THE construction sector has never had it this bad in a long time. The cost of building materials has skyrocketed, which has put a serious strain on the profitability of construction firms.
It has been widely reported that steel prices have gone up due to the Russia-Ukraine war, as these two countries are among the largest steel producers in the world.
Other challenges include labour shortages and supply chain kinks which can lead to delays.
“Don’t be surprised if one of the highly profitable big boys of construction report a quarterly loss soon,” says an industry player.
The view is echoed by Tan Sri Sufri Mhd Zin, the president of the Master Builders Association Malaysia (MBAM).
“Spikes in building material prices in the last two years have impacted the construction sector. Contractors are suffering badly and a handful have dropped out of business,” he says.
In a statement, MBAM points out that the price of steel bars had risen by 30.6% from RM2,680 per tonne in February 2021 to RM3,500 per tonne in April 2022.
Meanwhile, bulk cement rose 40% from RM210 to RM350, and diesel saw a whopping 128.4% jump from RM1.90 to RM4.34 per litre in the same period.
Taking a hit: Workers at a construction site in Kuala Lumpur. The Master Builders Association Malaysia notes that rising prices are threatening the viability of construction projects from infrastructure to residential projects.
The association notes that rising prices are threatening the viability of construction projects from infrastructure to residential projects.
MIDF Research, in email replies to StarBizWeek, notes that there have been rises in building material prices, such as cement, almost every month since 2021.
“Conventional wisdom would suggest that such factors would compress the margins of construction players as building material costs usually take up 30% to 40% of project costs.
“But from what we have gathered, prices at current levels are still manageable as some construction companies are able to mitigate this impact with the completion of other projects and with recalibration of margins,” says the research house.
However, it adds that if the cost headwinds persist, the impact on bottom line performances are inevitable.
“Still, we remain comforted as Prime Minister Datuk Seri Ismail Sabri Yaakob has recently directed government agencies to intervene and control the rising prices and to expedite the implementation of development projects,” says MIDF Research.
It added that newer contracts undertaken by construction companies have a form of variation of price (VOP) clauses, which allow part of the additional cost to be passed on to their clients, therefore providing some protection to their margins.
Meanwhile, construction firms acknowledge the impact of rising building material prices but some are able to mitigate the impact.
Wan azman
Gagasan Nadi Cergas Bhd group managing director Wan Azman Wan Kamal says: “While we may be unable to fully mitigate price hikes in the short term, we aim to improve efficiency by enhancing productivity for ongoing projects. We also administer wastage control on-site to optimise raw material usage.”
The group is involved in construction, concessions, utilities services and property development and has a RM1.6bil order book. This includes works for the mosque in Merdeka 118, building campuses for Mara Junior Science College (MRSM) in Perak and Terengganu. and the cardiology centre in Hospital Serdang, Selangor.
It is also a contractor for Rumah Idaman affordable homes in Bukit Jelutong, Elmina Shah Alam and Kwasa Damansara.
“As for government projects that we are undertaking, such as the construction of the MRSM campus and Hospital Serdang, the government as the project owner has been kind enough to compensate contractors for the price increase.
“For new projects, I believe that contractors have input a buffer to cater for potential increases in raw materials and volatility,” says Wan Azman.
However, he does foresee that margins for Gagasan Nadi’s construction segment will be affected, as its project portfolio is made up of projects from both the private and public sectors.
On the other hand, Wan Azman notes that the group’s margins should also be helped by its concession segment, where it provides facilities management for student hostels in International Islamic University Malaysia in Kuantan and Universiti Teknikal Malaysia Melaka in Melaka.
“We also provide utilities services for Datum Jelatek in Kuala Lumpur – the electricity distribution systems, and district cooling systems to supply chilled water to the mall,” he says.
Advancecon Holdings Bhd group CEO Datuk Phum Ang Kia says it is challenging to pass the rising costs to its customers if the group has signed fixed-price contracts for its earthworks contracts, particularly for private sector projects.
The construction group is involved in the provision of earthworks and civil engineering services.
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“For the earthworks and civil engineering segment, most of our public sector projects contain the provision for margin compensation due to fluctuating prices.
“However, only certain raw materials are eligible, where the price is fixed by the government from time to time, and are subject to other specific conditions,” says Phum.
On the group’s quarry business, he says it has a clause for some of its customers to subsidise the increase in diesel and explosive material price for the group’s operations at the customer’s quarry sites “but subject to negotiation”, whereas some costs can be passed down for sales of quarry products such as aggregates and bitumen.
Phum notes that Advancecon is facing cost pressures from hikes in diesel prices, as it relies on heavy machinery to conduct its earthworks and quarry operations.
“In our main earthworks and civil engineering segment, we are negotiating with clients to compensate for the increase in raw material prices for some of our projects.
“We also use our engineering expertise to optimise ongoing construction projects to achieve cost efficiency,” he says.
Phum adds that the group’s quarry business is negotiating the pricing with suppliers and also reducing wastage during operations.
“Overall, we have planned our work schedule ahead, so that we can manage our cashflow efficiently and do the job when it is needed,” he says.
Phum also points out that the group will likely see some margin compression due to rising material price issues and it is “negotiating with the private sector to provide additional support to absorb the extra cost”.
He notes that on the other hand, the government has provisions for margin compensation for public sector projects such as its ongoing works for new roads under the Upper Rajang Development Agency and the Pan Borneo Highway Sarawak.
“However, only certain raw materials are eligible, where the price is fixed by the government from time to time and are subject to other specific conditions. We are assessing their requirements and apply the margin compensation,” he says.
The group’s quarry business is also experiencing margin compressions due to higher diesel cost while the labour shortage is affecting its productivity levels.
Econpile Holdings Bhd CEO Raymond Pang also says the group’s ongoing projects will suffer margin compression, with the exception of its recent tenders.
Econpile is a piling specialist with a RM550mil order book including works for a Cambodia entertainment complex, phase two of Pavilion Damansara Heights and Pavilion Square.
“There is no provision in most of the construction contracts for price fluctuation, as the contractor bears the risk for the price variations.
“There are some contracts where our client agrees to certain price variation methods, which would reduce the impact.
“In many cases, when the contract period has been extended, the client normally negotiates to share the price increases upon completion of our projects,” says Pang.
He points out that Econpile is taking a more cautious projection in its basic material prices for new tenders, and is also talking to its clients on value engineering possibilities to reduce the steel content of the existing design.
Pang says the group does not expect the costs of raw materials to drop in the short term although they “may stabilise within 2022 if the global conflict does not escalate”.
“Also, as demand has dropped, this will impact the future prices of raw materials.
“In the short term, Econpile is monitoring the material cost on a daily basis and will order when necessary, especially for steel bars.
“For concrete supply, we are looking at the possibility of hedging the supply cost for the project or taking a cost-sharing approach to reduce the impact of the cost,” he says.
A call for help
Construction players suggest a number of initiatives that can help their situation. For example, MBAM’s Sufri says the government can intervene to control the price of building materials or allow contractors to claim for the upwards variations to prevent losses.
“We also hope the government can encourage or even enforce that VOP claims should be implemented in private projects,” says Sufri.
“Even for government projects, copper prices should be in the list for VOP claims as well, and with current fluctuations, as it is an essential product to cover. Other items to include are aluminium and related items like guard rail and lamp posts.
“Also, the rates of diesel, petrol, bitumen and other petrol related products are going through massive spikes right now and must be included for VOP claims,” he adds.
Sufri strongly urges the government to use the list prices of building materials given by the Construction Industry Development Board Malaysia (CIDB) instead of using the Statistics Department prices, “for a more accurate real-time information”.
He says CIDB’s pricing comes from MBAM for the National Construction Cost Centre programme.
Gagasan Nadi’s Wan Azman claims that there is a presence of raw material supply cartels and that these should be dismantled.
He adds that anti-competitive legislation should come full force into the sector to allow for market forces to determine the dynamics.
He also moots the idea for having raw material price fluctuation clauses in contracts, irrespective of whether it is a government or private project.
Wan Azman also urges the government to do away with import levy and taxes imposed on imported building materials.
“Circumstances for the imposition of such taxes and levy no longer apply in the post-Covid environment. Contractors should be given options for material sourcing that will help drive down overall costs,” he says.
Meanwhile, Econpile’s Pang says the government can help to reduce the impact on other production costs such as the foreign worker shortage.
He adds that the government can encourage foreign investments and the Malaysia My Second Home programme, speed up the implementation of mega projects like the Mass Rapid Transit 3 and the high-speed rail.
MBAM’s Sufri notes that some contractors are considering halting bidding for projects by local authorities because “the way in which contracts are often structured shifts too much risk onto contractors already stretched by the lag in the price tendered and actual current prices”.
“The problem is even more acute in private sector projects, many of which do not include provisions to account for hiked prices of raw materials in terms of a VOP,” he says.
As to when the situation will get better, it is anyone’s guess. Without government intervention it will be difficult to resolve, says Sufri.
“A lot will depend on the world economy – with the Russian-Ukraine war not ending anytime, and with worldwide inflation spiking, there is a lot of heavy pressure on the building material prices.
“There is an endless battle between the raw material prices, as well as dropping demand,” he says.
On a positive note, MIDF Research points out that construction companies under its coverage generally displayed a positive tone based on the first quarter of 2022 earnings results, with three companies coming in above expectations, two within and four below expectations.
“From that, we saw the profit margins for most of the companies have come off slightly, attributable to various factors which would usually include rising building material costs.”
The research house adds that prices will start to normalise when the supply and demand of the raw materials gradually return to normal.
“This is still unpredictable at the moment, mainly due to the ongoing Russia-Ukraine crisis.
“Note that both countries used to produce about 5% of steel globally and Ukraine is among the top exporters of iron and steel,” it says.