The engineering and construction sector was expected to be red hot in 2018. However, favorable factors like the demand for new housing, need for widespread infrastructure construction, changes in corporate taxes and increases in capital investments were not enough to keep the engineering and construction sector on pace with the broader market.
Engineering and construction (E&C) sector spending in the U.S. was forecast to grow 6 percent in 2018, a 50-percent increase over 2017. However, the sector did not perform as well as expected. One primary reason appears to be the so-called trade war the U.S. started against China, Canada, Mexico and other countries that supply construction goods.
Given the demand, it remains to be seen how much of a long-term impact the current tariff and trade tensions will have. The fundamentals remain in place for the sector in the U.S. and internationally to continue rapid growth through the end of 2018 and beyond, given the estimated $94 trillion in global infrastructure investment needed by 2040.
Key Engineering And Construction Sector Trends
Construction outlooks focus heavily on the pent-up infrastructure demand as well as housing. However, several trends are impacting overall engineering and construction sector results:
- Low oil prices constrain engineering growth. E&C investments have been hindered in the last few years by low oil prices. Oil and gas companies have been reticent to undertake new initiatives requiring major capital outlays. However, with projected increases in oil prices, investments are expected to increase.
- Private investment in private construction is growing. One trend is the increased interest of private equity firms in E&C companies. Investors are driving deals in the design and construction sector; maintenance companies, such as HVAC and refrigeration services; and other sector-related businesses. Merger and acquisition volume has dropped. However, activity is expected to increase, driven by Baby Boomer succession needs. Also, there is a rising interest in employee stock ownership plans (ESOPs). An ownership transfer survey in 2017 indicated 12 percent of owners planned on an ESOP; only 4 percent were considering an ESOP in 2007.
- Contracting is becoming tougher as the market matures. Engineering and construction sector contracting is changing, with movement toward lump-sum, turnkey (LSTK) contracts that require E&C firms to bear more risk on projects. Private and public sector clients are becoming savvier and demanding LSTK contracts. Some companies in the engineering and construction sector are still having difficulty factoring contingency costs into their bids. Another challenge is clients breaking larger initiatives into smaller, discrete elements requiring separate bids and contracts. This precludes E&C firms from subsidizing one aspect of a project with profits from one of their stronger areas. Conversely, a firm adept at a particular phase but weaker at others has a better shot at a deal. All these changes, as well as the growth in PPPs, offer more opportunities for some firms but adds risk to others.
- Consolidation is occurring throughout the sector. The volume of E&C mergers and acquisitions has dropped but is expected to bounce back. One factor is that smaller firms have reduced overhead and costs but may be questioning their future viability as stand-alone entities. Those that want to remain independent simply may not have the resources needed to grow. Both dynamics may lead to further consolidation.
- Capital and private equity growth also fueling acquisitions. Over 20 percent of M&A transactions in the engineering and construction sector last year involved a public company purchaser, the highest level since 2011. This trend is continuing into 2018. Additionally, several public E&C companies completed share buybacks and other equity moves.
- Forecast of growth in U.S. infrastructure (Trump plan). America’s crumbling infrastructure needs considerable work. As noted by the World Bank, “the United States cannot expect to have an “A” economy with “D+” infrastructure.” President Donald Trump announced a plan to create $1.5 trillion for repairing and improving the country’s infrastructure. However, analysts from the University of Pennsylvania’s Wharton School, the President’s alma mater, claim only $200 billion in direct federal investment is accounted for. It remains to be seen how much of the gap in infrastructure spending will be filled by states, local governments or Congress. While the total and timing are uncertain, the forecast for infrastructure spending is positive.
- Interest from China and India in the infrastructure market. With the acute need for infrastructure spending in the U.S. and Canada, international construction giants are looking for business or businesses to acquire here. For example, in 2017, a subsidiary of China Communications Construction Company Limited, the fourth-largest Chinese construction entity, tried to acquire Aecon Group, Inc. The Canadian government blocked the deal citing national security issues. While the White House would presumably take a negative view to deals with Chinese, Korean or Indian firms, many have considerable recent experience with major civil and transportation construction projects at home, where expertise in project management and financing is advantageous. Tariffs and trade wars may affect this, but traditionally foreign companies have been able to capitalize on lower costs.
With increased opportunity and increased competition, engineering and construction sector firms need to make some strategic changes to ensure continued success. The shift to LSTK contracts illustrates the need for companies to improve their capabilities in areas such as estimation and controlling costs.
Understanding their market position is critical for E&C firms to sense the market and remain competitive. Lastly, with internal and foreign competition, scrutinizing costs and looking for ways to improve cost structures, such as using newer technologies for design and procurement, will make them more nimble and efficient.
The E&C industry has changed dramatically requiring corresponding changes in organizations to be able to compete.
Timetric’s Construction Intelligence Center and the U.S. Bureau of Labor Statistics predict that the construction industry will be one of the fastest growing areas into 2020, with real output reaching almost $1.2 trillion by that time. The increased demand for housing and infrastructure spending will enable E&C firms to capitalize on that growth.
Using these insights will enable E&C firms to shape their next three to four years of growth and take advantage of increased construction spending. HJR Global specializes in small business advice and helps to develop strong business strategies for business owners. For more insight on construction trends and methods that business owners can apply to improve their business model, follow our blog. For more information about HJR Global, click here.
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