Construction Industry Report, T Oluwakiyesi

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Content: Construction Industry Report A Haven of Opportunities
May 27th 2011
This report captures our view of the construction industry in Nigeria, essentially from an analysis of the intrinsic long term potentials in the sector, which we believe is gradually being unlocked. On a company-
Analyst Tosin Oluwakiyesi [email protected]
specific level, we focus on Nigeria's construction giant ­ Julius Berger Plc,
maintaining an "Accumulate" on the counter. The next in line...? Amongst others, United Arab Emirate (UAE)s oil fuelled growth, Chinas industrial/export driven growth and the resultant construction
Market Cap:
N75.9Bn (US$506Mn)
Forward 2011 P/E:
9.9x
boom in these economies over the last decade, are all pointers to the high correlation between strong economic growth and the construction industry. Nigeria recently crossed the 7% growth rate, and has innate potential to record
EV/2011 EBITDA: 2011 Div Yield:
2.5x 8.6%
higher growth. This, coupled with healthy revenues from strong oil prices and Sector YTD perf: increasing investors interest in bridging the infrastructure deficit brings one
5.9%
question to mind- is Nigeria next in line for a construction boom? Without being Recommendation:
JBERGER
unrealistically optimistic, we strongly believe the next decade will provide a Rating: positive answer to this question. More than ever, the recent emphasis of all
Accumulate
stakeholders on infrastructural development is noteworthy ­ we might just be Share Price:
N55.71
close to seeing light at the end of the tunnel.
Target price:
N64.15
Latent opportunities; waiting to be unlocked: Across board, be it road/bridges, rail, ports, or real estate, the opportunities are enormous but latent. In real estate for instance, the demand for commercial real estate in Lagos is ever rising ­ office rent in Lagos ranks 5th highest globally (according to Knight Frank Research). More than 70% of the households are single rooms, mostly in urban slums and rural areas. In rail transportation, about 77 million
Expected Return:
15%
YTD NSE ASI vs Vetiva Construction Index (rebased Dec 31)
) Vetiva Construction Sector Index NSE ASI
tonnes of goods is transported per kilometre of railway per annum - a far cry 1.1
from frontier market average of 52.4 billion tonnes. In almost every yardstick
of measuring infrastructural development, especially in transportation and real estate, Nigeria lags most peers in the frontier and emerging markets. The 1.0
constraints have been overemphasized, we think, thus shadowing the
opportunities waiting to be explored.
0.9
Dec-10 Jan-11 Feb-11 Mar-11 Apr-11
Risks...not as bad: Nigerias operating environment, no doubt, has major constraints, both from a policy and politics point of view. Notwithstanding, Nigeria compares quite commendably relative to the big emerging markets ­ India, China and Brazil in some key metrics employed by the World Bank to compare general business environment, for the construction industry. One of such metrics is "dealing with construction permits" in which Nigeria ranks 167th (out of 183 economies) compared to India (177th), China (181th), Russia (182th), according to World Bank 2011 Ease of Doing Business Survey. Though, the constraints in Nigeria are very inherent, comparatively, we think the risks might have been overstated.
Source: NSE, Vetiva Research Vetiva Capital Management Limited 266B Kofo Abayomi Street Victoria Island, Lagos Tel: +234-1-46175213 Fax: +234-1-4617524 Email: [email protected]
The only pick: Our favourite quoted company in the construction sector is Julius Berger Nigeria Plc, given its sound fundamentals in the industry. Based on our DCF valuation target price of N64.15, we place an Accumulate rating on the stock in view of a potential return of 15% relative to its current price of N55.71.
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Table of Contents Summary....................................................................................... 1 Nigeria Construction Sector ­ a dissecting look ................................... 2 Physical Infrastructure ­ key investment case .................................... 4 What will drive construction boom? ................................................... 8 Industry Dynamics .........................................................................10 Segments .....................................................................................15 Rail..................................................................................15 Road and Bridges ..............................................................18 Ports................................................................................20 Real Estate .......................................................................22 Building Materials ­ Impact on Construction ......................................24 Investment Summary.....................................................................30 Company Section; Julius Berger Nigeria Plc .......................................31 Appendix ......................................................................................42 Disclosure .....................................................................................45
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Nigeria's construction sector ­ A dissecting look
Nigerias construction sector accounts for 1.4% of its GDP (Q310 est.) More important, is the fact that despite the growth seen in the construction sector output, (7 year CAGR of 35%, see figure 1 below), its contribution to total GDP has remained at abysmally low levels. In 1981, the construction sector accounted for 5.8% of Nigerias GDP and in the last three decades, Nigerias total GDP has risen to approximately 495 times its size. On the contrary, construction sector GDP has only grown to 125 times its size in 1981. Notably, the drivers of Nigerias GDP over the last three decades have remained the same ­ Agriculture (crop production), Crude oil production and Wholesale & Retail trade.
Construction output has lagged Crop Production, Crude Oil Production and Whole & Retail Trade ­ the 3 biggest drivers of Nigeria's GDP since 1981
The construction sector is yet to realise its potentials depsite Nigerias huge deficit in infrastructure. Over the last three decades reviewed, crop production, crude oil production and wholesale & retail trade have recorded a 27 year CAGR of 28%, 29% and 26% respectively, while the construction sector GDP grew at a CAGR 21% over the same period. It is evident therefore that Nigeria is way below realising its potential in the construction industry.
As at Q3'10, Construction accounts for 1.4% of Nigeria's Gross Domestic Product (GDP), from 5.8% in 1981
Figure 1: Building & Construction GDP and contribution to total GDP
400,000 300,000
5.1%
200,000
100,000
0
7-yr CAGR: 35%
6.0% 5.0% 4.0% 3.0% 2.0% 1.0% 0.0%
1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2009 2010
Building & Construction sector GDP
Contribution to total GDP
Source: National Accounts, Vetiva Research
Trailing major oil producers?
Oil wealth has been key to construction sector boom in major oil producing economies. In this regard, similar less diversified oil producers like the United Arab Emirates, Saudi Arabia, and more diversified oil producers like Russia, saw considerable boom in construction at various peaks of oil booms in the last three decades. The crude oil price boom of the 1970s for instance, sparked off the growth of UAEs construction sector. Despite low crude oil prices in the 80s, key middle east economies, particularly Saudi Arabia and UAE managed to sustain its infrastructural development.
Oil Wealth has been a
major
driver
of
construction boom for oil
producing economies over
the last 3 decades
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Oil fueled economic growth, favourable demograhic fundamentals, growing commercial activities and tourism, have caused considerable construction boom in these countries. According to a 2007 report by "Economic Forum", 15% ­ 25% of the worlds construction cranes were operating in the Gulf region with an estimate of over 2,100 construction projects planned or underway. By 2009, UAEs contruction sector has grown very rapidly with construction accounting for c.11% of its GDP (almost sustaining the 10% average in the late 1970s). The recent crude oil price boom (2006-2008) also saw UAE record significant boom in infrastructure and hence its construction sector benefitted immensely ­ the completion of the Worlds tallest building in January 2010 ­ Burj Khalifa - attests to this.
Similar to others in the Gulf Region, UAE has continued to sustain the construction boom originally sparked off in the 70s by discovery and exploration of crude oil
Figure 2: Some OPEC Members Construction Sector GDPs
20000 16000 12000 8000 4000 0
7.4%
5.7%
6.0%
5.0%
8.0% 6.0% 4.0%
UAE
Kuwait
Construction GDP
2.0% 1.4%
Qatar
Saudi/Arabia Nigeria
Sector Contribution to total GDP
0.0%
Source: Country National Accounts, Vetiva Research
As a net importer of crude oil, Chinas construction boom cannot be said traced to oil wealth, but rather, by export driven industrial growth. Chinas construction has been driven by plans for urban revitilisation and new development. Hence the country witnessed significant increase in the output of its construction industry, especially in the last decade. In the first two decades of its reform era (1978 -1999), construction (as percentage of Chinas GDP) grew to 6.6% from 3.8%. Over the last decade however, the growth in Chinas construction output has been very tremendous as it accounted for 13% of its 2010 GDP. While noting that the spike in Chinas construction is rather unsustainable, the emphasis in this case is the sustained commitment, of first the state, and then private sector on infrastructural development. The question is, when will it be the turn of Nigeria - OPECs sixth largest crude oil exporter?
China's construction boom was fueled by export-led industrial growth
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Light at the end of the tunnel ­ the next decade story We see the next decade or two as important to Nigerias infrastructural growth. More than ever, the emphasis on infrastructure deficit is laudable. While noting that the challenges (poor policy and budgetary implementation, lack of transparency in government contract procedures and the attendant abandoning of many projects) which mitigated the growth of the construction sector are somehow still inherent, we emphasise the milestones that have been recorded over the years. One of this is the significant rise in local cement production output (cement imports have dropped to about 30% of total consumption in 2010 (from 72% in 2005) and the planned projects still on-going to further increase local production capacity (Dangote Cement and Lafarge). With a local construction industry that has historically been plagued by high material prices from importation (cement and steel particularly), the boost in cement output is an indicator of "better days ahead" in the construction sector.
With the rising emphasis and
growing
interest
of
stakeholders on bridging
Nigeria's infrastructure gap,
we believe next decade
holds good prospects for
construction
Secondly, the fast growing emphasis on PPPs, at least over the last five years, is another case that supports our optimism. For instance, the Lekki Free Trade Zone, Eko Atlantic City are projects opening up major opportunities for construction activities in Nigeria. At least, the thought of an artificial Island would have been unimaginable in Nigeria a decade ago! Notwithstanding, we admit that the bottlenecks are still inherent, but then, the long term ­ the next decade or so, holds exciting opportunities for the construction sector in Nigeria. Hence, we emphasise the robust long term potential of the construction sector.
Our optimism on the construction is supported by increasing involvement of the private sector and the boost in cement production output seen over the last few years
Physical Infrastructure Deficit - Key Investment Case
Nigerias physical infrastructure gap, especially in transportation ­ road, rail, airports and sea ports - is the strongest investment case for our optimism of growth in the construction industry. Only about 30% of Nigerias 193,200 km total road network is paved, relative to an average of 70% and 58% for frontier and emerging markets respectively. The gap is wider when compared with advanced economies with an average paved road network of c.100%. (see figure 3 below).
The key investment case for the construction sector remains the deficit of physical infrastructure especially in transportation, and real estate
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Figure 3: Relative Comparison of Nigeria's Paved Roads (as % of total road network) to Some Frontier Market Countries, *Emerging Markets (EM) and **Developed Markets (DM) Averages 100% 80% 60% 40% 20% 0%
Source: World Bank Database, Vetiva Research
The deficiency in rail infrastructure is even worse, as Nigerias existing 3,528km rail network is grossly insufficent to cater for the rising need for mass transit of people and goods, given its large population (about 150 million; annual growth rate c.2.5%) estimated to be growing at an annual rate of c.2.5%. Apart from this, the design of the rail network (narrow gauge), quite obsolete thus limiting the capacity and type of trains that can be used on the rails. According to the Federal Ministry of Transport, the rail transport sector recorded the highest volume of freight (2.4 million tonnes) in 1977 even as passenger numbers reached its highest of 15.5 million in 1984. However, from the World Banks latest yearly data, volume of freight transported through rail in Nigeria is about 77 million tonnes per kilometre, while passengers conveyed stood at 174 million passengers per kilometre. These figures rank quite low in comparison to peer countries like South Africa and Egypt (see figure 4 below) similar frontier market like Argentina, Ukraine, Romania and Kazakhstan; and extremely incomparable to bigger emerging markets like China, India and Brazil.
Compared with frontier markets average of 52.4 billion tonnes only 77 million tonnes of goods (per km) are transported by rail in Nigeria annually
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Figure 4: Nigeria's rail transport (total network and passenger/freight transported by rail) to African peers Vs Frontier, Emerging and Developed Markets Averages
120000 90000
106,014
30000 25000 20000
60000 30000 0
40,830
52,409
15000
12,714
36,790 10000
13,865
12,714
10,804 18,526
5000
4,188
174 77
0
Nigeria South Africa Egypt FM average EM average Developed ex BRIC Mkt. Avr. ex US Passengers Carried (mill. passenger/km) (LHS) Goods Transported (mill. tons/km) (LHS) Total Route (Km) (RHS)
Figure 5: Nigeria's rail transport (total network and passenger/freight transported by rail) to African peers vis-а-vis Frontier, Emerging and Developed Markets Averages 2500000
2000000
1500000
1000000
500000
174 77 0 Nigeria Brazil
Russia
Passengers Carried (mill. passenger/km)
India
China
South Africa
BRICS average
Goods Transported (mill. tons/km)
Source: World Bank Database, Vetiva Research Whilst noting the improvement made in airport infrastructure over the last 10 years ­ specifically the construction of the Nnamdi Azikwe Abuja Airport and Lagos Muritala Muhammed Airport Terminal 2, airport infrastructure ­ in terms of numbers, quality of infrastructure and even capacity (using airside and landside constraints) cannot rank pari passu with comparable African Countries ­ Egypt and South Africa especially.
Despite the investment in airports in the last decade (MM2, for instance), Nigeria's airport capacity as measured by passenger traffic ranks low to South Africa and Egypt
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According to the International civil aviation Organisation (ICAO), the air-side of an airport comprise runways, taxiways, gates and parking positions. The number of aircraft movements (departures/arrivals) per unit of time typically determines the air-side capacity of an airport, amongst other factors such aircraft mix and weather. The landside of an airport comprise terminals and all the facilities used by passengers and cargo shippers, including security, immigration and custom facilities as well as access to roads and railways, parking space and storage facilities. Land-side capacity is measured in terms of number of passenger per year or the maximum number of passengers per day. For instance, South Africa has fewer international airports than Nigeria (3 as against 4), however the combined capacity, based on runway length, of the three airports significantly outweigh Nigerias four international airports (see figure 6 below). Due to their higher passenger handling capacities, South Africas Johannerburg airport and Egypts Cairo airport had annual passenger traffic of about 16 million and 14 million (based on 2009 figures) respectively compared to combined annual passenger traffic of about 10.2 million for Nigerias four international airports.
Nigeria has 4 international airports compared to South Africa which has 3; However, annual passenger traffic of Johannesburg airport alone outweighs the total for Nigeria's 4 international airports
Figure 6: Comparison of Nigeria's Airport Infrastructure Capacity by Passenger Traffic, Length of Runway, Freight and Registered Carriers Departures
18
40
800
180
35.07
640
157
17
30
135
29.48 480
16
20
90
320
15
10
160
10.25
58 45
18
14 South Africa
Nigeria
Egypt
0
South Africa
Nigeria
Freight (mill. ton/km)-LHS
0 Egypt
total length of runway (km) - LHS total passenger traffic (million) - RHS
Registered Carriers departures ('000)-RHS
Source: World Bank Database, Vetiva Research
Having highlighted the deficiencies in few physical infrastructure ­ roads, rail, airports and ports, we note that more attention is being given to proferring solutions to bridge the gap. From the recent relaunch of the power sector reform, growing popularity of borrowing (among sub-nationals) as a means to finance infrastructural shortages, the rising acceptance of Public-Private Partnership, there seem to be a renewed commitment to addressing key infrastructureal challenges. Against this backdrop, we believe the construction sector is positioned, on a long term basis, to benefit immensely from the anticipated rise in infrastructure spend.
The growing popularity of subnational bond issuance, amongst other means to address the problem of infrastructure deficit signify long term value generation for the construction industry
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What will drive construction boom?
Strong Growth and Economic Diversification: Nigeria has been growing at a an average of 7.4%, over the last 2 years, owing to strong agricultural output despite the chronic infrastructure problems affecting manufarturing and other real sector. Various developmental institutions (IMF and World Bank for instance) have forescast growth of at least 7% over the medium term. In our opinion, Nigeria can achieve a higher growth rate if key infrastructural bottlenecks, especially power is removed. In addition, we believe the on-going reforms of the banking sector and interest of the apex bank (Central Bank of Nigeria) to encourage lending to the Small and Medium Scale Industry through de-risking of the value chain of key sectors ­ particularly Agriculture, will boost Nigerias growth. Commercial Agriculture is a key sector that can push Nigerias growth into the double digit region. Mining is also receiving attention lately. For instance, Australian Mines Limited, with due dilligence recently completed, is in the process of acquiring Nigeria Gold Pty Limited. Following the acqusition, which would give the company access to Gold mining rights in Northern Nigeria, we should begin to see some development of the mining industry in the region which, prior to now, has been underexplored. The development of the mining sector also implicitly portend opportunities for the contruction industry. An example like this, in the long term, will set stage for increased economic activities, which will in turn boost demand for commercial and residential real estate and by default, growth of the construction industry.. As observed during the rapid growth phase of Asian countries like China, there is a high correlation between economic growth and boom in construction activities.
Nigeria's growth rate which crossed 7% last year, is laudable but focus must be on the country's inherent potential to achieve higher growths rate; this is key to unlocking the prospects in the construction sector
Rapid Urbanisation: Nigeria is undoubtedly one of the fastest urbanising countries in Sub-Saharan Africa. Close to 50% of Nigerias population now live in urban areas, compared to only 20% in 1980, 16% in 1970 and 13% in 1960. The concentration of business in few centres have been the key driver of rapid urbanisation in specific cities like Lagos and Port-Harcourt. According to a recent report from UN-Habitat: State of African Cities, Lagos States population is expected to reach 12.4 million by 2015, overtaking Cairo ­ the current most populated city in Africa. Population explosion in urban cities have therefore led to the fast growth and urbanisation of previous neighbouring rural communities. In the case of Lagos State, the influx of population has caused increasing urbanisation in neighbouring towns of Ogun State. Whilst the threats of over-urbanisation are imminent (population growing faster than urban economies), concrete steps are already being taken to provide adequate infrastruture. For instance, the Lagos State Light Rail, Eko Atlantic City and Lekki Free Trade Zone Projects are some of the key infrastructural projects of the State Government to address population explosion and rapid urbanisation. Demographics and housing demand: With a median age of 19 years and approximately 55% in working age bracket (15 ­ 64 years), Nigerias population distribution portends strong potential for continuing growth in housing demand despite the high rate of unemployment (estimated at c.19%) which reduces effective demand. It is obvious however that the long term opportunity present in real estate construction, can only be realised on the back of strong economic growth and employment generation.
With Nigeria urbanizing at one of the fastest rates in SSA (c.50% now live in urban areas vs. 20% in 1980), the constructions sector will no doubt benefit from this rapid urbanisation With a median age of 19 years and 55% in the working class age, there's an inherent opportunity for real estate construction given the housing need of this age group
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Relatively strong commodity prices in the long term: Notwithstanding the gradual de-emphasis of oil and the need to shift to alternative fuels, we opine that oil prices would still remain strong, even in the long term. Biofuels, algae and other alternatives proposed for crude oil are far from being produced in such commercial quantities that would meet the worlds growing energy needs. Moreover, the shift to biofuels for instance may potentially result in high food inflation. This, in addition to the fact that more newly industrialised economies (particularly in Asia, Eastern Europe, and Africa) would emerge, underpins our view, that oil prices will stabilise around c.100/barrel, though short term fluctuations and volatilities are inevitable. It therefore implies that Nigeria, as the eighth largest exporter of crude oil globally, is positioned to benefit from strong oil revenues if its internal challenges can be resolved. This further strengthens our view of a potential boom in Nigerias construction industry, as a result strong oil revenues.
If
properly
managed,
Nigeria's infrastructure can
benefit immensely from high
crude oil price which we
believe
will
remain
sustainably strong into the
long term, despite short term
volatilities
Increasing Capacity in Cement Production: A major militating factor to significant growth in construction activities in Nigeria, has historically been the local shortage of building materials, especially cement and steel. Nigerias per capita cement consumption averaged 83kg between 2006 and 2009 and prior to 2009, imports accounted for the larger proportion of cement consumed in Nigeria. It should be noted that self-sufficiency in cement production is a major step for construction boom. Countries like China, Saudi Arabia,etc, that have witnessed significant boom in construction, are net exporters of cement. However, over the last four years local production of cement has risen significantly, thus, now accounting for about 70% of consumption. With the additional plants currently under construction in the sector, Nigeria may likely approach selfsufficiency in cement production in the medium term (within the next 2 years).
The significant boom in production capacities seen in the cement sector over the last four years support a potential boost in construction activities
Public-Private Partnerships (PPP): Across the globe, Public-Private Partnerships (PPP) are becoming increasingly popular in delivering physical and social infrastructure to people. Despite the need for more aggressive public-participation in the delivery of basic infrastructure in Nigeria, we note that there has been a rise in the number of PPPdriven infrastructural projects over the last 20 years. Based on data obtained from Private Participation in Infrastructure (the World Bank arm on PPPs), up to 51 projects within the 20 years between 1990 and 2009, were undertaken through PPPs in Nigeria. Most of the projects occurred within the last five years, with the transport sector being the major beneficiary, as close to half ­ 24 projects ­ were reported for the sector between 2005 and 2008. In terms of actual value, annual investments rose to $3.1 billion from merely $22.0 million as at 1997 and zero as at 1990, adding up to $23.6 billion from 1990 to 2009. Based on actual value, investments in the Telecoms sector was the highest, totalling $18.4 billion and accounting for 78% of the total investments within the period.
The idea of PPP driven
infrastructure
projects
is
becoming more acceptable in
Nigeria, and this will encourage
increase in construction activities
over the next decade
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Figure 7: Number of PPI Projects by sector (1990 - 2009)
Figure 8: Investment Value (US$ Billion) of PPI Projects in Nigeria by sector (1990 - 2009)
9
24
18
0
Water and Sewage
Telecoms
Transport
Energy
51 Total
2.2 3.0
18.4
23.6
0
Water and Sewage
Telecoms
Transport
Energy
Total
Figure 9: Percentage distribution of number of PPI Projects by number (1990 ­ 2009)
Figure 10: Percentage distribution of PPI Projects by Investment Value (1990 ­ 2009)
Energy, 18%
Telecoms, 35%
Energy, 9% Transport , 13%
Transport, 47%
Telecoms, 78%
Source: World Bank PPI database, Vetiva Research
Industry Dynamics
Characteristics High Correlation with budgetary CAPEX: Due to minimal private sector participation, the construction industry is highly correlated with governments budgetary CAPEX. Based on historical data between 1982 and 2006, a regression of the construction sector GDP on governments total capital expenditure (federal and states) gave a correlation coefficient of 0.92.
From 1982 ­ 2009, the construction section has a correlation coefficient of 0.92 to government CAPEX
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Figure 11: Construction Sector GDP vs. Total Govt. CAPEX (1982 ­ 2009)
3000
2500
2000
1500
1000
500
0 1982
1985
1988
1991
1994
1997
2000
2003
2006
2009
Construction Sector GDP
Government CAPEX
Source: CBN Statistical Bulletin, Vetiva Research
Huge Operating leverage and low margins : Globally the construction industry is characterised by heavy fixed asset base, hence high operating leverage, depreciation expense and low profit margins. Specialisation: Given the varied types of construction projects, construction firms are usually specialised and mostly function only in areas of core strengths, which are determined by their human capacity and equipments. On a broad scale, construction projects can be divided into three: Building, Heavy/Civil Construction and Industrial Construction. In Nigeria, very few construction firms operate in all the three classes. In our view, this is a major reason for Julius Bergers dominance in the industry as it has the capacity (equipments and human) and expertise to operate across these three broad classes of construction projects.
Construction firms are highly
specialised, and are broadly
divided into three classes:
Building
Construction,
Heavy/Civil Construction and
Industrial Construction
Earnings seasonality: Construction activities are usually stalled during rainy seasons; hence the earnings pattern of the construction companies are seasonal. Another form of seasonality in the construction industry also relates to the timing of release of budgetary allocation for capital expenditure. Based on weather patterns, construction companies in Nigeria typically report higher earnings in the first and fourth quarters of the year.
Earnings in the construction industry is affected by seasonal rain patterns
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Interplay of Professionals: From the first step in the construction process which is designing, to the final stage of building, construction requires indepth human multitasking and hence involve the interaction of many professionals ­ engineers, architects, quantity surveyors, lawyers and even financial advisors.
Players
The Nigerian construction industry is dominated by international construction firms, although a number of smaller local companies are emerging. Julius Berger Nigeria Plc remains the market leader, as it controls a large chunk of public sector construction. With the entrant of Chinese Construction giants however, the dominance of Julius Berger faces significant threat in the long term. As an example, China Civil Engineering Construction Company was appointed by the Lagos State Government as the contractor for the Lagos Light Rail Project. The firm was also awarded the rehabilitation of LagosJebba rail track by the federal government. The growing popularity of PPPs also means more international construction firms are likely to come into the Nigerian market.
There are many construction firms in Nigeria, but only few operate on large scale; examples of these include Julius Berger, Stabilini Visinoni, Costain and China Civil Engineering
Other medium-size (based on scale of operation) constructions firms in Nigeria are as follows Costain W.A Plc, PW Nigeria, Cappa & DAlberto, Stabilini Visinoni, Bi-Courtney Limited, Lekki Concession Company, Reynolds Construction Company Ltd and Setraco Nigeria Limited, Gerrawa Global Engineering Limited, Piccolo-Brunelli Eng. Ltd, Philco Nigeria Ltd, Kopek Construction, Niger Construction Ltd, , Enerco Limited, Borini Prono and Company Limited, Arab Contractors Limited, Triacta Limited, CGC Nigeria Limited, Standard Construction Limited, Dantata and Sawoe Construction Company Nig, Ltd, and Mother Cat Limited.
Challenges
Similar to other Sub Saharan Africa (SSA) countries, we identify financing, dearth of technical expertise and corrupt governments/poor implementation as key challenges mitigating the development of infratructure and hence the growth of the construction sector in Nigeria. Shortage of Technical Expertise: The construction industry generally involves the interplay of different professionals ­ engineers, architects and quantity surveyors. Most construction firms in Nigeria, especially the big names like Julius Berger, China State Engineering, PW Nigeria rely on expatraiates in these areas as local counterparts are mostly unskilled and inexperienced. From the perspective of financing and deal structuring, most local financial institutions do not have the required expertise to structure infrastructural projects. There are few specialised project finance and trade finance institutions and the requisite skills to appropriately appraise and structure the project finance deals and price the associate risks accordingly are not locally sufficient.
Most construction firms rely on expatriates for core functions as locals are largely unskilled
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Business Environment ­ Regulatory and Policy: Based on various World Bank metrics on the receptiveness of the business environment to investments, Nigeria still lags. For instance, Nigerias days of dealing with construction permit is 350, higher than sub-Saharan average of 268 (see figure 12 next page) . The World Bank 2011 ranking on "Ease of Doing Business" indicates that Nigeria now ranks 167th (out of 183 countries examined) in "Dealing with Construction Permits", and 97th in "Enforcing Contracts". For the purpose of examining the competitiveness of Nigerias business environment for construction companies, we have limited our analysis to three out of World Banks nine metrics, to capture a countrys ease of doing business. These three are; "dealing with cosntruction permits", "enforcing contracts" and "protecting investors" (see figure 13 also). While admitting the regulatory and policy bottlenecks in Nigeria, we note that Nigeria ranks quite better than bigger emerging markets like India and China in "Protecting Investors" and more importantly observed from our analysis, is that Nigeria still ranks quite better than Brazil, Russia, India and China (BRIC) in at least two of the three meaures examined.
Notwithstanding, the complexity of Nigerias business environment, especially with regards to dealing with construction permits, the bottlenecks in Land acqusition, and general laxity in contract enforcements are still key regulatory impediments to infrastructural development vis-а-vis the growth of the construction industry. In addition, the unwillingness on the part of the populace to pay for infrastructure projects and the resultan t legal tussles that PPP concessionaires may likely face (for instance the on-going case of Lekki residents against Lekki Concession Company and the Lagos State government) are considerations that tend to limit participation of the private sector in infrastruture development.
Figure 12: Comparison of Sub-Saharan African Countries in Business Environment Attractiveness for Construction Companies Dealing with construction permit (days) 700 628 601 600
500 400 300 200 100
410 328 239 212 214 167
426
321
240249
255
195
210220
201
169164 120
128
167 146 125
381
350
265
271
283 255
308 277
322 254266
215 163178
201
213 184
139
210 220
181 144
174 143
107
93
84
0
Notwithstanding
various
regulatory
bottlenecks,
Nigeria ranks comparatively
well in a number of metrics
employed by the World Bank
to
measure
business
environment competitiveness
Angola Benin Botswana Cote d'Ivoire Congo, Rep. Cape Verde Algeria Ethiopia Ghana Gambia, The Equatorial Guinea Liberia Morocco Mali Mauritania Malawi Namibia Nigeria Sudan Sierra Leone Swaziland Chad Tunisia Uganda Congo, Dem. Rep. Sub-Saharan Africa
Sources: World Bank Africa Development Indicators Database, Vetiva Research
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Figure 13: Ranking of Emerging and Frontier Markets in business environment competitiveness relative to Nigeria
Country
Dealing with construction permit
Enforcing Contracts
Protecting Investors
Group 1 - better than Nigeria in at least 2 of the 3 parameters ranked
Thailand
12
25
12
Mexico
22
81
44
Estonia
24
59
50
Colombia
32
150
5
Mauritius
39
61
12
South Africa
52
85
10
Lithuania
59
17
93
Indonesia
60
153
44
Czech Republic
76
78
93
Hungary
86
22
120
Pakistan
98
155
28
Malaysia
108
59
4
Croatia
132
47
132
Turkey
137
26
59
Kazasthan
147
36
44
Nigeria
167
97
59
Group 2 - worse than Nigeria in at least 2 out of the 3 parameters ranked
Egypt
154
143
74
Kenya
35
125
93
Brazil
112
98
74
India
177
182
44
China
181
93
93
Russia
182
48
93
Argentina
168
45
109
Ukraine
179
109
43
Jordan
92
129
120
Phillipines
167
97
59
Sources: World Bank Database, Vetiva Research
Financing: Given the huge capital requirement for infrastructural development, financing has consistently been a major bottleneck. It is important to note that there are conflicting estimates as to the required amount needed to bridge Nigerias infrastructural deficit. However, according to recent statements in the media by Nigerias minister of finance ­ Mr. Olusegun Aganga ­ Nigeria would need close to $100 billion dollars to close the gap in infrastructural development. Until recently, Nigeria did not have an international bond rating against which sub-nationals and corporates seeking foreign debt can be benchmarked.
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Furthermore, Nigeria, like most SSA economies, has low sovereign debt ratings (typically below the BB rating) implying that foreign investors have higher risk perceptions of the economy. Some of these risks which largely stem from the political and regulatory uncertainties (relating to policy continuation) are further exacerbated by long payback periods for infratructural projects. Hence, investors are typically worried about re-couping investments within stipulated timeframes. Therefore, it is difficult to access foreign capital for long term investments as it is required, for infrastructural financing. It has also been observed that local financial markets do not have the capacity to finance infrastructure projects, both from the perspective of actual funding and technical expertise. This observation is similar across Sub-Saharan African countries, with South Africa being an exception as its domestic banks, to some extent, have been able to consistently provide local currency financing for infrastructural projects.
Accessing long term foreign
capital
to
support
infrastructure development is
still a major hurdle
Misappropriation and poor policy implementation: Central to most of the challenges already identified, are corruption and poor implementation of projects. Even in PPPs, the Government needs to play a major role for the PPPs to be successful. Mechanisms that will enhance and guarantee transparency in the Bid and Tender process, procurement specifications and final selection of contractors are deemed not to be in place or enforced. Governments, embarking on open Public Hearings for major contracts and appointmentof independent agencies to carry out appraisals on the projects, would be major steps to correctly address this problem.
Most of the challenges facing infrastructural development visа-vis construction firms are hinged on lack of transparency, misappropriation and poor policy implementation
Segments Rail Current State of Rail Transport: As earlier stated, Nigerias rail network consists about 3,500 km, narrow gauge (1.067m) single track lines running from Lagos to Kano, Port-Harcourt to Maiduguri and the uncompleted 349km of standard gauge from Itakpe to Warri through Ajaokuta. Since rail transportation is generally in a dilapidated stateand most of the available wagons and locomotives are defective and in poor conditions, this mode of transportation currently accounts for less than 1% of the land transportation in the country, thus, putting the roads under significant pressure from heavy haulage. In the last four years however, the Government appears to have taken major steps in developing rail transportation by awarding some contracts in rail construction (see figure 14 below). We note however that some of these projects may not have commenced, hence the proposed completion date may be extended beyond that indicated
Transportation
by
rail
constitute less than 1% of land
transportation in Nigeria, but
over the last four years it
seems federal government is
taking good steps to develop
rail transport
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Figure 14: Summary of projects/contracts already awarded in rail
construction
Value
Proposed Time
Rail Projects*
( Mn USD)
Company of Completion
China Civil Engineering
Abuja Light Rail
102
Construction Corporation
2013
China Civil Engineering
Abuja-Kaduna Railway
850
Construction Corporation
n/a
Jebba-Kano rail line
rehabilitation
79
Costain Engineering
n/a
Lagos Light Rail
1130
China Civil Engineering Construction Corporation
2013
Sources: Business Monitor, Vetiva Research
* Projects may have also been included in summary of federal government planned investment on next page
Outlook: Based on federal governments national medium term national development towards NV:2020, there are considerable opportunities in rail transportation. In line with this, the national planning commission has itemised the following as key targets to be achieved in rail transportation;
Total rehabilitation of 3,500 km of the existing narrow gauge rail Completion of the Ajaokuta ­ Warri standard gauge line Increasing the tonnage of freight transported through rail to 1 million metric tonnes from the current volume of 50,000 tonne Transportation of 4 million passengers per year To achieve 500,000 daily trips via mass transit Introduction of private sector participation Completion of rail works that have reached 50% of completion as at December 2009 Commencement of the Abuja/Idu to Kaduna standard gauge rail line, coastal rail line (Niger Delta Rail line) Calabar to Benin and East-West Rail line Aboekuta to Benin Linkage of Abuja through rail to the seaports of Lagos, Warri and Port-Harcourt Figure 15 below summarises the key projects indicated in the targets and the amount allocated for the projects in the medium term plan.
In the medium term, close to 10 rail projects have been itemised by the federal government for completion
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Figure 15: Federal Government planned investment in rail construction Investment Value (N'Billion)
Projects
2011
2012
2013
Rehabilitation of existing narrow gauge from Lagos to Kano
33.85
39.47
39.68
Completion of the 22km standard gauge from Ovu to Warri
0.94
1.09
1.14
Construction of 187.15km standard gauge from Abuja to Kaduna
15.05
17.49
18.31
Construction of 6 stations between Itakpe and Warri
140.82
163.65
171.26
Construction of modern coastal line from Benin to Calabar across 6 Niger Delta States
55.58
64.59
67.59
Construction of Abuja light rail project
19.62
22.81
23.86
Sources: National Planning Commission medium term plan, Vetiva Research
Whilst lauding the targets of the National Development Plan as regards rail transport, Nigerias poor history of implementation warrants a cautious perspective towards the achievement of the plan. Based on the average rate of budgetary implementation on the capital expenditure (CAPEX) side, just about 42% for 2009 and 2010, we do not see more than 40% - 50% of the stated targets for revamping the rail sector (itemised above) being achieved under the current administration in the medium term. We believe therefore, that focus for rail sector development in Nigeria should be on public private partnerships.
We laud the targets of the
national development plan,
but remain cautious on its
investment outlook given the
history
of
poor
implementation
Also, sub-nationals have a more pivotal position to play in rail infrastructure development. For instance Lagos State, through a PPP scheme with China Civil Engineering Construction as the contractor, has begun the construction of the Lagos Light Rail. The Light Rail Project consists of three basic projects ­ the Iddo/Ijoko line, Agbado/Marina line and Okokomaiko/Marina line. The Iddo/ljoko line would be 45% financed by Federal Government, 40% financed by Lagos State Government and 15% financed by Ogun State Government. The other two lines (both stations and infrastructure), being funded by the Lagos State Government, is estimated to cost N170 billion ($1.13 bn) but the operation and maintenance of the rail line would be run by a concessionaire for a period of 25 to 30 years. According to media sources, China Civil Engineering Construction Company commenced works on the Okokomaiko/Marina line in late 2010. The rail line is expected to be completed by 2012.
At the sub-national level,
Lagos State has been has
been
prominent
in
infrastructure development,
especially with the Lagos Light
Rail project which sparked off
last year
Based on the National Development Plan, the Federal Governments proposed investments in the Transportation sector over the medium term (2011-2013) is estimated at N2.2 trillion ($14.7 billion). However, considering the increasing role of state governments in infrastructural development, it is difficut to forecast the total expected investments in rail construction given the unavailabilty of the development plans of most state governments in this regard.
Based
on
federal
government's medium term
development
plan,
proposed investment in
Transportation in the next 3
years is about $14.7 billion
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Roads and Bridges
Current state: Nigeria currently has a total road network of 193,200 kilometres which comprise 34,123km federal roads; 30,500km state roads and 129,577km local government roads. Therefore, in percentage distribution, local and state government roads account for 82% of Nigerias total road network, further supporting our assertion that sub-national governments (local and state) have a major role to play in road infrastructure development. In our view, federal and state government roads constitute the most parts of the 30% paved portion (58,260km) of Nigerias total road network. (Figure 16 below shows some ongoing projects in road and bridges construction across Nigeria)
Close to 70% of Nigerian road are unpaved; over 80% of the 30% paved portion are federal roads
Figure 16: Federal Government ongoing investment in road construction
Value
Projects (Ongoing)
(million USD)
Company
River Niger Bridge at Onitsha Rehabilitation of Akungba-Ikare-Omuo-Kabba Road in Ondo and Ekiti States Rehabilitation of Ifon-Uzebba-Irukpen-Road/road to Ose Bridge, Edo State Rehabilitation of Nguru-Gashua-Bayamari Road, Yobe State Rehabilitation of Oba-Nnewi-Okigwe road
5
Setraco Nigeria Limited
10
Philco Nigeria Limited
13
Piccolo-Brunelli Eng. Ltd
15
Gerawa Global Engineering Ltd
Bullettine Construction
17
Company Ltd
Time for Completion 2009 2011 2011 2011 2011
Rehabilitation of the Shagamu-Ajebandele-OreBenin road section 2, Ogun State Rehabilitation of the Aba-Owerri Road in Abia/Imo states Rehabilitation of Abakilik-Afikpo Road (Ebonyi State)
Boriri Prono and Company
17
Nigeria Ltd
18
Niger Construction Ltd
Bulletine Construction
20
Company Ltd
2011 2010 2011
Rehabilitation of the Kano-Katsina-Kaura Namoda-Jibia Road section, Zamfara state
20
Mothercat Limited
2011
Rehabilitation of Abakaliki Afikpor Road section 2, Enugu State Rehabilitation of Efon Alaaye-Erinmo-Iwaraja, Ekiti State Rehabilitation of Mararaba PambeguwaSaminaka-Jos Road section 2 (Kaduna/Plateau States)
23
CCECC Nigeria Limited
23
Kopek Construction
2011 2012
24
PW Nigeria Limited
2011
Sources: Business Monitor, Vetiva Research
Outlook: There is a huge opportunity in road infrastructure development in Nigeria, given that approximately 70% total road network is unpaved and perhaps unmotorable. In Nigeria, road development has historically been the Governments responsibility. More recently however, the private sector through PPPs is beginning to participate in road infrastructure, albeit at a very low rate.
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The Lekki Concession Company (LCC) /Lagos State government PPP for the Lekki-Epe Expressway (still under construction) is the flagship example of Public- Private Partnership in road infrastructure in Nigeria. The project, estimated to cost US$300 million is the flagship PPP of the Lagos State Government, and includes the upgrading of the first 49.4 km kilometres of the Lekki-Epe Expressway and the development of the first 20 km of the coastal road with an option to construct a southern by-pass. According to the arrangement, LCC will build and operate the road for 30 years before transferring to the State Government. Recent protests by native residents in the area has however stalled the charging of toll fees by the concessionaire.
The future of road construction gradually tilts more to PPPs; the Lekki-Epe expresswayflagship PPP road project in Nigeria is an example
Not so much has been achieved at the Federal Government level in terms PPPs in road infrastructure as its flagship PPP with Bi-Courtney Limited ­ a local construction company ­ is yet to commence after close to 3 years. The development of road infrastructure on a longer term basis would be highly dependent on budgetary implementation, number of effective PPPs and the Governments ability to secure long term debt for general infrastructural development. According to the National Devevelopment Plan, it has been estimated that Federal Governments investment in rehabilitation and expansion of Federal Government (Trunk ,,A) roads would at least be N700 billion ($4.7 billion) over the medium term (2010 ­ 2013). Some of the projects to be covered under this are summarised below; Figure 17: Federal Government planned investment in road construction
Not much has been achieved in federal government led PPPs in road projects; the Lagos ­ Ibadan to Bi-Courtney is yet to commence appreciably since more than 3 years Investment Value (N'Billion)
Projects (to be funded solely by federal government)
2011
2012
2013
Dualisation of Onitsha ­ Owerri Road and Onitsha Eastern Bypass
1.64
1.91
1.99
Dualisation of Ibadan-Ilorin road section 1
0.79
0.86
0.99
Dualisation of Abuja-Abaji-Lokoja road
n/a
n/a
n/a
Dualisation of Kano-Maiduguri road
n/a
n/a
n/a
Dualisation of East-West road Warri to Oron via P/Harcourt
n/a
n/a
n/a
Construction of Kano Western Bypass
2.06
2.40
2.51
Construction of Panyam ­ Bokkos Wamba Road
0.84
0.98
1.03
Sources: National Planning Commission medium term plan
The federal government also has a number of road projects which are proposed to be implemented through PPPs - see figure 18 below, though the actual investment in these projects are unavailable.
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Figure 18: Summary of federal government planned investments in road construction through PPPs
Projects
Details
Lagos-Ibadan Expressway Concession
Upgrading of existing road by expansion to 8 lanes (Lagos-Shagamu) and 6 lanes (Shagamu-Ibadan)
Concession of 1.35km Guto-Bagama bridge across River Benue
Completion of 1.35km with adjoining roads between Enugu and Abuja
Construction of 2nd Niger Bridge across River Niger at Onitsha/Asaba
Completion of 1.75km bridge, 14km road with 3 flyover bridges and 3 other bridges
Road Rehabilitation and expansion Ports
Shagamu-Benin, Benin-Asaba, Abuja Kaduna, LagosBadagry, Seme Boarder, Kaduna - Kano dual carriage ways Sources: National Planning Commission, Vetiva Research
Nigerian seaports are owned by the Federal Government through the Nigerian Ports Authority (NPA). There are 13 major ports, 11 oil terminals and 128 jetties with a total annual cargo handling capacity of about 35 million tonnes. Given the problems of inefficiency and the resultant port congestion, the government commenced the reform and restructuring of the ports to introduce private sector participation in 2001. In April 2006, private operators took over as terminal operators of the sea ports, after a competitive bidding process, with the NPA focusing on its role as the "Landlord". The port reforms birth the first major PPP in infrastructural development and currently there are about 19 terminal operators managing Nigerian seaports in partnership with the NPA.
The PPP model was adopted in decongesting the port, following the port reform process that commenced in 2001
Figure 19: Private Port Operators in Nigeria
Company APM Terminals Apapa Bulk Terminal ENL Consortium Greenview Dev. Nig. Ltd Josepdam Port Services Ltd TCI Container Ltd P&C handling Services Five Star Logistics APMT Finance Port &Terminal Operation Bua Ports and Terminals Ecomarine Addax logistics Asso. Marine Services Global Infrastructure Atlas Cement Julius Berger Gulfinger Ltd Intels Nig. Ltd
Terminal Apapa Container Terminal Apapa, Terminals A&B Apapa, Terminals C&D Apapa, Terminal E TCIP Terminal A TCIP Terminal B TCIP Terminal C TCIP Roro Terminal Lilypond Cont. Terminal Port Harcourt Terminal A Port Harcourt Terminal B Calabar New Terminal B Calabar New Terminal C Warri Old Terminal B Warri New Terminal A Onne FOT Jetty Warri Terminal A Koko Terminal Onne, FOT A, FLT B, Calabar New Terminal A, Warri old Terminal A & New B
Sources: FPPPN, Vetiva Research
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According to the World Bank data on infrastructure, Nigerian port infrastructure ranks 3 on a scale of 1 to 7 (1 being the worst ranking and 7 the best). Though Nigerias ranking falls below average, the quality of Nigerian ports can be said to be close to other emerging market comparables like South Africa, Egypt, India, Brazil, and Argentina (see figure 20 below). While Nigerias ranking prior to the port reforms (launched in 2000) is unavailable, we believe the privatisation of port terminal operations (through PPPs) over the last decade would have contributed to the relative competitiveness in comparison to similar emerging markets (Brazil, India and Argentina).
On a scale of 1 to 7, Nigeria's port infrastructure ranks 3, according to World Bank
Figure 20: Ranking of Nigeria's Port Infrastructure on a scale of 1 (worst) to 7 (best), to other emerging and developed markets
7
Singapore, 7
6
Switzerland, 6
USA, 6
5
4 Russia, 4
3
Brazil, 3
2
South Africa, 4
China, 4
Egypt, 4
India, 3
Nigeria, 3
UK,5 Bulgaria, 4 Argentina, 3
1
Outlook:
Sources: World Bank, Vetiva Research
Based on the medium term development plan, the federal government plans to rehabilitate and construct river ports, jetties and wharfs (in Baro, Lokoja, Oguta, Degema and Yenagoa) by 2013. In addition, the construction of new seaports are also expected in Epe/Lekki Axis, Brass, Bonny and Badagry as well as development of Calabar port to support free trade zone. Figure 21 below lists some of the planned/ongoing projects in ports construction.
Figure 21: Planned investment in port development
Project
Value (million USD)
Company
Lokoja Port
15
n/a
Comment on timeline Construction resumed June 2009
Olokola deep water port Port Complex Lagos Lagos Free Trade Zone Port
1000 n/a 6000
COSCO Dubai Ports Authority and Sifax Group n/a
At planning stage since 2008 Talks ongoing Approval obtained for the project
Construction of Degema River Ports Isiala Ngwa Inland Container Depot
Planned under FG's medium
12
n/a
term plan for three years
Construction to have begun
n/a
n/a
in 2009
Sources: Business Monitor, National Planning Commission, Vetiva Research
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Real Estate
Current State: The real estate sector in Nigeria is largely divided into Residential and non-Residential segments. The Residential segment largely account for the larger chunk of real estate/housing demand in Nigeria. Residential Segment: According to estimates from the Federal Housing Authority and other players in the housing sector, housing deficit has been widely reported to be about 16 million units. Since its inception in 1992, the FMBN has approved a total of N121.2 billion mortgage through Primary Mortgage Institutions (PMIs) and Estate Development Loans (EDLs); however only half of the approved loans (N61.6 billion) has been disbursed. Hence a total of 53,518 housing units have been built over the 19 year period from Mortgage backed bonds and Estate Development Loans. Therefore, it is evident that the Governments involvement in housing delivery through the Federal Mortgage Bank, is grossly inadequate to meet housing demand, which is growing at such a fast pace, causing widening deficit. With a weak supply side, theres immense opportunity in the residential real estate segment. Beyond the fact that housing supply lags demand quite significantly, another key constraint in bridging the huge gaps in housing delivery lies on the demand side, as only a minute portion of Nigerias 150 million people can afford these houses. FMBN and privately owned residential estates are only affordable to individuals in the High and Upper Middle Income bracket (1Upper Middle: $3,945 - $12,200; High Income: > $12,200 based on World Bank Classification). In the same vein, mortgages are only accessible to individuals in this income bracket, which, based on our estimates is less than 5% of the total population. Hence, the majority (about 95%) of the population which are in the low income bracket still reside in sub-standard houses mostly single rooms in urban slums or thatched houses in the rural areas. Figure 22 below shows the distribution of Nigerian Population by the housing type.
The Federal Mortgage Bank, through Primary Mortgage Institutions, is at the forefront of housing delivery, with an about N121 billion given out as loans since its inception in 1992
With less than 5% of the
population able to access
mortgage,
housing
delivery has consistently
lagged demand despite the
efforts of FMBN
About 70% of Nigerians live in single rooms in urban slums or rural areas
Figure 22: Percentage distribution of households by type of housing units in Nigeria, 2008
Whole Building 0.8%
Others 0.3% Flat 15.8%
Duplex 15.0%
Urban
Others 0.4%
Whole Building 31.2%
Single Room 68.1%
Flat 2.5% Duplex 0.2%
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Others 0.4% Whole Building 27.2%
National
Single Room 65.7%
Flat 5.8% Duplex 0.3%
Single Room 66.3%
May 2011
Source: NBS Statistical Bulletin, Vetiva Research
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Commercial Segment: The demand for commercial real estates (offices, shops, warehouses, hotels) in Nigeria is highly concentrated in commercial cities like Lagos, (South West) and Port Harcourt (South South). Though this segment accounts for the less than 20% of real estate demand (our estimate), demand still outpace supply, especially as available properties are signficantly premium priced. According to Knight Frank Research, Lagos has the fifth highest office rent (measured US$/sqft/yr) globally as at Q409. In Nigeria, Julius Berger Plc, HFP Engineering and Costain W.A are the major construction companies with focus in construction of commercial real estate.
Commercial real estate accounts for less than 5% of real estate construction, but with higher demand, available properties are significantly premium priced
Percentage distribution by type of real estate in Nigeria
Industrial, 0.5%
Others, 1.6%
Commercial , 4.6%
2008
Residential, 93.3%
Commercial Residential Industrial Others
Source: NBS Statistical Bulletin, Vetiva Research
Outlook on Residential Real Estate: There are immense opportunities in the residential housing sector. A major constraint to the development of this potential has however being the high interest rates on mortgage and low penetration of mortgage facilities. Recently however (March 2011), the Federal Mortgage Bank (FMBN) announced that plans to increase its capital base to N150 billion within the next the 24 months are underway.
Based on BusinessDay Newspaper reports (March 22, 2011), part of FMBNs two year plan would subsequently include the injection of N250 billion annually. In addition to the planned recapitalisation which would make the FMBN adequately positioned to lend to estate developers, there was also a change in the fund disbursement policy to lenders. The change involves reducing the number of tranches in which monies are released to estate developers to 3 from the previous 4. Estate developers in the new policy dispensation would have access to higher liquidity and would be in a position to complete housing projects at a faster rate.
With
the
planned
recapitalisation of the FMBN,
underway over the next 2
years, more estate developers
will be positioned to access
mortgage loans
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Building Materials ­ Impact on Construction Cement, aggregates, steel and iron represent the basic materials needed for most construction activities. The construction industry more or less represents the service arm to building materials sector, as the output of the latter forms the input of the former. Therefore, the growth of the building materials sector has a direct implication on the outlook of the construction industry. In Nigeria, a key factor constraining the realisation of the full potential of the construction industry is the dearth of key building materials, particularly cement, steel and iron. We examine each of these key building materials below, with focus on current demand and supply, outlook and expected long term impact on the growth of construction industry.
Cement ­ Gradual move towards Self-Sufficiency
Although Nigeria is still a net importer of cement, there has been considerable improvement in local supply - production capacity and utilisation. Local production now accounts for at least 70% of cement consumption from about 25% some five years ago, given the rise in local production capacity (to 13.85 million tonnes per annum from 4.25 million tonnes per annum) over the same period. Even with the phenomenal rise in local production, it is important to note that most of the cement plants (perhaps with the exception of Dangote Cements Obajana Plant and Lafarge WAPCOs Ewekoro plant) are still operating measurably below full capacity. This implies that there is some potential for growth from existing capacities. More exciting, is the fact that new plants (Ibese, Lakatabu, Obajana Line 3), which are expected to become operational later this year, would add about 13.2 million tonnes per annum to existing capacities of 13.85 million tonnes per annum.
With the increase in local production local production now accounts for c.70% of total cement consumption, as against 25% five years ago
Given the expected increase in local cement output, industry players have postulated that Nigeria would become self-sufficent in cement production, and may even become a net-exporter by 2013. Whilst we allude to this postulation in the medium term, we believe that self-sufficiency would be very transient if the construction industry grows at such a rate to realise its full potential. The additional capacities would put Nigerias cement consumption per capita at c.180kg; but still a far cry in comparison to UAE (4,198kg), China (1,055kg), and Saudi Arabia (1,294kg), countries which have witnessed major surge in construction activities over the last two decades.
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Building & Construction GDP (N'Billion) vs Cement Consumption (million tonnes)
600
25
20 450 15 300 10 150 5
0 2007
2008
2009
2010E
2011E
Cement Consumption (million tonnes), RHS Building & Construction GDP (N'Billion), LHS
0 2012E
Source: CBN, Vetiva Research
Aggregates - Market is Fragmented and Underdeveloped
Despite the fact that aggregates also form a major component of concrete, the market for the product is largely fragmented in Nigeria. The big cement producers, which practically are better positioned to forward integrate into aggregates production are currently not doing so, thereby leaving the aggregates market into the hands of small, fragmented partipants who either operate on an wholesale or retail. Demand for aggreagtes would continue to rise as it is a complimentary product to cement. This presents major opportunities in the form of forward integration for cement companies in the long term.
The aggregate market is still largely fragmented with supply in the hands of small, fragmented participants; cement producers can capitalize on market opportunities here through forward integration
Steel & Iron ­ Local Production Still a Mirage
The construction industry has continued to see notable rise in the use of steel as a building material. Major characteristics which have continued to endear the material to contractors and developers include its high strength, ductility, adapatation to prefabrication, speed of erection, among others. Currently, Nigerias steel industry is in a moribund state, even as Ajaokuta Steel (Nigerias main steel producer) is performing suboptimally; not surprising then, Nigerias per capital steel consumption, which is less than 10kg, is awfully low in comparison to similar African countries like South Africa (c.112kg), Egypt (c.95kg), and even Algeria (about 38kg). Emerging markets like China (405kg), Russia (178kg), South Korea (936kg), Malaysia (345kg), Thailand (150kg) all have higher per capita steel consumption. Egypt and South Africa are the major steel producers in Africa, with South Africa as the largest with production of 7.5 million tonnes in 2009 versus Egypts production of 5.5 million tonnes, according to the International Steel Statistics Bureau. Currently, Nigeria does not produce crude steel. At best imported crude steel are processed into bars by private rolling mills.
Nigeria's steel industry is practically non-existent as production of crude steel is almost nil; hence per capita steel consumption of 10kg is abysmally low
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Nigeria Vs South Africa & Egypt (Steel production, consumption and consumption per capita)
9000
120
7500
100
6000
80
4500
Nigeria does
60
not produce
3000
crude steel
40
1500
20
0 Nigeria
South Africa
0 Egypt
Steel Production ('000 tonnes),LHS Consumption per capita (kg),RHS
Steel Consumption* ('000),LHS
Source: World Steel Association, Vetiva Research
Comparison of Per Capital Use of Steel (Steel Consumption per Capita, 2009) in Kg
1000
936
800
600 405 400
200
176
93
115
95
48
10
0
419 345
187
179
Russia Brazil Sout h Africa Nigeria Egypt India China Sout h Korea USA Germany Japan Worl d Average
Sources: World Steel Association, Vetiva Research
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According to the African Iron and Steel Association, Nigerias demand for steel has been
estimated at 12 million tonnes per annum, which implies that there would still be a
shortfall of about 6 million tonnes, even if Ajaokuta Steel Company (annual capacity of
5.2 million tonnes) and Delta Steel Company (annual capacity of 1 million tonnes)
becomes fully operational. With Delta Steel Company and Ajaokuta almost non-
operational, it is evident how far Nigerias steel industry is towards optimising its
potentials. From the foregoing, the poor state of the local steel industry has been a
major retardant on the potential of the construction industry, as reliance on imported
steel has meant higher costs for construction firms. More importantly most of the
imported
steel
bars
have
been
adjudged
sub-standard.
Even if Ajaokuta and Delta Steel Company starts operating optimally, local production will still be a far cry to Nigeria's steel demand, estimated at 12 million tonnes per annum
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Figure 18: Emerging market construction companies comparable metrics
Company
(Mkt Mn EBITDA Margin
Country USD)
2010E 2011E
EBIT Margin 2010E 2011E
ROE (%) 2010E 2011E
EV/EBITDA 2010E 2011E
P/E (x) 2010E 2011E
Dividend yield 2010E 2011E
ARABTEC
UAE
512.88 12.44% 11.55%
8%
7%
13.56
9.95
2.96
3.08
5.46
7.37
0
0
RAUBEX
S/Africa 488.39
25%
20%
20%
15%
31.77
20.95
2.82
3.31
5.58
6.53
6
5.19
Long Yuan
China
986.31
6%
6%
n/a
n/a
10.1
10
17.47
13.08
28.83
20.84
n/a
n/a
JBerger
Nigeria
402.41
14%
14%
6%
4%
41.9
41.1
2.57
2.24
18.81
18.04
4.52
4.73
ACC Limited India
4,025.41 23%
20%
18%
15%
18.17
16.84
8.94
8.72
16.44
16.26
2.19
2.49
LSR Group China State Construction
Russia China
3,667.88 25%
3,643.32
9%
26% 9%
21% 9%
23% 9%
6.81 20.3
14.71 19.16
11.97 25.41
8.23
158.22 57.88
18.99
25.9
18.85
n/a 1.21
n/a 1.58
ORASCOM Reliance Infrastructure
Egypt India
8,862.74 22% 3,136.59 11%
25% 12%
17% 10%
20% 8%
18.16 9.31
21.73 7.82
10.29 18.46
8.5 13.62
16.25 9.06
12.58 9.1
4.23 1.36
4.61 1.3
GRF
S/Africa 499.55
9%
9%
7%
6%
21%
16%
1.87
2.35
5.54
7.21
4.44
3.66
Sources: Bloomberg, Vetiva Research
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Investment Summary
Stock market performance
There are six listed construction companies in Nigeria (excluding Cappa & DAlberto), constituting only 1% of the total market capitalisation, with Julius Berger (JBERGER) accounting for more c.80% of the sectors capitalisation. Most construction stocks are small cap stocks with low liquidity. The sectors performance is largely dependent on JBERGER, given its dominant sector weight. YTD, the construction sector has only appreciated by 5.85%, lagging the Building Materials (Cement) sector, and the NSE ASI, which have risen by 10.1% and 3.4% respectively. The lagging performance of the construction sector has been due to the YTD loss of 20% on COSTAIN, eroding some gains in the YTD performance of JBERGER.
The construction sector on the stock market is only 1% of total market cap; Julius Berger accounts for c.80% of sector's capitalisation
Figure 26: Share Price Performance Year Open to 26th May 2011 (Rebased)
1.3
1.1
0.9
0.7 Dec-10
Jan-11
Feb-11
Vetiva Construction Sector Index
JBERGER; +4% Construction Index; +2.5%
Mar-11 JBERGER
COSTAIN; -20% Apr-11 Costain
Sources: NSE, Vetiva Research
YTD gain of the construction sector (measured by Vetiva Construction Index) stands at 2.5%
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Julius Berger Plc Consistent Track Record Still the market leader...Julius Berger remains the market leader in the construction sector, controlling more than 60% of Federal Governments contracts. Given its huge equipment base and expertise in different aspects of construction ­ heavy/civil, real estate and industrial - the company has sustained its leadership position in the construction space. ...But competitive threat is on the rise: We see Julius Bergers market position becoming gradually pressured with the entrant of the Chinese Construction firms. In our view, the rising preference for Chinese Construction companies may be due to the fact that they can deliver projects at cheaper rates, thus, attracting higher technical and partnership agreements with Nigeria. Moreover, most of the firms are state owned; meaning Nigeria stands to benefit in other sectors from the bilateral relationship. Notably, China Construction Engineering Company was awarded the gigantic Lagos Light Rail Project which is estimated to cost $1.4 billion by the Lagos State Government. We note also that the Lagos ­ Kano rail project, which was initially awarded to China Construction Engineering Company at a cost of $8.3 billion in 2006 but not executed due to the funding challenges, has recently been re-scoped in six stand-alone segments in which the Abuja ­ Kaduna line would be the start off. Valuation and Recommendation: We maintain an "ACCUMULATE" rating on Julius Berger, given that the stock (at a current share price at N55.71) has an expected upside of 15% to N64.15- the midpoint of our revised target price range (N60.45 ­ N68.35). Our target valuation is based on the DCF methodology, with Julius Bergers fair value rolled one year forward at its weighted average cost of capital.
ACCUMULATE
Stock Data Bloomberg Ticker: Market Price (N) Shares Outs (bn) Market cap (Nbn) Target Price range (N) Rating
JBERGER:NL 55.71 1,200 62.50 60.45 ­ 68.35 ACCUMULATE
Price Performance 12-month (%) 6-month (%) YTD (%)
JBERGER 5.9 11.4 11.4
NSE -1.1 3.8 3.4
Financials Turnover (N'bn) EBITDA (N'bn) PAT (N'bn) EBITDA Marg (%) PBT Margin (%) PAT Margin (%)
2009A 150.3 23.2 3.3 41.1 33.6 32.4
2010E 160.2 23.0 4.3 57.8 50.9 49.3
2011F 184.3 27.9 6.8 59.6 55.1 54.0
Valuation P/E (x) P/BV (x) EV/EBITDA (x) Div. Yield (%)
2009A 19.3 8.1 2.9 4.5
2010F 14.3 7.5 2.9 5.7
2011F 9.4 6.7 2.4 9.1
Figure 31: YTD Share price performance vs. ASI and sector index (Rebased); Shareholding Structure
1.2 Vetiva Construction Sector Index 1.1
JBERGER
NSE ASI
1.1
1.0
1.0
0.9 Dec-10
Jan-11
Feb-11
Mar-11
Apr-11
Nigerian Citizens, 29.9%
Benue State Government , 5.3% Plateau State Government , 4.6%
Lagos State Government , 10.3%
Bifilger Berger, 49.9%
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Investment Thesis
Expertise & Experience: Julius Berger has more than 40 years of vast construction experience in roads and bridges, railways, airports, dams and buildings. Notable projects which Julius Berger has handled in the past include the Eko and Third mainland Bridges in Lagos, the Tuga (River Niger) Bridge, Nnamdi Azikwe Airport Abuja among others. (See figure 28 on page 36 projects carried by Julius Berger in Nigeria). The companys expertise centres round its capability to plan, design, and construct. Julius Berger operates its own quarries, mixing plants, repair and recondition workshops as well as a large land and transport fleet. (See list of equipments in figure 27 below) This massive investment in equipments coupled with the expertise of its staff, makes the company capable of starting and delivering on projects promptly, hence giving Julius Berger preferential considerations for government contracts.
Julius Berger has a rich 40 years experience in Nigeria's construction industry and wide range of equipments for various construction activities
Strong Revenue Potential: Julius Berger remains the strongest listed construction firm; its history of proven job quality in the Nigerian construction space is largely unrivaled. In view of the rising emphasis on physical infrastructural development in Nigeria, we believe it is necessary for investors to have some exposure to such infrastructure-linked equities like Julius Berger in a bid to benefit directly from the expected boom in the longer term. The renewed interest in the power sector also offers Julius Berger some growth opportunities; we believe the company would participate actively in the construction works in the power sector due to its dominant market share in Federal Governments construction contracts.
Julius Berger is poised to benefit from rise in construction activities in view of the anticipated infrastructure development
Strategic positioning of operational bases: Julius Berger has operational bases in three key zones in Nigeria ­ North Central (Abuja), South West (Lagos) and South-East/South-South (Niger Delta Region), which gives the company the a strategic advantage of wide coverage. More importantly, these regions are areas of fast growing construction activities. Lagos, being the commercial nerve-centre of Nigeria is witnessing significant growth in construction activities, especially in the area of transportation. Abuja, also as the Federal Capital Territory has seen a major rise construction activities in the past decade, especially as population influx into the city has necessitated expansion into new towns. Julius Bergers NigerDelta base enables the company to be a major partaker in the construction activities in the regions oil industry.
Julius Berger's operational bases are positioned in Lagos, (South-West), Abuja (North-Central), and the Niger Delta, giving the company a strategic advantage
Economies of Scale: In the construction industry, economies of scale refer to the less-than-proportionate rise in construction costs as project size increases. As the biggest construction company in Nigeria, a key strength of Julius Berger in this regard, is the fact the company, as a result of its massive equipment base, is more favourably disposed to win contract bids on large-scale construction projects, given the inherent cost minimisation edge over smaller construction companies.
In a industry that mainly comprise small/medium scale players, Economies of scale is a major comparative advantage for Julius Berger
Good Brand Name: Julius Berger has a good brand, which has been known for good work, quality and consistent track record, in the Nigerian construction industry. The companys brand is almost indistinguishable from the entire construction industry.
Julius Berger enjoys technical support from the parent Bilfinger Berger SE through Bilfinger Berger Nigeria
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Strong Support from the parent: Another notable competitive advantage of Julius Berger is the strong support, in form of technical expertise, financing and innovation, of its parent company ­ Bilfinger Berger Nigeria, which is a multiservice international construction group, formed in 2006 as a wholly owned subsidiary of Bilfinger Berger SE. Bilfinger Berger Nigeria oversees and coordinates the groups (Bilfinger Berger SE) business in Nigeria. Through the company, Julius Berger taps into the vast potential, experience and technical know-how of the group Bilfinger Berger SE ­ a German ­ based international multiservice construction company formed in 1975 from a merger of three construction companies. Business Overview Profile Julius Berger Nigeria Plc was established in 1965, originally set up as a subsidiary of a German-based construction company who has been contracted to work on a bridge-building project. It subsequently diversified into road and industrial construction. Since inception, Julius Bergers major client has remained federal and state governments. The first contract the company executed in Nigeria was the erection of the 2nd mainland bridge (popularly called the Eko Bridge). Julius Berger changed to a publicly limited liability company in 1979. The company played a major role in the construction of the industrial and civil infrastructure of the 70s and the 80s. Following the promulgation to make Abuja the Federal Capital Territory in 1976, the company became closely involved in the building the infrastructure of the new federal capital territory. Julius Berger became a publicly quoted company (listed on the Nigerian Stock Exchange) in 1991 and commissioned its head office complex in Abuja in 2001. The company operates through its three operational bases in the Lagos (South-West), Abuja (North Central) and Niger Delta (South-South). Construction Activities Julius Berger can perform a wide-range of construction as summarised below; Buildings - Office Buildings, Functional Buildings, Residential Facilities, Sports/Recreation Facilities; Specific examples include the National Assembly Complex, Federal Ministries Complex, Central Bank of Nigeria Headquarters Abuja. Infrastructure ­ Roads and Bridges, Railways, Airports, Dams and Water Supply; Specific Examples include Port-Harcourt/Onne Rail line, Itakpe/Ajaokuta, Challawa Gorge Dam etc Industrial Construction ­ Plants and Factories (Cement Plant Obajana, Fertilizer Plant Onne), Oil and Gas (Bonny LPG Tank, Floating Filling Stations), Power Stations (Power Plant Ikot Abasi Aluminium Smelter) etc Marine ­ Ports, (Apapa Wharf Extension and Rehabilitation), Jetties and Piers, Dredging Julius Berger operates as a full vertically integrated company through its support services units detailed as follows;
Julius Berger was established on 1965 and since then, the company's major client has been the Nigerian government Julius Berger's construction activities are broadly divided into building construction, industrial construction, infrastructure and marine construction
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Support Service Units
Plants and Quarries: Julius Berger runs its own quarries and mixing plants. The company operates 10 quarries with an aggregate production capacity of 2.5 million tonnes per annum, 11 concrete mixing plants with a hourly capacity of 550m3 and 7 asphalt mixing plants with combined capacity of 630 tonnes per hour.
Julius Berger runs its own quarries and concrete mixing plants
Equipments: The Company owns and operates a large number fleet of construction equipments.
Figure 27: Julius Berger Construction Equipments
Equipment Description
Specific Type Number
Earthmoving Equipments Lifting Equipments Transportation & Marine Equipments
Excavators
130
Dozers
90
Wheel/Track Loaders
60
Graders
60
Scapers
10
Compactors
130
Tower Cranes
65
Mobile Cranes
100
Gantry and Overhead Cranes
70
Material and Personnel Hoist
20
Fork Lifts
110
Truck Mounted Concrete Pumps
15
Trucks
660
Trucks with Trailers
465
Tugboats
20
Pontoons
35
Diesel Locomotives
7
Bucket and Platform Wagons
60
Speed and Working boats
80
Jack Up Barges
3
Pontoons for Pile driving of pile
boring operation
2
Sources: Company, Vetiva Research
Laboratories: Julius Berger operates central laboratories in Abuja and Lagos for the testing of all its construction materials.
Special Facilities: These are used in fabrication of steel products, manufacturing of aluminium products, production of oxygen gas, remoulding of truck tyres and reconditioning of truck and marine engines.
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The company also has established factories for pre-cast concretes units, railway sleepers, roof tiles, interlocking pavement, blocks, kerbstones, and sewage pipes. These products were designed to ensure quality and flexibility whilst enhancing the timely completion of projects. Special Units Foundation Technology: This ensures the delivery of customised cost effective solutions for the foundation structures of Julius Berger projects. The services provided by this unit are as follows; Explanatory drilling, Soil reports, Foundation design and engineering, Subsoil consolidation, Wick drains, Bored Piles (5 drilling rigs), Driven Pills (5 pilling rigs) and Water Wells Technical Services: Services provided include design and engineering for building and civil engineering projects, budget estimates for feasibility studies, scheduling, feasibility studies and project management. Subsidiaries Julius Berger Services Nigeria Limited: The company is a wholly (100%) owned subsidiary with principal activities in port management services. Abumet Nigeria Limited: It is a 70% owned subsidiary of Julius Berger Plc with major activities in manufacturing and installation of building aluminum components. Julius Berger Nigeria plc Corporate Structure Bilfinger Berger SE
The company operates special facilities used in fabrication of steel and manufacturing of aluminum products
Bilfinger Berger Nigeria
ICS*
Julius Berger Nigeria
CEC**
Support Service Units
Special Units
Subsidiaries
Plants and Quarries, Equipments, Laboratories, Special Facilities
Foundation Technology, Technical Services
Julius Berger Services Nig. Ltd (100% owned)
Abumet Nig. Ltd (70% owned)
Source: Vetiva Research, Company Website *International Contracting Service Limited; **Construction Engineering + Contracting
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Figure 28: Construction Projects Handled by Julius Berger Projects Buildings/Sports/Recreational Centres Construction Central Bank of Nigeria HQ, Abuja Federal Ministries Complex, Abuja Police Force HQ, Abuja National Assembly Complex National Stadium, Main Bowl, Abuja IBB International Gold Course, Abuja National Chilren's Park and Zoo, Abuja Velodrome Sports Complex, Abuja International Conference Centre, Abuja National Hospital, Abuja Shehu Musa Yaradua Centre Ogeyi Place Hotel, Port-Harcourt Tinapa Business Resort Railway Village Agbor Army Barracks Abuja Residential Area, LNG, Bonny Island Infrastructure - Roads, Bridges, Railways, Airports, Ports, Jetties Eko Bridge, Lagos Inner Ring Bridge, Lagos Imo River Bridge Tuga Bridge, River Niger Tombia Bridge, Nun River Infrastructure works for Abuja Ekole Bridge, Yenagoa Itakpe-Ajaokuta Rail line Nnamdi Azikwe Int. Airport Abuja Osubi Airport, Warri Katsina Airport & Infrastructure Yola Airport Tincan Island Port, Lagos Warri Port Sapele Port Apapa Wharf Extension Apapa Wharf Rehabilitation Bonny LNG Jetty Bonny LPG Jetty Ikot Abasi Jetty Industries; Factories, Power Plants, Oil & Gas Construction Aladja Steel Plant Warri Ajaokuta Steel Plant lot 2 Alumium Smelter, Ikot Abasi Fertilizer Plant, Onne Cement Plant, Obajana Bonny LNG Plant Bonny LNG Storage Tank Atlas Cove Single Point Mooring Floating Filling Stations Niger Delta NNPC Retail Outlets Phase I-V Power Plant, Ikot Abasi Alumium Smelter Power Plant, Warri Port Power Plant, Tincan Island
Construction
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Construction Period 1999 - 2002 1990 - 1995 1998 - 2001 2004 - 2007 2000 - 2003 1987 - 1991/1994 2001 2002 - 2003 1990 - 1991 1997 - 1998 2000 - 2002 2000 - 2003 2005 - 2007 1997 - 1999 1989 - 1992 1996 - 1999 1973 - 1975 1975 - 1979 1991 - 1993 1988 - 1989 2001 - 2002 1980 - 1998 2006 - 2007 1987 - 1990 1993 - 1997 1997 - 2000 2006 - 2007 2000 - 2001 1976 - 1977 1977 - 1979 1980 - 1982 1975 - 1978 2000 - Ongoing 1996 - 1999 2000 - 2002 2001 - 2003 1978 - 1982 1980 - 1990 1990 - 1999 1983 - 1987 2003 - 2005 1996 - 2000 2000 - 2003 2000 - 2001 2007 - Current 2002 - 2007 1993 - 1995 1977 - 1979 1976 - 1977 Sources: Company, Vetiva Research 36
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Revenue Structure Construction activities account for c.98% whilst sales of goods and services from its subsidiaries account for only 2% of the companys total revenues. We estimate that federal government contracts account for 55% ­ 60%, state governments 25% ­ 30% and private sector (mainly Oil and Gas industry) 10% - 20%. This estimate shows that Julius Bergers revenue is highly concentrated with government contracts, which in turn is dependent on budgetary allocation to capital expenditure and more importantly, implementation of the capital expenditure budget. We believe there would be increased competition in the Oil and Gas sector if the Petroleum Industry Bill is implemented, given the bills focus on local content development. Hence, we are likely to see increased participation of fully indigenous construction company in the construction contracts of the oil and gas industry. Nonetheless, Julius Bergers capacity (in terms of asset base) to undertake and execute complex construction contracts in the oil and gas industry would continue to give the company a good edge.
Revenue is concentrated around federal government's budgetary allocation to CAPEX
Outlook on Revenue Given the capital intensive nature of infrastructure projects, governments have been the biggest spender on infrastructure in Nigeria. Hence, Julius Bergers revenue fortunes in the medium term (3 to 5 years) remains largely hinged on governments (state and federal) budgetary allocation to capital expenditures. Notably, however, the landscape of infrastructure financing on the African continent is gradually changing with rising focus on private sector participation, especially in form of PPPs. In this regard, construction companies are going beyond construction to patterns like "Build and Operate" (BO) or "Build, Operate and Transfer" (BOT) arrangements in which the companies are the co-financiers of the projects, with the government or other financiers. Drawing a cue from the construction of Lekki-Epe expressway and Muritala Mohammed Airport (MMA) 2, which are PPP projects and the on-going Lagos Light Rail Projects being constructed by the Chinese State Engineering Corporation using a similar PPP pattern, we believe the structure of the construction industry, in the longer term (5 ­ 10 years), will no doubt change towards this pattern. It is therefore important for Julius Berger to begin to re-position its business model for long term relevance in the Nigerian construction industry. Notwithstanding, Julius Bergers revenue prospects remain very strong at least in the next five years. The key reason, which cannot be overstressed, is the investments anticipated in physical infrastructure from the government. However, a likely drag on Julius Bergers strong prospects in the medium term, in our view is poor budgetary implementation, especially on the CAPEX side. Notably, budgetary implementation on the CAPEX side stood around 27%, in contrast to over 100% implementation on the recurrent side. On a quantitative note therefore, we estimate a 7% and 15% growth in revenues in 2010 (yet to be announced) and 2011 respectively. With the expectation that federal government would have fully settled in from 2011 transition and therefore pursue infrastructure development a bit more aggressively, we project a higher growth rate of 20% (YoY) in revenue over the medium term (2012 ­ 2015).
Medium term revenue outlook is
hinged on CAPEX budgetary
implementation;
however
a
repositioning of Julius Berger's
business model in the longer term,
to capture PPP opportunities is
imperative
With CAPEX budgetary still very low at around 27% (based on 2010 budget), stronger revenues is anticipated for Julius Berger as implementation increases
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Cost Structure
The cost of the construction industry is quite complex, given the diverse forms of construction projects, but generally, the costs component of a construction firm is divided into variable and fixed costs. The variable component is subdivided into two categories: Wages and Materials. Construction materials include cement, aggregates, steel, iron rods, wood etc. Though wages generally increase with the size of construction (as more labour would be required), we believe, the reverse is true for Julius Berger ­ hence construction materials account for a larger portion of its variable costs rather than labour. In Nigeria, construction labourers are somewhat poorly paid and most of these workers are purely on a wage basis with no benefits from the company. Also, the construction materials, especially cement and steel are quite expensive in Nigeria ­ about one the highest globally ­ since Nigeria is still a net importer of these materials. While noting the high operating leverage of the construction industry (due to high fixed costs) variable costs as a proportion of total costs, still tends to be higher than in the manufacturing industry. The fixed component of the construction costs is essentially in the form of depreciation and maintenance charges, given the high fixed asset base of the industry. For Julius Berger, which is more or else a fully integrated construction firm with Plants, Quarries, Pre-cast concrete factories, Heavy machineries and equipments, overall depreciation and maintenance charges for these units would be quite significant. The advantage of its fully integrated service structure however is the fact that overall production costs of pre-cast construction materials would tend to be lower than if the materials were purchased ready-made. Economies of Scale: Unlike the manufacturing sector where economies of scale is quite noticeable and the benefits therewith easily accruable, the workings of the construction industry is somewhat different and it is difficult to achieve economies of scale. The key to economies of scale in the construction industry is integration. Julius Berger is perhaps the only construction firm in Nigeria that can be said to have achieved some level of economies of scale, given its special services unit (which comprises its pre-cast factories, plants, quarries and equipments). Outlook on Costs As against the historical rising trend of Julius Bergers costs (especially costs of sales), we expect some moderation in material costs growth, and hence total costs. Our expectation is predicated mainly on the expected reduction in cement prices in the long term, with the increasing production output in the sector. This, coupled, with the companys economies of scale (relative to smaller sector players), should see Julius Bergers costs grow at a slower pace. We estimate a 3 year CAGR of 18% over FY10 to FY13 as against the historical 3 year CAGR (from 2006 to 2009) of 42.9%.
Cost structure is complex but broadly driven by cost of construction materials, depreciation and other fixed costs and wages Economies of scale is difficult to achieve in the construction industry, but Julius Berger can be said to have achieved economies of scale given its integration In line with the expected increase in cement sector output in the next few years, we expect some moderation in growth of construction material costs
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Financial Analysis In line with our overall medium term expectations for Julius Berger revenues, we project a 3-year CAGR growth of 65% from FY10E of N160 billion to FY13F of N265 billion. Expected growth in profitability however, is not as impressive as topline since we do not anticipate any major improvement in Julius Bergers characteristically low profit margins, given the huge operating leverage of the business. Hence we project a 3-year CAGR of 18.3% in EBITDA and 7.4% in EBIT.
We project a 3-year CAGR growth of 65% in revenue to N265 billion in FY'13 from FY'10E of N160 billion
Figure 29: JBerger's Revenue (N'Billion) and YoY Revenue Growth (%)
250
50.0%
44.2%
200
39.0%
40.0%
150
31.9%
30.0%
20.0%
100
20.0%
15.0%
50
10.0%
6.6%
0
0.0%
2007 2008 2009 2010E 2011F 2012F
Revenue (N'Billion)
YoY Growth (%)
Figure 30: EBITDA (N'Billion) and EBITDA Margin (%)
35
16%
15%
15%
26
15%
14%
14%
18
9 11% 11%
12%
0
10%
2007 2008 2009 2010E 2011F 2012F
EBITDA (N'Billion)
EBITDA Margin (%)
Sources: Annual Accounts, Vetiva Research Estimates
Given the nature of Julius Bergers business, we believe the company would continue to invest in its physical assets and hence, would continuously require periodic financing. The company still has up to a C50 million 3 year credit line with HSBC Bank London, with about 69% drawn as at FY09. Given that the loan is priced at a floating rate of Euribor plus 1.2%, it is difficult to project interest payments, however we expect minimal interest payments (low interest rate compared to local borrowing rates), though subject to exchange rate volatility.
Julius Berger's C50 million loan was 69% drawn down as at FY'09; the loan has a 3 year tenor, expiring in 2012
With the loan expected to be fully repaid by 2012, we have assumed that the company will not take up any long term debt for the rest of our forecast period. We project a 3 year CAGR growth of 14.7% and 29.9% in pre-tax and after tax income to N14.1 billion and N9.5 billion in FY13 from FY10 estimates of N9.1 billion and N4.3 billion; hence we expect Julius Bergers Earnings per Share to come close to N7.95 by FY13 from N2.82 FY10 estimate (3-year CAGR of 29.6%)
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Figure 31: Operating Profit -EBIT (N'Billion) and EBIT Margin (%)
14
7.5%
6.8%
6.9%
11
6.5%
6.2%
7 5.1%
5.5% 5.5%
4
4.5%
4.0%
0
3.5%
2007 2008 2009 2010E 2011F 2012F
EBIT (N'Billion)
EBIT Margin (%)
Figure 32: Pre-tax profit (N'Billion) and EBITDA Margin (%)
12.5
184%
200% 150%
10.5 8.5
66%
80%
100%
50%
6.5
23%
4.5
9% -3%
0%
2.5
-50%
2007 2008 2009 2010E 2011F 2012F
PBT (N' Billion)
PBT growth (%)
Sources: Annual Accounts, Vetiva Research Estimates In line with our assumption that Julius Berger is unlikely to take up new long term debts in the short to medium term after its current C50 million line matures in 2012, we expect the companys debt ratios (total debt to equity & total debt to assets) to moderate downwards.
Figure 33: Debt, Debt to equity and CAPEX to total assets ratios 160.0%
120.0%
80.0%
40.0%
0.0%
2007
2008
Total Debt to Equity
2009
2010E
2011F
2012F
Total Debt to Assets
CAPEX to Sales
Sources: Annual Accounts, Vetiva Research Estimates
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Valuation
Our valuation is based on the Discounted Cash-flow Methodology (DCF) with forecasts spanning five years.
DCF assumptions -
Revenue growth: 15% in 2011; 20% from 2012 to 2015. As the industry approaches its peak growth rate, we expect some declines in growth rate, until it finally stabilizes in the longer term.
Our forecast span through five years, assuming 15% growth rate in 2011 and 20% from 2012 to 2015
Our long term perpetual growth rate stands at 4% based on our thinking that growth in the construction industry would eventually lag long term GDP growth rate (estimated at 6%), expected as a country moves towards being a developed economy. Cost of sales (as percent of sales): Assumption of 82% over forecast period, slightly lower than historical three year average of 83.5%, as we see only a little upside to costs in the long term, given our expectation of relatively stable cement prices, a single digit growth in long term inflation and expectations of an improved power sector. CAPEX: Based on three years historical CAPEX/sales ratio of 15.5%
Costs (as percent of sales) is kept at 82% in the forecast period
WACC assumptions are stated in the table below;
Figure 34: WACC Assumptions After tax cost of debt* tax rate Risk free rate Beta Equity risk premium Debt/Total Capital Shareholders Equity/Total Capital WACC DCF value FY'11 Target Price (rolled six month forward at WACC)
2.2% 32.0% 12.5% 0.71 5.0% 23% 77% 14.2% N59.55 N64.15
4 six month exponential weighted average of 20 year bond yields adjusted quarterly Rating Our revised DCF-based valuation for Julius Berger gives a target price of N64.15 which implies a potential return of 15% relative to the companys current price of N55.71 Hence we maintain an "Accumulate" rating on Julius Bergers shares.
Our revised target price for Julius Berger is N64.15 ­ a potential 15% return to its current price; hence we maintain an "Accumulate"
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Appendix 1: financial statements: Actual and Forecasts (N'Mill)
INCOME STATEMENT (N'Mill) Turnover Cost of Sales Gross Profit Operating Expenses Core Operating Profit EBITDA Depreciation & Amortization EBIT/Operating Profit Interest Payable & Charges Profit Before Taxation Taxation Profit After Taxation
2,007 79,074 (66,243) 12,831 (4,435) 8,396 8,748 (5,595) 3,152 3,152 (1,384) 1,768
2,008 114,029 (96,786) 17,243 (5,610) 11,632 12,736 (6,922) 5,814 (573) 5,241 (2,733) 2,508
2,009 150,358 (123,102) 27,256 (6,437) 20,819 23,169 (12,977) 10,192 (747) 9,444 (6,144) 3,300
2010 E 160,282 (131,431) 28,851 (5,802) 23,048 23,048 (11,932) 11,117 (1,983) 9,134 (4,859) 4,275
BALANCE SHEET (N'Mill) Fixed Assets Long Term Investments Inventories Debtors Bank and cash balances Other Receivables and Current Assets Total Current Assets TOTAL ASSETS Creditors & Accruals Other Creditors Short Term Loan Taxation Total Current Liabilities Long-Term Loans Provision for Gratuity Total Non-Current Liabilities TOTAL LIABILITIES Net Assets
2,007 24,000 5,684 9,901 30,873 3,947 14,149 58,870 180,982 1,929 74,640 118 1,389 78,076 3,975 3,975 176,865 4,117
2,008 28,574 12,146 45,171 22,844 29,694 109,854 207,274 5,334 114,530 4,290 2,184 126,338 4,582 4,582 201,638 5,635
2,009 48,689 2,000 15,222 47,083 9,047 32,659 104,012 235,954 4,046 119,880 8,094 3,954 135,974 3,569 6,304 9,874 229,310 6,644
2010 F 57,949 2,000 17,463 58,754 12,633 32,183 121,033 278,012 3,896 146,691 6,307 4,859 161,753 5,593 4,250 9,843 270,183 7,829
2011 F 184,324
2012 F 221,189
(149,671) 34,653 (6,673) 27,980 27,980 (16,601) 11,379 (1,428) 9,951 (3,184) 6,767
(180,822) 40,367 (8,007) 32,360 32,360 (20,151) 12,209 12,209 (3,907) 8,302
2011 F 67,579 2,000 19,887 67,567 13,229 37,011 137,695 350,103 4,480 168,695 7,041 3,184 183,400 2,937 9,825 12,762 341,644 8,458
2012 F 78,881 2,000 24,026 81,081 5,553 44,413 155,072 395,816 5,376 202,434 7,501 3,907 219,217 2,379 2,379 386,362 9,454
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Appendix 2: Financial Statements: Actual and Forecasts (USD Mill)
INCOME STATEMENT (USD'Mill) Turnover Cost of Sales Gross Profit Distr. & Admni Expenses Core Operating Profit EBITDA Depreciation & Amortization EBIT/Operating Profit Interest Payable & Charges Profit Before Taxation Taxation Profit After Taxation
2,007 672 (563) 109 (38) 71 74 (48) 27 0 27 (12) 15
2,008 916 (777) 138 (45) 93 102 (56) 47 (5) 42 (22) 20
2,009 1,021 (836) 185 (44) 141 157 (88) 69 (5) 64 (42) 22
2010 F 1,034 (848) 186 (37) 149 149 (77) 72 (13) 59 (31) 28
2011 F 1,189 (966) 224 (43) 181 181 (107) 73 (9) 64 (21) 44
2012 F 1,427 (1,167) 260 (52) 209 209 (130) 79 0 79 (25) 54
BALANCE SHEET (USD'Mill) Non-Current Assets Fixed Assets Long Term Investments Inventories Debtors Bank and cash balances Other Receivables and Current Assets Total Current Assets TOTAL ASSETS Creditors & Accruals Other Creditors Short Term Loan Taxation Total Current Liabilities Long-Term Loans Provision for Gratuity Total Non-Current Liabilities TOTAL LIABILITIES Net Assets
2,007
2,008
2,009
2010 F
2011 F
2012 F
204 48 84 263 34 120 501 1,539 16 635 1 12 664 0 34 34 1,504 35
229 0 98 363 183 238 882 1,664 43 920 34 18 1,014 0 37 37 1,619 45
331 14 103 320 61 222 706 1,602 27 814 55 27 923 24 43 67 1,557 45
374 13 113 379 82 208 781 1,794 25 946 41 31 1,044 36 27 64 1,743 51
436 13 128 436 85 239 888 2,259 29 1,088 45 21 1,183 19 63 82 2,204 55
509 13 155 523 36 287 1,000 2,554 35 1,306 48 25 1,414 0 15 15 2,493 61
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Appendix 3: Financial Ratios ­ Actual and Forecasts
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RATIOS Growth Turnover growth EBITDA Growth PBT Growth PAT Growth Liquidity Ratios (x) Current Ratio Quick Ratio Cash Ratio Days in receivables Days in payables Profitability Return on Average Equity Return on Average Assets EBITDA Margin EBIT Margin PBT Margin PAT Margin Per Share Data Earnings Per Share Dividend Per Share Net Assets Per Share Sales Per Share Valuation Multiples P/E (x) P/B (x) Dividend Yield (%) EV/EBITDA (x)
2007 39.0% 13.1% 182.8% 6008.9% 0.8 0.6 0.1 116.6 25.3 36.3% 2.0% 11.1% 3.6% 4.0% 2.2% 1.5 1.3 4.7 65.9 37.8 11.9 2.2 7.9
2008 44.2% 45.6% 66.2% 41.8% 0.9 0.7 0.2 121.7 13.4 40.9% 2.2% 11.2% 4.0% 4.6% 2.2% 2.1 1.8 5.5 95.0 26.7 10.1 3.1 5.5
2009 31.9% 81.9% 80.2% 31.6%
2010 E 6.6% -0.5% -3.3% 29.5%
0.8 0.6 0.1 112.0 13.6
0.7 0.6 0.1 120.5 10.8
45.6% 2.3% 15.4% 5.1% 6.3% 2.2% 2.7 2.4 6.5 125.3 20.3 8.5 4.3 3.0
52.5% 2.5% 14.4% 6.8% 5.7% 2.7% 3.6 3.0 7.0 133.6 15.6 7.9 5.5 3.0
2011 E 15.0% 21.4% 8.9% 58.3% 0.8 0.6 0.1 125.1 10.0 75.6% 3.5% 15.2% 6.9% 5.4% 3.7% 5.6 4.8 7.9 153.6 9.9 7.1 8.6 2.5
2012 E 0.2 0.2 0.2 0.2 0.7 0.6 0.0 122.6 9.7 82.5% 3.7% 14.6% 6.2% 5.5% 3.8% 6.9 5.9 8.9 184.3 7.7 6.2 11.1 2.1
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INVESTMENT RATINGS Vetiva uses a 5-tier ratings system for stocks under coverage: Buy, Accumulate, Neutral, Reduce and Sell. Buy +25.00% expected absolute price performance Accumulate +10.00% to +24.99% expected absolute price performance Neutral +5.00/+9.99% range expected absolute price performance Reduce -5.00% to +4.99% expected absolute price performance Sell < -5.00% expected absolute price performance Definition of Ratings Buy rating refers to stocks that are highly undervalued but with strong fundamentals and where potential return in excess of or equal to 25.00% is expected to be realized between the current price and analysts target price. Accumulate rating refers to stocks that are undervalued but with good fundamentals and where potential return of between 10.00% and 24.99% is expected to be realized between the current price and analysts target price. Neutral rating refers to stocks that are correctly valued with little upside or downside where potential return of between +5.00 and+9.99% is expected to be realized between current price and analysts target price. Reduce rating refers to stocks that are overvalued but with good or weakening fundamentals and where potential return of between -5% and -+4.99% is expected to be realized between current price and analysts target price. Sell rating refers to stocks that are highly overvalued but with weak fundamentals and where potential return in excess less than -5% is expected to be realized between current price and analysts target price.
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CONTACTS
Nigeria
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Vetiva Research Pabina Yinkere Adedayo Idowu Adedoyin Adelakun Abiola Rasaq Tosin Oluwakiyesi Olamidun Laniyan
Email
Head, Research
[email protected]
Analyst, Macro & Fixed Income [email protected]
Analyst, Consumer (Food & Beverages)
[email protected]
Analyst, Banking & Insurance [email protected]
Analyst, Cement & Construction [email protected]
Analyst, Consumer (Breweries, [email protected] Conglomerates)
Vetiva Wealth Management Damilola Ajayi sales @ Vetiva
Head, Wealth Management
[email protected] [email protected]
For further details, kindly contact Vetiva Capital Management Limited Plot 266B Kofo Abayomi Street Victoria Island Lagos, Nigeria Tel: +234-1-4617521-3 Fax: +234-1-4617524 Email: [email protected] [email protected]
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DISCLOSURES SECTION Analyst Certification The research analysts who prepared this report certify as follows: 1. That all of the views expressed in this report articulate the research analyst(s) independent views/opinions regarding the companies, securities, industries or markets discussed in this report. 2. That the research analyst(s) compensation or remuneration is in no way connected (either directly or indirectly) to the specific recommendations, estimates or opinions expressed in this report. Other Disclosures Vetiva Capital Management Limited or any of its affiliates (collectively "Vetiva") may have financial or beneficial interest in securities or related investments discussed in this report, potentially giving rise to a conflict of interest which could affect the objectivity of this report. Material interests which Vetiva may have in companies or securities discussed in this report are herein disclosed: Vetiva may own shares of the company/subject covered in this research report. Vetiva does or may seek to do business with the company/subject of this research report Vetiva may be or may seek to be a market maker for the company which is the subject of this research report Vetiva or any of its officers may be or may seek to be a director in the company which is the subject of this research report Vetiva may be likely recipient of financial or other material benefits from the company/subject of this research report. Disclaimer This research report is based on public information which the research analyst(s) consider credible and reliable. Facts and views presented in this material have not been reviewed by, and may not reflect information known to, professionals in other business areas of Vetiva, including the investment banking team, as Vetiva has established information barriers between its Research team and certain business groups. Whilst reasonable care has been taken in preparing this document, no responsibility or liability is accepted either by Vetiva, its officers or any of its employees for any error of fact or opinion expressed herein. No reliance should be placed on the accuracy, fairness or completeness of the information contained in this report as it has not been verified by the research analyst(s) involved or the companies whose securities have been referred to except as otherwise disclosed. Neither Vetiva nor any of its officers or employees including the research analyst (s) warrant or represent the accuracy or completeness of information set out in this report. Any ratings, forecasts, estimates and opinions set forth in this report constitute the analyst(s) position as at the date of this report and may not necessarily be so after the report date as they are subject to change without notice. It is also instructive to note that a companys past performance is not necessarily indicative of its future performance as estimates are based on assumptions that may or may not be realized. The value, price or income from investments mentioned in this report may fall as well as rise due to economic conditions, industry cycles, market indices, operational or financial conditions of companies or other factors. Thus, Vetiva and its officers and employees shall not accept liability for any loss arising from the use of this report or its contents in making investment decisions or recommendations. This report provides General Information only. It is not intended to provide personal investment advice and does not take into account the specific investment objectives, financial situation and the particular needs of any specific person. Investments discussed in this report may not be suitable for all investors and the reader(s) should independently determine their suitability and evaluate the investment risks associated with such investments.
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