New Govt. circular cements support for local firms in construction industry

• Asia Securities says move to give preference to local firms in Govt. procurement will boost capacity, encourage new players

Asia Securities has said that the Government’s new circular on procurement as exclusively published by Daily FT yesterday will extend strong protection for local firms, encourage capacity expansions and entry of new players. 

The Ministry of Finance recently issued a circular amending the procurement guidelines to further support local industries. (See also http://www.ft.lk/top-story/Boosting-local-industries-Government-walks-the-talk/26-707535) Asia said the guidelines in the circular were in favour of local construction and construction-related-material manufacturers. 

“With the sudden influx in demand driving local manufacturers of construction-related materials to operate at maximum capacity, a key theme we see playing out in the near to medium-term is 1) capacity expansions and 2) welcoming of new players to help cater to the increase in demand, thereby creating more local value addition,” Asia Securities said in an Equity Outlook on the Construction Sector of the Colombo Stock Exchange.

According to the circular, any contract over Rs. 150 million up to Rs. 600 million should exclusively be awarded to local construction companies with CIDA grading of C3 and C2. Further, any contract over Rs. 600 million should be awarded exclusively to local contractors with gradings above C1. 

“We see Access Engineering Plc (AEL) directly benefitting from this given that majority of its specialisations are above C3 grade category. The guidelines are likely to keep foreign contractors away from Government-funded projects and put local construction companies at the forefront,” Asia Securities said. 

Citing other facets of the circular, Asia said other listed companies such as Tokyo Cement, Royal Ceramics, Lanka Tiles, ACL Cables, Kelani Cables, Alumex and Parquet Ceylon stood to benefit. 

For local construction contracts when goods and materials are required under the BOQ, these should be sourced exclusively from domestically manufactured/produced goods/materials.

They are 1. Cement, 2. Reinforcing steel and certain sections of steel angles, 3. Clay bricks, cement blocks and concrete products, 4. Roofing material (clay tiles, cement titles, asbestos, zinc alum, GI), 5. Ceramic and granite tiles, 6. Parquet and wooden flooring, 7. Pantry cupboards and wooden furniture, 8. PVC and UPVC pipes, gutters, down pipes and fittings, 9. Electrical cables LT, 10. Transformers with accessories, 11. Electrical switches and sockets, ceiling fans, 12. Aluminium extrusions, doors and windows, 13. Sliding/roller shutter doors and gates, 14. Plywood doors, wooden doors, fibre glass doors and steel doors including fire rated, 15. Brass iron monger, 16. Paints, 17. Water pumps, foot valves and 18. Electrical panel boards.

Asia said cement capacity expansion was highly likely in the next 12-24 months for Tokyo Cement and unlisted INSEE and new players would be welcomed to cater to higher demand.

“We see cement manufacturers TKYO and INSEE benefiting immensely from the new amendments to support domestic industries. With the local manufacturers offering more than 25% local value addition, we see these players being the top preference for local construction contracts who have been asked to exclusively seek domestic suppliers,” Asia said. 

On the other hand, the entry of Melsta Gama and Lanwa Steel will now be more welcomed to take on the addition demand that the local manufacturers will not have the capacity to take on. Asia sees the lower margin categories being supplied to by the new players, in order to make up for what will be a sharp increase in demand. TKYO and INSEE on the other hand will be moving on to take on the higher margin construction projects.

“We see local cement manufacturers bursting at the seams to cater to the increase in demand. To this regard, we see a capacity expansion for both TKYO and INSEE being fully justified in the next 12-24 period. With our expectation of strong results over the upcoming quarters and debts being paid down, we see more room for debt to accommodate a capacity expansion of up to one million MT p.a., which our channel checks indicate will come at a cost of $ 35-50 m,” Asia said. “As such, we see a very low likelihood of a rights issue to raise funds for expansion,” it added. 

The investment bank also said the new circular offered a much-needed move for the underutilised aluminium extrusion sector.

Local extrusion manufacturers have been operating at 30.0-35.0% of their capacity over the past two years given tepid demand. Furthermore, cheaper sources of extrusion from foreign markets have also led to local contractors sourcing aluminium from abroad for construction projects. 

“With the latest amendments to support domestic firms, we expect domestic construction demand coming to local players ALUM and PARQ to benefit them immensely and help with increased plant utilisation which will help drive scale benefits. We note that imports of aluminium profiles have accounted for 15.0-20.0% of market volumes in the past,” Asia said. 

In terms of tiles, it said capacity expansion and new players would be needed to cater to domestic demand.

“Already operating at maximum capacity with the import bans in play, we see local tile manufacturers RCL and TILE carrying the momentum in the near to medium-term. It is our understanding that local tile manufactures are currently falling short of being able to provide for the current local demand,” Asia said. 

“As such, with the support given to domestic industries, we see tile manufacturers increasing capacity in the next 12-24 months provided the protection for domestic industries remain in place. Furthermore, our conversations with local tile manufacturers suggests an openness and encouragement to welcome other players into the tile industry to support more local value addition,” Asia added.

Largest cable players ACL and KCAB are to benefit the most from the new circular. 

“With electrical cables, electrical switches and sockets, etc. also falling under the protected domestic firms, we see ACL and KCAB, along with its subsidiary companies such as APLA benefitting from their market leader position. We note that ACL and KCAB together account for 70.0% of the cable sector market share,” Asia Securities said. 

In addition to construction companies being given more preference, the circular further goes to note that preference should be given to domestic firms (registered with a relevant authority in Sri Lanka with more than 51% ownership held by Sri Lankan nationals) offering at least 25% local value addition in hardware in terms of manufacturing or assembling categories.