This article first appeared in The Edge Malaysia Weekly on July 31, 2017 - August 6, 2017

THE construction sector is expected to enjoy another bumper year, riding fat order books that are expected to continue growing. But there may be increasing risks to contractors’ margins — from labour shortages to rising steel prices.

This year alone, Shanghai steel rebar futures have risen 22.5% to RMB3,565 per tonne. Compared with a year ago, the futures are up 44.8%.

Nonetheless, the big boys say the situation is still manageable.

“Rising steel bar prices and labour shortages will affect construction. Fortunately, we [construction companies] have already prepared for it or adapted to it,” Ekovest Bhd managing director Datuk Seri Lim Keng Cheng tells The Edge.

He estimates that the cost of labour has increased by 10% to 20% due to the shortage of foreign labour. But given that labour only makes up 10% of total costs, it hasn’t put undue pressure on the sector.

“That means the overall increase in cost is about 1% to 2%,” he says, noting that Ekovest has not been adversely affected.

IJM Corp Bhd CEO and managing director Datuk Soam Heng Choon expects the labour situation to improve in the near term.

“Now that the Raya season is over, the Indonesian workers should start to come back,” he tells The Edge.

However, he urges the government to ensure that the labour supply is not disrupted given the large number of infrastructure projects in the pipeline.

“A comprehensive plan is needed to address the labour shortage,” he says.

Just like Ekovest’s Lim, Soam is of the view that the current shortage is still manageable. Looking ahead, however, labour shortages are difficult to anticipate. Furthermore, they tend to affect construction companies asymmetrically.

“There is really not much data ... that we can use to predict the labour situation. And even if we could anticipate it, it affects companies very differently. One could face huge problems while another remains unaffected, depending on how they are sourcing their labour. This will continue to be a risk for the industry in the future,” says an analyst at a bank-backed research house.

One project that has been flagged as particularly vulnerable to cost inflation due to foreign labour shortages is Petroliam Nasional Bhd’s Refinery and Petrochemical Integrated Development project in Pengerang, Johor. This is because the project relies heavily on foreign labour, notes the analyst.

That said, not all foreign labour is created equal.

“You would be surprised to find that projects like the mass rapid transit (MRT) pay very well, especially for the underground work. Even for foreign workers. This is because the workers are well trained, justifying the higher pay. Such projects have less trouble sourcing labour,” says the analyst.

In addition, the industry is rapidly adapting to the new reality — that labour is neither abundant nor cheap.

“We cannot rely on cheap labour forever. We have to become more efficient. Rising costs are already forcing us to adapt and develop more sustainable designs. For example, you would notice that more projects these days are not plastering and painting as much as in the past.

“[Plastering and painting] are mainly for cosmetic appearance and do not affect the structure itself. Not only does it save labour costs, it also cuts down on raw materials,” Lim says.

Furthermore, construction companies are beginning to focus on increasing the productivity of their workers. Either by paying more for skilled workers or by investing in technology like industrialised building systems that reduce labour intensity.

Steel price still reasonable

Construction uses two main raw materials — cement and steel. On the one hand, the industry has been enjoying relatively low cement prices.

“There is an oversupply of cement, so contractors have been able to get good prices. Oftentimes, they are able to negotiate lucrative rebates, putting their cost well below the so-called market price. This has helped their margins,” says the analyst.

On the other hand, domestic steel prices have rebounded sharply to about RM2,100 per tonne this year. While this has chipped away at margins, it is still at a tolerable level, say Ekovest’s Lim and IJM’s Soam.

“I believe the rise in steel prices is seasonal. Moving forward, I expect it to be range-bound, it should not pose a problem,” says Soam.

That said, it is interesting to note that some mega projects, such as the second MRT line, are not yet in full swing.

“Steel prices are expected to remain flat for the short term with an upward bias. But some of these projects, like the MRT, are only going to begin steel-intensive work in about six months’ time, exposing them to the prices at that time,” notes the analyst.

However, contractors are not completely exposed to price fluctuations.

“Those working on government contracts should not be badly affected by rising raw material prices. Government contracts come with VoP — variation of price — provisions in the contracts. So the contractors do not bear any risk of cost increases. Even most lump-sum contracts have VoP provisions,” says Lim.

And sometimes, contractors forward-buy steel in bulk to hedge the risk.

“We sign our contracts and steel procurement for the whole project back-to-back,” says Eversendai Corp Bhd chairman and managing director Tan Sri A K Nathan Elumalay.

“We are in the business of construction, not speculation and trading of steel. So we lock in our costs up front,” he says, pointing out that Eversendai has not been affected by the jump in steel prices.

While the same might not be true for smaller contractors, most of the big, listed construction boys appear prepared to handle the rising costs.

Looking ahead, investors should expect robust revenue growth from the construction sector as it draws down record-sized order books.

However, close attention should be paid to factors such as steel and labour that may erode margins.

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