considerable pick up already, especially in the mid-tier segment. The reduction of VAT and abolition of NBT has worked well for us. One of the biggest challenges for the buyer, however, is the high borrowing cost, and the moment that is resolved we expect to see a significant boost. Mortgage relief, especially for first home buyers, could be one way of resolving that issue.” Predicting an uptick in the luxury apartments segment in the second half of the year, Rajendra highlighted that despite the slowdown in 2019, the need for housing has always been consistent and is driven by fundamentals like population growth and urban migration.

Speaking on labour capacity in the construction industry, Mega Kularatne noted that labour costs have doubled over the last five years. In addition, he stated that low labour productivity levels have forced labour companies to import foreign labour at higher costs even though the productivity of foreign labour has not much higher.

Noting that it is not sustainable to keep importing labour, Kularatne is optimistic that Sri Lanka is equipped to cover 70-80% of the future demand for the next five years. However, he highlighted that the sector needs to tackle labour productivity issues, invest heavily in training, and eliminate the social stigma associated with construction work. He suggested that institutions like the Construction Industry Development Authority (CIDA) could take the lead by partnering with financial institutions like the World Bank and Asian Development Bank (ADB) to offer effective vocational training to address the shortage of skilled labour.

Concurring with Asia Securities’ growth forecast of 5.2% for the industry over a four-year period (2019-2023), Praveen Gnanam stated that local cement producers will be able to sufficiently meet this demand. He also commented on the need for safeguards for the domestic industry, noting that local construction companies are at a disadvantage when competing with foreign contractors due to incentives provided by their respective governments. Sri Lanka enacted anti-dumping laws in 2018 and companies stand to benefit once they are implemented. Citing the lack of an equal playing field, Gnanam suggested that local construction contractors should get some preferential treatment during the tendering process.