September 25, 2011 / 2:37 PM / 6 years ago

Construction is a weak bet as economy struggles

VANCOUVER (Reuters) - Canadian construction and engineering stocks have lost about a quarter of their value this year, yet one sector is considered in buying territory while the other is seen at risk of further losses.

After a promising start to the year, investors have soured on both industries as government stimulus funds have dried up, private-sector recovery has lagged and competition has squeezed operating margins. Fears of another global recession only add to the gloom.

But analysts and industry figures note companies providing engineering services tend to work on far more projects at any one time than construction companies do, spreading their risk.

They also tend to get higher-margin work and generally pay richer dividends than the construction companies that actually do the bricks and mortar work.

“Construction stocks are stuck in a no-man’s land. The environment is slow and it’s going to take a while for the construction side to improve,” said Maxim Sytchev, a managing director at investment bank AltaCorp Capital Inc.

“A lot of the work they were bidding on, we only now know what margins they were bidding on. People were essentially just bidding to bid,” Sytchev said, referring to the period after the 2008-09 recession.

Before stepping in to buy at reduced prices, investors need to see signs that the likes of Aecon Group Inc (ARE.TO), Canada’s biggest publicly traded construction company, and rivals Churchill Corp CUQ.TO and Bird Construction Inc BDT.TO are in the running for some large contracts at fatter margins than in the past year.

Analysts are more optimistic about engineering, an industry that includes global player SNC Lavalin Group Inc SNC.TO, acquisitive engineering services group Stantec Inc (STN.TO) and small engineering consulting firm Genivar GNV.TO.

This is not to say that there aren’t challenges, both general and company-specific, for engineering companies.

SNC Lavalin is still waiting to restart C$1 billion ($971 million) worth of work in Libya, which it suspended due to the turmoil in the North African country.

Closer to home, elections are coming up in four Canadian provinces, creating uncertainty about government contracts.

“There is a slowdown in procurement processes during the election process. For example, we do a lot of renewable energy in Ontario, and a new government could change the energy policy,” Pierre Shoiry, chief executive of Genivar, said at a Montreal conference, referring to Ontario’s October 6 provincial election.

Some forecasters are also worried about the risk of a Canadian recession after the economy shrank in the second quarter, its first quarterly decline since the 2008-09 financial crisis.

ALL IS NOT LOST FOR CONSTRUCTION SECTOR

While the outlook may not be sterling for construction companies, some bright spots remain.

The relative strength of commodity prices, such as metals and oil, will generate construction work in those industries for at least the next six to 12 months, Raymond James analyst Frederic Bastien said in a recent report to clients.

Canada’s economy is also in much better shape than most developed countries and construction-sector employment has fully recovered to pre-recession levels, Bastien said.

“The expiration of stimulus funding in Canada had a visible impact on some - smaller - project activity,” he said. “However, there are still plenty of large infrastructure projects with long gestation periods underway in many regions of the country.”

That view was recently echoed by executives at Aecon, who also said they are seeing a slow recovery in the industrial sector, which includes the oil industry, where the company recently took a steep writedown on a fixed-price contract.

“We are more active on the industrial side, bidding, than we have been for some time,” Mitch Patten, Aecon’s senior vice-president of corporate affairs, said last week.

A sector recovery is likely to start with companies adding to their backlog of orders, followed by an improvement in revenue and lastly by a widening of margins, he said.

Still, the rewards for investors could be some time away. Patten said construction activity in general may not really ramp up until 2012.

That tallies with a reading of the market by Sytchev, who points out that up and down cycles in the construction sector tend to last five years. The last peak was in 2007, he said.

“If you apply this five-year pattern, then sometime in 2012 we should be cycling into pretty positive territory. It takes a while for companies to bid on things and win, and then for the impact to cycle through financials,” Sytchev said.

($1=$1.03 Canadian)

Editing by Jeffrey Hodgson and Frank McGurty

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