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The construction industry, which is a major cog in the Australian economy, could be under threat from external pressures. Inflationary pressures have pushed up costs these increases are beginning to take their toll on sector. Specifically higher Labour and materials costs have increased pressure on the margins of the large construction companies. Furthermore, as interest rates rise and the housing market decelerates, further stress is being placed on the industry. The threat is not just imaginary, Probuild and Condev both went into voluntary administration as they were unable to maintain their profitability.
The Issue with Construction contracts
Structural issues within the pricing model for many construction companies makes it difficult for them to pass on increased costs. Firstly, contracts are set with a fixed price prior to commencement. Ross McEwan NAB CEO outline that these contracts make it hard to adjust for higher cost of goods. They cannot cope with the ‘shift’ in prices because they do not have the means to adjust the contract. Therefore as the prices of supplies has gone up margins have fallen. Steel prices are 42% higher than last year, timber is 21% higher and electrical products are 14% more expensive for the same period.
Issues to the supply chain have also increased costs. During Covid, disruptions were especially difficult with the procurement of supplies from China. More recently the Russia and Ukraine crisis has caused a supply shock as many crucial materials have been difficult to obtain. Furthermore as the world moves a to a more renewable future supplies for projects in that sector have become critical and the supply is not yet ready to cover the demand.
Pressure on the Housing Market
The housing market and the construction industry are obviously very well linked. With housing prices expected drop due to the increase interest rates this again places pressure on the rest of the market. The general economic conditions are also slowing down growth in home buying which also may cause a slowdown in the constructions sector home prices begin to fall and borrowing reduces. The chart below emphasises how interest in home buying has dropped.
The impact of potential insolvencies and failures of these large construction companies can have disastrous effects on the wider economy. When such large companies go bust they can cause a shock to the economy. The impact of the slow down and construction struggle can be seen in some of the price charts below. Charter Hall Group, (CHC), Lend Lease (LLC) and Scentre Group (SCG) are three of the largest construction companies in Australia.
The price pattern of these charts is fairly similar. All three are clearly in a down trend and have struggled to hold above the key moving averages. Specifically, LLC and SCG, have been unable to break through either the 50 Period MA or the 200 Period MA and instead fell back down. CHC on the other hand has diverged quite a significant distance away from both MAs. In addition, the 50 period MA is accelerating more steeply as it falls.
As there doesn’t seem to be much respite from inflation coming any time soon, these stocks are not showing any signs of a rally in the near term. Potential support to the sector may be provided through government initiatives/infrastructure or a resurgence in foreign investment in property.
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