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China construction sector faces revamp amid slowdown
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as China rebalances toward more sustainable consumption-driven growth, fixed asset investment (FAI) growth will slow significantly, resulting in a sharp drop in the fortunes of less competitive construction-related companies and setting the stage for more rapid consolidation in the sector.
Driven by China’s large population and rapid urbanization, growth in investment has outpaced that of overall GDP for all but two years since 1991 (1997 and 2007). This lifted the share of investment in China’s GDP to 48.1 percent by 2012. Progress has yet to be made in rebalancing the Chinese economy away from investment toward consumption. Investment contributed 4.1 percentage points of the 7.6 percent GDP growth in the first half of 2013, against 3.4 percentage points from consumption. If investment continues to grow faster than GDP, it would soon exceed domestic savings (50.8 percent of GDP in 2012), which is not sustainable. Deceleration in investment growth is inevitable, though the pace may be slow.
When investing activities weaken, revenue and orders will drop across all construction-related sectors and lower the utilization rate of these industries. Lower utilization will depress margins and increase working capital requirements across industries, and marginal players may become unprofitable and even financially vulnerable. This will set the stage for consolidation.
Leading state-owned enterprises are better positioned to be industry consolidators, supported by both their industry leadership and government support, including better access to funding.
Some acquirers are likely to switch part of their expansion capital expenditure to fund transactions at time of weak demand when acquisition costs are lower, so they may expand without adding new capacity to the market. Companies operating with high positive working capital cycles, such as construction machinery manufacturers, will also benefit from releasing cash trapped in working capital.
We believe that any slowdown in Chinese construction sector will accelerate market leaders’ overseas expansion, particularly into other large developing markets like Indonesia, India and Brazil.
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