Building up their hopes
The building industry begins 2003 in what the aviation industry would describe as a "stall profile." The question is, what comes next, a sharp dive to earth, or the industry's motors spluttering back into life for a sharp pull out from recession?
Construction has been on hold, in terms of growth, since the end of 2000. The dynamism which drove the industry all through the 1990s fell prey to a number of factors: more expensive money, gradually faltering FDI and new privatisations, investor uncertainties about the economy among them. What had been star performers on the WSE turned into black holes, as some quoted construction firms reported evaporating profits. Shares in Mostostal Gdańsk, to take one bleak example, slumped 94%, though Mostostal Warszawa, drawing on the buoyant capital market, pleased investors by going ahead 25%.
Yet, the underlying uncertainty about the industry's prospects is such that most investors are placing their funds elsewhere, at least until there are positive signs of recovery. There are two principal scenarios for the coming year. One suggests that the tonic of approaching EU membership will end the wait-and-see mood among prospective investors from abroad, who will regard accession as a major risk reduction. The other, more negative, vision suggests that the industry may have to make do with approvals already in the pipeline, rather than anticipate a fast take-off from recession. This inevitably will mean that many of the smaller firms, and a lot of sub-contractors, will go to the wall.
At Kredyt Bank, analyst Dariusz Jacak thinks there might be some credibility in an EU-driven boost to the industry, in terms of potentially lucrative infrastructure and environment-related projects, with the catch that tender procedures tend to be aimed at larger, foreign-owned outfits. This would favour companies such as Mostostal Warszawa, Acciona and Skanska, backed as they are by foreign capital.
"But we can't expect a sudden revolution in the industry," Jacak said. "If you break it up into sectors, the residential industry should anticipate little change, although the mortgage system is already up and running. People are uncertain about their economic status and that does not encourage them to make long-term investments.
"Mortgage loans have been becoming more popular and are characterised by the highest increase among bank loans. I do not think we can anticipate a boom here."
Jacak predicted that modest growth would feed through into the office sector during the second half of the year, with the proviso that banks, which traditionally stimulate construction, had become reluctant to invest. General stagnation in the market would unquestionably threaten many small builders with bankruptcy, with delays in payments one of the major factors.
Peter Gage Morris, managing director of Ober-Haus real estate agency, presents a picture of mixed prospects. The sluggish economy and overall business caution has slowed office building and maintained downward pressure on rents, with class A facilities down €2, at €24 per square metre. But there is still strong corporate demand due to the perception of Warsaw as the region's "first city." Agnieska Jachowicz at DTZ Zadelhoff Tie Leung agrees.
"What lures the institutional investors to Poland is the fact that yields are still higher by 1%-2% than those in Prague and Budapest," she said.
And she is bullish that new players will enliven the Warsaw market, with no shortage of investors for quality projects. "Investors are also looking at markets outside Warsaw which are not as well developed but bring in higher returns," she said. Jachowicz cited Kraków, Wrocław and Poznań as the most favoured cities, with some interesting transactions in Szczecin and Lublin.
From the perspective of Budimex, there are few optimistic signs. Spokesman Waldemar Mierzwa sees no indications of recovery.
"We are not expecting an improvement," he said. "On the contrary, we are expecting our income to decrease." The group's portfolio is about 60% full, and the company anticipates income from infrastructure and road building will climb 10% to account for half the total order book, with growth appearing in the second half.
"The tenders are taking place all the time," he said. "Their numbers are likely to increase towards the end of the year, when the funds for infrastructure expansion will appear."
Budimex is on line with warnings that construction is now a question of survival of the fittest, which means only companies with significant foreign capital are likely to survive on the market. The largest Polish firms had already been taken over, two of them by Spanish companies, which was itself an immediate consequence of imminent EU accession.
"Without an investor who is financially backed and most of all experienced, it is difficult to imagine existence on the market at the moment," Mierzwa said.
The company conceded that shrinking margins, which are traditionally tight, were turning into a major nightmare for finance directors. The biggest danger to the industry was therefore the appearance of small operators with no signs of a previous track record.
"Companies that enter the market on dumping prices, that is they lower their prices only to get their foot in the door," Mierzwa said, "that is the real danger because companies are facing the problem of profitability of their contracts, even the ones with private ownership."
It's the squeeze on margins more than anything else which has sent most of the quoted companies reeling. Richard Mbewe, chief economist at Warsaw Investment Group (WGI), pointed to other factors, including a tendency by some companies to "put their fingers into too many pies." Other observers agreed and said this had been a prime cause behind the virtual implosion of Pia Piasecki, spelling a warning to others who had made the same mistake.
The drive for cost-cutting among the survivors was intense in order to maintain internal liquidity as well as bid for new contracts.
"Major projects by foreigners, like the Złote Tarasy, won't have problems because in this case, Skanska is a major construction firm," Mbewe said. "One domestic company that's in a good position is Warbud, also Mitex. But some of the Mostostal companies have had trouble."
The fear of hungry predators pouring over the newly open EU borders chills the entire industry. They won't only appear from the west, according to Mbewe. He expects not only Czech and Hungarian companies, but also firms from "Estonia and Latvia if they feel they can do the job." Such companies would have other advantages over the home firms already on the plot. "They will have a distinct advantage, especially if they pay taxes in their own countries, since they are then subject to non-double taxation policies," he said. "They will also have an advantage if they decide to employ their own people, because if they employ Poles, they'd have to pay ZUS, which is a big cost here."
The vice president of one major firm, who asked not to be named, shared the alarm over dumping prices. "There is stagnation on the market; residential sales are not as high as we expected," he said. "Everyone is fighting for the few contracts that are up for grabs on the market. And some are resorting to using dumping prices."
The view that the good times may be over, or at least the boom times, was echoed by another analyst who declared that the "entire construction industry hinges not on government support but on banks which already now dictate conditions on the market, and ultimately everything depends on the loan potential of individual companies, as well as the entire society."
Figures by Polish Market Review suggest that in the first three quarters of 2002, construction by larger firms (defined as more than nine employees) fell almost 10% compared with the same period in 2001. And the value of sales similarly slumped by the same figure. The net profitability of the industry fell 2.9% - no wonder the worry about costs and dumping. But the most worrying indicator was the parallel fall in the level of capital investment, at 11.9%. These are the figures which illustrate how much ground the industry needs to recover before it can safely set aside the mood of recession.
Mbewe at WGI thinks most of the western European institutions interested in Poland are already here or in the process of setting up. These are largely investors taking on major structures, such as shopping malls and hotels. Yet he feels that the EU may be a sufficient tonic to spur growth of 15% this year over 2000, when the fall in activity first began to bite. Most other observers dismissed this as far too optimistic, on the grounds there were still too many imponderables surrounding the issues of EU membership.
The industry's growth has been fuelled almost entirely by the dynamics of Warsaw. Accession was considered by most experts to favour the provinces nearest the western border, and especially Wrocław, already acting as a powerful magnet to inward investors with the benefit of good links to Germany. But Mbewe tipped Silesia as the region to watch, despite the unstoppable declines in smokestack industries such as mining and metals.
"Once the government embarks on a plan to revitalise the area, then you can expect a real construction boom," he said. The same effect would not work to the advantage of the Tri-City region, despite being on the waterfront facing Scandinavia. It was because there were no major firms in the area which needed new office blocks.
Structural factors which the industry cannot itself resolve are another impediment to escaping the recession trap. These include the country's antique system of usufruct, the law of leasehold over 99 years which as often as not has the land and the structures standing on it in different hands. The arrangement makes many potential investors queasy, and one beneficial consequence of EU accession may be the start of a massive lobbying campaign for change.
Almost everyone contacted by the Business Journal had something to say about the contemporary deficiency in financing mechanisms. The present method of financing, largely at bank risk, had the effect of making both office and apartment rentals much too expensive, so that a low cost economy ended up with a high rental market - at least in Warsaw. One path suggested by Warsaw Investment Group was the greater employment of escrow accounts, where a client's money would find a safe home against investment by the banks or other financial players. The lack of there being any major institutional participants, such as the pension funds in western markets, willing to pump money into building was frequently cited as another drag effect.
The impact of the EU on infrastructure investment and renewal appears, in the early stages at least, to be the one positive benefit the industry may expect from accession. Grzegorz Trawiński, head of Eurohypo's local representative office, sees the country as a major beneficiary, particularly since there are hardly any expressways to speak of as well as a huge backlog in the maintenance of ordinary highways. Such spending would also have the tonic effect of shifting useful spending away from the gravitational pull of Warsaw. But the amount of cream spread in this fashion would not be equal everywhere.
"It will depend upon the attractiveness of the region and the positive approach of the gminas towards investors," he said. Summed up, as little bureaucratic shilly-shallying and obstructionism as possible, please.
The question of Polish firms scouting for work abroad attracts a wide range of responses. About half the respondents suggested that a concentration by mergers on the home market was certain to come first. One analyst unwilling to be named indicated that although Polish companies had foreign expertise, they had acquired it mostly in other regional markets in North Africa and the Middle East.
"There are issues of the ability to deliver quality, which will require attention first," he said. "Under EU laws, firms will have to construct to, shall we say, more demanding standards. But in theory, there is nothing against it."
Mbewe of WGI thinks that local builders would also find more natural targets in neighbouring Central European countries. And Jerzy Binkiewicz, managing director of Strabag, assigns quality to the top of the mast. It is the one area where no responsible company would make cuts, he said, pointing out that putting mistakes right is an exercise which hits straight at the bottom line.
In any event, there are going to be a lot fewer builders in the near future. The Central Statistical Office (GUS) has figures which suggest there are 323,393 companies on the market, supposedly with fewer than 10 employees each, but the majority are one- or two-man shows registered for contract advantages and dependent on the big players.
Construction has been on hold, in terms of growth, since the end of 2000. The dynamism which drove the industry all through the 1990s fell prey to a number of factors: more expensive money, gradually faltering FDI and new privatisations, investor uncertainties about the economy among them. What had been star performers on the WSE turned into black holes, as some quoted construction firms reported evaporating profits. Shares in Mostostal Gdańsk, to take one bleak example, slumped 94%, though Mostostal Warszawa, drawing on the buoyant capital market, pleased investors by going ahead 25%.
Yet, the underlying uncertainty about the industry's prospects is such that most investors are placing their funds elsewhere, at least until there are positive signs of recovery. There are two principal scenarios for the coming year. One suggests that the tonic of approaching EU membership will end the wait-and-see mood among prospective investors from abroad, who will regard accession as a major risk reduction. The other, more negative, vision suggests that the industry may have to make do with approvals already in the pipeline, rather than anticipate a fast take-off from recession. This inevitably will mean that many of the smaller firms, and a lot of sub-contractors, will go to the wall.
At Kredyt Bank, analyst Dariusz Jacak thinks there might be some credibility in an EU-driven boost to the industry, in terms of potentially lucrative infrastructure and environment-related projects, with the catch that tender procedures tend to be aimed at larger, foreign-owned outfits. This would favour companies such as Mostostal Warszawa, Acciona and Skanska, backed as they are by foreign capital.
"But we can't expect a sudden revolution in the industry," Jacak said. "If you break it up into sectors, the residential industry should anticipate little change, although the mortgage system is already up and running. People are uncertain about their economic status and that does not encourage them to make long-term investments.
"Mortgage loans have been becoming more popular and are characterised by the highest increase among bank loans. I do not think we can anticipate a boom here."
Jacak predicted that modest growth would feed through into the office sector during the second half of the year, with the proviso that banks, which traditionally stimulate construction, had become reluctant to invest. General stagnation in the market would unquestionably threaten many small builders with bankruptcy, with delays in payments one of the major factors.
Peter Gage Morris, managing director of Ober-Haus real estate agency, presents a picture of mixed prospects. The sluggish economy and overall business caution has slowed office building and maintained downward pressure on rents, with class A facilities down €2, at €24 per square metre. But there is still strong corporate demand due to the perception of Warsaw as the region's "first city." Agnieska Jachowicz at DTZ Zadelhoff Tie Leung agrees.
"What lures the institutional investors to Poland is the fact that yields are still higher by 1%-2% than those in Prague and Budapest," she said.
And she is bullish that new players will enliven the Warsaw market, with no shortage of investors for quality projects. "Investors are also looking at markets outside Warsaw which are not as well developed but bring in higher returns," she said. Jachowicz cited Kraków, Wrocław and Poznań as the most favoured cities, with some interesting transactions in Szczecin and Lublin.
From the perspective of Budimex, there are few optimistic signs. Spokesman Waldemar Mierzwa sees no indications of recovery.
"We are not expecting an improvement," he said. "On the contrary, we are expecting our income to decrease." The group's portfolio is about 60% full, and the company anticipates income from infrastructure and road building will climb 10% to account for half the total order book, with growth appearing in the second half.
"The tenders are taking place all the time," he said. "Their numbers are likely to increase towards the end of the year, when the funds for infrastructure expansion will appear."
Budimex is on line with warnings that construction is now a question of survival of the fittest, which means only companies with significant foreign capital are likely to survive on the market. The largest Polish firms had already been taken over, two of them by Spanish companies, which was itself an immediate consequence of imminent EU accession.
"Without an investor who is financially backed and most of all experienced, it is difficult to imagine existence on the market at the moment," Mierzwa said.
The company conceded that shrinking margins, which are traditionally tight, were turning into a major nightmare for finance directors. The biggest danger to the industry was therefore the appearance of small operators with no signs of a previous track record.
"Companies that enter the market on dumping prices, that is they lower their prices only to get their foot in the door," Mierzwa said, "that is the real danger because companies are facing the problem of profitability of their contracts, even the ones with private ownership."
It's the squeeze on margins more than anything else which has sent most of the quoted companies reeling. Richard Mbewe, chief economist at Warsaw Investment Group (WGI), pointed to other factors, including a tendency by some companies to "put their fingers into too many pies." Other observers agreed and said this had been a prime cause behind the virtual implosion of Pia Piasecki, spelling a warning to others who had made the same mistake.
The drive for cost-cutting among the survivors was intense in order to maintain internal liquidity as well as bid for new contracts.
"Major projects by foreigners, like the Złote Tarasy, won't have problems because in this case, Skanska is a major construction firm," Mbewe said. "One domestic company that's in a good position is Warbud, also Mitex. But some of the Mostostal companies have had trouble."
The fear of hungry predators pouring over the newly open EU borders chills the entire industry. They won't only appear from the west, according to Mbewe. He expects not only Czech and Hungarian companies, but also firms from "Estonia and Latvia if they feel they can do the job." Such companies would have other advantages over the home firms already on the plot. "They will have a distinct advantage, especially if they pay taxes in their own countries, since they are then subject to non-double taxation policies," he said. "They will also have an advantage if they decide to employ their own people, because if they employ Poles, they'd have to pay ZUS, which is a big cost here."
The vice president of one major firm, who asked not to be named, shared the alarm over dumping prices. "There is stagnation on the market; residential sales are not as high as we expected," he said. "Everyone is fighting for the few contracts that are up for grabs on the market. And some are resorting to using dumping prices."
The view that the good times may be over, or at least the boom times, was echoed by another analyst who declared that the "entire construction industry hinges not on government support but on banks which already now dictate conditions on the market, and ultimately everything depends on the loan potential of individual companies, as well as the entire society."
Figures by Polish Market Review suggest that in the first three quarters of 2002, construction by larger firms (defined as more than nine employees) fell almost 10% compared with the same period in 2001. And the value of sales similarly slumped by the same figure. The net profitability of the industry fell 2.9% - no wonder the worry about costs and dumping. But the most worrying indicator was the parallel fall in the level of capital investment, at 11.9%. These are the figures which illustrate how much ground the industry needs to recover before it can safely set aside the mood of recession.
Mbewe at WGI thinks most of the western European institutions interested in Poland are already here or in the process of setting up. These are largely investors taking on major structures, such as shopping malls and hotels. Yet he feels that the EU may be a sufficient tonic to spur growth of 15% this year over 2000, when the fall in activity first began to bite. Most other observers dismissed this as far too optimistic, on the grounds there were still too many imponderables surrounding the issues of EU membership.
The industry's growth has been fuelled almost entirely by the dynamics of Warsaw. Accession was considered by most experts to favour the provinces nearest the western border, and especially Wrocław, already acting as a powerful magnet to inward investors with the benefit of good links to Germany. But Mbewe tipped Silesia as the region to watch, despite the unstoppable declines in smokestack industries such as mining and metals.
"Once the government embarks on a plan to revitalise the area, then you can expect a real construction boom," he said. The same effect would not work to the advantage of the Tri-City region, despite being on the waterfront facing Scandinavia. It was because there were no major firms in the area which needed new office blocks.
Structural factors which the industry cannot itself resolve are another impediment to escaping the recession trap. These include the country's antique system of usufruct, the law of leasehold over 99 years which as often as not has the land and the structures standing on it in different hands. The arrangement makes many potential investors queasy, and one beneficial consequence of EU accession may be the start of a massive lobbying campaign for change.
Almost everyone contacted by the Business Journal had something to say about the contemporary deficiency in financing mechanisms. The present method of financing, largely at bank risk, had the effect of making both office and apartment rentals much too expensive, so that a low cost economy ended up with a high rental market - at least in Warsaw. One path suggested by Warsaw Investment Group was the greater employment of escrow accounts, where a client's money would find a safe home against investment by the banks or other financial players. The lack of there being any major institutional participants, such as the pension funds in western markets, willing to pump money into building was frequently cited as another drag effect.
The impact of the EU on infrastructure investment and renewal appears, in the early stages at least, to be the one positive benefit the industry may expect from accession. Grzegorz Trawiński, head of Eurohypo's local representative office, sees the country as a major beneficiary, particularly since there are hardly any expressways to speak of as well as a huge backlog in the maintenance of ordinary highways. Such spending would also have the tonic effect of shifting useful spending away from the gravitational pull of Warsaw. But the amount of cream spread in this fashion would not be equal everywhere.
"It will depend upon the attractiveness of the region and the positive approach of the gminas towards investors," he said. Summed up, as little bureaucratic shilly-shallying and obstructionism as possible, please.
The question of Polish firms scouting for work abroad attracts a wide range of responses. About half the respondents suggested that a concentration by mergers on the home market was certain to come first. One analyst unwilling to be named indicated that although Polish companies had foreign expertise, they had acquired it mostly in other regional markets in North Africa and the Middle East.
"There are issues of the ability to deliver quality, which will require attention first," he said. "Under EU laws, firms will have to construct to, shall we say, more demanding standards. But in theory, there is nothing against it."
Mbewe of WGI thinks that local builders would also find more natural targets in neighbouring Central European countries. And Jerzy Binkiewicz, managing director of Strabag, assigns quality to the top of the mast. It is the one area where no responsible company would make cuts, he said, pointing out that putting mistakes right is an exercise which hits straight at the bottom line.
In any event, there are going to be a lot fewer builders in the near future. The Central Statistical Office (GUS) has figures which suggest there are 323,393 companies on the market, supposedly with fewer than 10 employees each, but the majority are one- or two-man shows registered for contract advantages and dependent on the big players.
