Deloitte: CEO optimism in GCC's construction sector bounces back

31 January 2022 6 min. read
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Deloitte recently conducted its annual survey of chief executives in the GCC construction industry. Middle East-based Deloitters Jaimi Raikundalia, Nishant Gupta and Scott Mathias walk through some of the report’s key insights.

As we emerge from the pandemic, optimism seems to have returned to 2018 levels with 61% of respondents being more optimistic about their future prospects relative to the past 12 months. This comes as no surprise with oil prices returning to above US$60 but also with US$173 billion of projects under tender in the GCC.

When asked if their pricing strategy had changed, more than 80% of chief executives surveyed said that they continued to adopt the same pricing model as prior to the pandemic. Looking ahead, over 43% are expecting an increase in operating margins over the next 12 months.

Average Optimism

With 70% of respondents stating that they have had projects either terminated or put on hold over the last 12 months, many contractors have used the downturn as an opportunity to reflect on their delivery models, operations, staffing and asset requirements with a staggering 78% being more optimistic about their future due to the internal transformations they have made during the pandemic.

Consistent with many sectors and economies across the world, we saw that in response to the pandemic, in 2020 all of our respondents had implemented self help measures, with 38% reducing headcount, 31% implementing temporary salary reductions and another 31% implementing both.

A year on, 13% of our respondents continue to operate with temporary salary reductions, 35% with a reduced headcount and 17% continuing to implement both. 35% of the respondents are no longer implementing any self help measures.

When asked if pricing on tenders had become more competitive in the last 12 months, 83% of the respondents believed that it had, however when asked about the next 12 months, it was not surprising that 61% of respondents expect their revenue to increase with a growth in project pipeline and projects that were put on hold being mobilised again, with over 30% expecting to hire in the next 12 months and 43% expecting internal restructuring to yield results through increased operating margins and cashflows.

Cash conversion cycle 

With cash preservation being the top of everyone’s agenda, it came as no surprise that during the pandemic the cash conversion cycle for contractors, i.e. the time taken from when work is performed on site to being certified and then being paid, was almost 1 year in 2020.

Cash conversion cycle

To determine the average cash conversion cycle for 2021, we asked respondents about the average time for conversion of ‘work done (uncertified WIP) to receivables’ and the average ‘collection time of receivables’ once certified. On average, the cash conversion cycle reduced by 85 days compared to levels at the height of the pandemic and is back at 2019 levels, leaving contractors providing funding for approximately 9 months of working capital.

It should be noted that the above collection timeframe assumes there were no legal/ contractual disputes. Respondents indicated that when there is a dispute with the employer, the collection period is substantially longer, and this further increases the financing requirements of the business.

Volume of contractual disputes 

When asked on whether the level of contractual disputes has increased in last 18 months, more than half of respondent said “Yes”. Over 70% of the chief executives surveyed continue to be involved in contractual disputes, which has remained a consistent trend over the last 5 years.

Organizations involved in Contractual Disputes

With 50% of respondents estimating these claims to be between 2% and 5% of their revenue and 74% of respondents (2020: 60%) not recognising revenue on these claims until the disputes are resolved, given the uncertainty associated with this revenue, more and more contractors continue to feel that they have no choice other than to enter into dispute resolution proceedings to recover costs on variations and delays.

Some relief: A reduction in dispute resolution time

Whilst dispute activity is on the rise and the working capital cycle remains similar to 2019 levels, there appears to be some relief for those contractors that are involved in dispute resolution. The average dispute resolution time appears to have reduced significantly; 35 months in 2019 to 24 months in 2021, which has been attributed to both parties’ collective approach to reach a resolution.

Average time to resolve contractual disputes
When asked about the outcome of dispute resolution for any contractual disputes completed over the past 12 months, more than 50% of respondents said that the resolution was fair to both parties. This is a significant development from 2019 where just above 20% of respondents said that resolution was fair. This change in sentiment follows the formation of numerous dispute resolution committees across the region to drive a fair process.

Is financing getting tougher to obtain?

Due to the increasing number of contractual disputes, there has been an increase in the number of bonds being called in the market, increasing banks’ exposure. This in turn had led to banks requiring higher guarantee margins from contractors, further putting strain on cash.

As such, it is not surprising that 48% of respondents feel that their level of nervousness around bonds being called compared to 12 months ago has increased. With a 9 month cash conversion cycle, 24 month dispute resolution time and the requirement for increased guarantee margins, there remains a growing pressure on contractors to fund and manage project liquidity.

Resolution of Disputes over the Years

As a result, the majority of respondents (70%) are experiencing greater pressure to fund projects compared to 12 months ago. With banking regulations and the risk appetite of traditional banks transforming with the implementation of the different pillars of Basel, almost 40% of respondents are finding it hard to obtain finance, which has doubled from 2019.

With a decrease in availability of traditional finance, an ever-increasing spotlight on sustainability and the availability of green funds , now appears to be the ideal time to look at re-balancing contractual risks and change previously established practices to allow contractors and employers to fund feasible projects.