Complex Made Simple

Building bridges

The Saudi Investment Authority is looking to invest US$750 million in an infrastructure fund for development in India. What does this mean for GCC efforts to grow the construction industry beyond the Arabian Peninsula?
By Jay Akasie

One of the truisms of investing is to follow the money. When it comes to the Middle East, the benefits of high crude oil prices trickle down to many industries, not the least of which is construction. In recent years, these high prices have translated into impressive spending programs on highways, railways and – in the case of Saudi Arabia – even an entire university.

That’s why allocating a portion of any investment portfolio to stocks of publicly traded construction companies based in the Gulf region is a safe bet. Better still is that many of these companies are branching out beyond the Arabian Sea and attempting to take advantage of the coming infrastructure boom in South Asia. Investors bullish on the construction industry in the developing world are fond of pointing out that the last mile of rail laid in the entire Indian subcontinent was in 1947 – the year the British left.

It’s no wonder, then, that Saudi Arabia is looking to invest some US$750 million in a joint fund aimed at improving infrastructure in India, with an emphasis on hydrocarbon production and refineries. The construction giants of the Gulf Cooperation Council know that the best remedy to a slumping real estate market at home is lucrative business abroad. Especially in a country with such a great demand for new infrastructure development like India – the world’s second-fastest growing economy and soon to be the world’s largest country by population.

According to the Saudi Arabian Monetary Agency, Saudi Arabia is India’s fourth-largest trading partner; trade between the two countries surpassed US$25 billion last year alone. Although Saudi Arabia is the 11th-largest market in the world for Indian exports, it’s the source of only 5.51 per cent of India’s global imports. India is the fifth-largest market for Saudi’s exports. There’s a lot of room for expansion.

Add to this scenario the fact that the eurozone continues to be a huge economic liability. Each time Europe’s finance ministers come up with a plan to prevent that continent from collapsing, its socialist economies go back to their free-spending ways and another, larger disaster looms on the horizon. For a modern and nimble construction sector like Saudi Arabia’s, who needs Europe?

To be sure, GCC investors remain bullish on the eurozone’s luxury real estate. The National Bank of Kuwait, for instance, has opened a real estate office in London focused entirely on servicing clients with investments there. “NBK London aims at making all real estate services more convenient,” the chief executive officer of NBK London, Fawzi Dajani, says. “In a simple and straightforward procedure, customers can now buy and sell, lease or rent, settle bills, receive real estate assessments and many other services with our competitive prices. We finance up to 70 percent of the value of the property which will be held as security.”

But India – and not Europe – is where the construction activity will be for GCC firms. Arab investors have always favored real estate as an investment over all other asset classes. But with the eurozone’s economy continuing to slump and India providing an enormous and virtually untapped market, construction and infrastructure investments are the way of the future for the sophisticated GCC investor.

According to a recent survey by the Indian Federation of Chambers of Commerce and Industry, 53 percent of Indian companies in the poll said they have been “adversely impacted” by the continuing European economic crisis. Some three quarters of companies said European stagnation has cost them up to 15 percent of their business generation. As a result, more than 30 percent of those surveyed said they are looking past the eurozone with a key eye on the MENA region and even North America.

Most of India’s states are larger than most European countries. And they hold a lot more economic promise as well. Saudi’s US$750 million investment is just the tip of an economic iceberg. “India needs an investment of close to a trillion dollars in the next five to seven years to build and expand its existing infrastructure to be able to sustain a GDP growth rate of 8 and 9 percent,” Indian finance minister Pranab Mukherjee said in New Dehli at the beginning of the year to a Saudi Arabian delegation, which included commerce minister Tawfeeq bin Fouzan al Rabea.

Particularly important for Saudi Arabia is the enormous Indian demand for energy. “India would be happy to participate in the exploration and production activities with Saudi Arabia in our two countries and also in third countries. India has national plans to build refineries and petrochemical projects,” Mukherjee said.

Indeed, a recent Bank of America-Merrill Lynch analysis of the Middle East-North Africa construction sector says that Saudi Arabia’s booming industry is a relatively inexpensive investment play. Consider this: Saudi Arabia accounts for neatly half of the Mena project pipeline — a construction project valued at US$401 billion. In fact, Merrill Lynch analysts recommend even non-Saudi companies with exposure to that country’s booming construction sector.

That includes United Arab Emirates-based DSI, which has 54 percent of its total backlog exposed to the Saudi Arabian market, according to Merrill Lynch. Other factors that make the company an attractive investment are its healthy balance sheet (AED97 million, or US$26.4 million, of net cash), strong revenue growth (management expects 25 percent in 2012) and the fact that stock trades at a 29 percent discount to its MENA peers, according to a recent Merrill Lynch report.

Saudi giant Al-Khodari is another construction company to watch. The firm’s management says it expects new contract awards to double this year, translating into SAR2 billion (US$533.3 million).

“Al-Khodari has the highest profitability within the Mena construction space,” says the Merrill Lynch analysis. “Management expects contracting gross margins to remain in the 19 to 23 percent range in the medium term. This is higher than peers DSI (14.7 percent) and Arabtec (12.1 percent).”

In all, Merrill expects Saudi Arabia’s economy to grow at a 5 percent pace this year. Although that’s not as rapid as India, it’s clearly robust compared to the ailing economies of Europe. That’s another reason why the construction giants of Saudi Arabia and the rest of the GCC view their massive neighbor across the Arabian sea as a good extension of their industry. The relationship between the GCC and India is symbiotic because of the subcontinent’s rising demand for oil and services, as well as the infrastructure that provides those services. And with the price of oil remaining high, the GCC’s economies remain robust.

“Discharged cargos of construction goods are above their 2008 average levels, while Japanese exports of construction services have picked up noticeably, which bodes well for construction activity,” according to a Bank of America Merrill Lynch study. “The credit environment has improved with continued signs of a pick-up in private sector growth. liquidity is adequate, interbank rates remain low although they have increased moderately since October due to a back-up in LIBOR and on the back of regional tensions. Banks have continued to draw down their excess reserves in 2012 after a large reversal late 2011. Credit to the private sector was up by 12.1 percent in February, the highest since April 2009. Nevertheless, credit by specialized funds continues to be made available, and is likely to accelerate in 2012 on the back of the large capital injections into real estate, credit funds or the housing authority in our view.”

Rapid urbanization is what’s behind much of India’s heightened demand for construction services. A recent Dun & Bradstreet analysis stated that respondents to a company survey said they expect domestic demand and rapid urbanization to be the key factors driving construction industry growth this year. “With a score of 0.77 and 0.72 respectively, these two demand drivers have received the highest rankings among the major industry growth drivers,” according to D&B.

But challenges do lie ahead. According to the economic survey, construction firms continue to face the unpredictability of the commodity markets. “The industry expects rising raw material prices to be the most critical challenge,” according to Dun & Bradstreet. “The industry also expects rising fuel transportation costs to be another major challenge facing the industry. Rising market competition and financing of business operations have emerged as the other major anticipated challenges.”

Indeed, investment in infrastructure accounts for nearly 12 percent of India’s gross domestic product. And with GCC firms better suited to deal with the complexities of rising commodity prices, the subcontinent is a natural fit for their expansion. Dubai development giant DAMAC Properties has long invested in India. So have other Emirati firms such as Nakheel and Dubai World, which followed a number of prominent North American private equity and real estate investment companies keen on profiting from India’s infrastructure boom.

So whether it’s that first mile of railway to be built since 1947, or roads, bridges, tunnels, power plants, oil refineries and ports, the promise of the vast and largely untapped Indian marketplace is providing GCC investors with a lucrative investment opportunity for decades to come.