Domestic supply sustains growth in Nigeria's construction sector

 

Following a difficult 2016 the Nigerian construction sector showed signs of stronger growth in the first half of 2017. The uptick in activity comes on the back of a low base, however, as the country’s first recession in 25 years affected private investment in real estate building and oil companies had to scale back investment plans due to lower global oil prices.

The stabilisation of the naira, the utilisation of new contract structures and an increase in local suppliers are now helping to provide fertile ground for activity. Local content, in particular, is playing a larger role in the market, with domestic companies active as both standalone contractors and as subcontractors for foreign firms. While public sector tenders – which have traditionally been the source of major works – remain limited compared to the booming years of the 2000s, the increase of private development in the residential and commercial building segments offers promise.

Performance

According to data from the National Bureau of Statistics, the construction sector shrank by 6% in 2016 compared to growth of 4.4% in 2015. However, quarterly figures illustrate that the slowing began in late 2015 and carried into the following year; in the fourth quarter of 2015 construction activity fell 6.1% compared to the same period of 2014. Growth had picked up by the final quarter of 2016, with activity expanding 7.7% year-on-year (y-o-y), and in the first three months of 2017 the sector bounced back in a big way, registering y-o-y growth of 21.3%.

Also noticeable in early 2017 was the growing role of construction in the overall economy, accounting for 4.1% of total GDP in those first three months compared to recent quarterly contributions of around 3%. “Things were slow in the second half of 2016, our clients were still recovering from the shock of the slowdown in 2015,” Igbuan Okaisabor, CEO of Construction Kaiser, told OBG. “In the first quarter of 2017, however, things have opened up. We are seeing increased inquiries and tenders, and business confidence is clearly improving.”  REGIONAL STANDING: Much of the construction activity in Nigeria has traditionally been driven by public infrastructure and energy projects, but this is changing. According to the “Africa Construction Trends Report 2016” published by Deloitte, the proportion of West African construction spending funnelled to energy projects fell from 24% in 2014 to 18% in 2016. The report states that 78% of major projects in the region are owned by state governments, and one-third of funding for these projects comes from the public sector. However, tighter fiscal belts have led to financial challenges for the development of government projects.

Still, Nigeria is highlighted as one of the most attractive markets in Africa for construction works. In West Africa, of the nearly $120bn committed to infrastructure spending across 92 projects identified by Deloitte, 61% is earmarked for plans in Nigeria. The country currently has 68 major building projects with a total capital expenditure of approximately $73bn, second only to South Africa on the entire continent.

Given the size of the Nigerian economy and traditional spend of other African states, however, these figures mask a historical underspend in gross fixed capital formation (GFCF), a category that includes infrastructure projects and land improvements. An average GFCF of 30% of GDP is considered optimal for creating a growth-conducive environment, but in recent years Nigeria has spent just 11.9% of GDP compared to a sub-Saharan Africa average of 21.5%. Ethiopia, the continental leader, spent an average of 32.8% of its GDP on infrastructure over the last decade.

Nigeria’s lower expenditure has resulted in the country’s power production being approximately 10% that of South Africa’s, and just 17% of its roads are paved compared to over 70% in Algeria, Tunisia and Morocco. “With many infrastructure projects frozen, road construction companies have increasingly looked to other industries for new opportunities,” Edmund Martin-Lawson, territory development director of Mantrac, told OBG.

Stimulus

The government’s response to the recession of the last few years has been to increase spending. In December 2015 President Muhammadu Buhari announced that capital and current spending would triple to N6trn ($21.2bn) in the coming three years. As part of this, the government announced plans to establish a $25bn national infrastructure fund to be dedicated to projects set out in the National Integrated Infrastructure Master Plan (NIIMP), a long-term roadmap that includes projects for energy, transport, ICT, water, housing and social infrastructure. The national fund will draw from local pensions and the country’s sovereign wealth fund. “The fund seeks to raise the stock of infrastructure from the current level of 20-25% of GDP to at least 70% by 2043,” Udoma Udo-Udoma, the minister of budget and national planning, told local media. “A total investment outlay of $3.05trn will be required for the implementation of the NIIMP.”

While many of the NIIMP projects are yet to be designed and tendered, a number are ongoing. Nigeria has $8bn worth of road projects under way, chief among them the $3bn Calabar-Kastina-Ala Super Highway. A further $22.7bn is earmarked for the country’s ports. This includes a $10bn investment for the Olokola Deepsea Port, located near a refinery and fertiliser plant; $6bn for the Lagos Free Trade Port; and $2.8bn for the Onne Port Complex, to be situated near a number of petrochemicals projects.

Several large-scale projects are under way outside of the public sector, as well – local conglomerate Dangote Group is in the process of building a $12bn refinery in Lagos, for example. There are also two mixed-use projects in development: Centenary City near Abuja and Eko Atlantic City in Lagos. The first is an $18bn project on 1267 ha of land that will host a financial district, and leisure and commercial facilities. Eko Atlantic City is spread over 10 sq km and will provide accommodation for 250,000 people along with commercial and industrial space. These private developments will provide a large volume of contracts for real estate, road and social infrastructure projects.

Real estate construction has shown a positive trend in early 2017 due in no small part to the weakness of the naira and high inflation. “We have seen middle class Nigerians invest in real estate rather than keep their money in the bank,” Victor Jolaoso, marketing communications and research manager of Nigerite, told OBG. “We have seen growth in new residential and commercial projects in the major cities.” 

Cash Flow

Although the sector is recovering, the recession has left issues that firms still grapple with. Delays in government payments to contractors have led to a sizeable buildup of arrears. Julius Berger, one of the country’s largest contractors, revealed in July 2015 that it was owed N90bn ($318m) from public and private clients, with much of that stemming from work on the Nnamdi Azikiwe International Airport in Abuja.

To address the situation, the federal government announced in May 2017 its intention to prioritise payments of N600bn ($2.1bn) in arrears owed to contractors, as well as interest accrued. While the commitment has restored some confidence, it will take time to fully pay the backlog. In July 2017 Julius Berger and Reynolds Construction Company, the contractors responsible for the expansion of the Lagos-Ibadan dual carriageway, suspended their work, saying the government owed them nearly N9bn ($31.8m).

The situation extends beyond the federal government. “For the first time in 2016 we saw private clients not honouring obligations,” Okaisabor told OBG. “Even major energy companies have issues paying on time. It was never a major problem before, but now construction firms are encountering challenges with payments, especially due to difficulty in enforcing contracts.”

Withholding taxes have restricted funds even further. In a sector where net profits tend to be relatively low, the decision to revert to a 5% rate in June 2016 – following the imposition of a 2.5% rate in January 2015 – had a significant effect on cash flow.

Exchange Balancing

As is the case elsewhere in the economy, contractors have also been impacted by the fall in value of the naira. While Nigeria is endowed with natural resources such as iron ore, limestone and aggregates that serve as inputs for building materials, the country remains heavily dependent on imports.

The rapid depreciation of the local currency led to a spike in costs (see analysis), making planning difficult. One result of the exchange rate risk has been contractors revising the structure of contracts that they offer clients. “We have to come up with innovative ways of making contracts attractive,” Okaisabor told OBG. “One way is to break project costs down into low-, medium-and high-risk segments based on the likelihood of price fluctuations during the duration of the project. A client – depending on his cash flow and risk aversion – might choose to pay the high-risk items up front.”

Local Content

There is a silver lining to the sector’s past challenges, however, in increasing demand for locally produced building materials and reducing foreign exchange risk for contractors. “There’s a clamour to buy “Made in Nigeria”,” Okaisabor said. “We now understand the need to cut down on the importation of items and construction services. We need the supply side to grow to fill the gap, but we are already seeing improvements. For the first time in 24 years our firm used Nigerian-made tiles for a project; companies are increasingly looking inward to domestic supply.”

Cheaper steel and cement from the local market, in particular, could go some way in reducing the country’s import demand for these materials, and deepening the domestic supplier base would provide local options for finished products. The limited number of firms in the market have already seen the benefit of the weaker naira. “In the past couple of years, exchange rate depreciation led to strong demand for our locally manufactured products – well beyond our predictions. We expected a slow year for 2016 but in the end we saw reasonable growth,” said Jolaoso, whose firm Nigerite supplies roofing, ceiling and drywall construction solutions made from over 80% local content. “Local suppliers had a good year and we even saw locally manufactured products become competitive with low-quality imports from China.”  

Incentives

Domestic industries should be further supported by government policies. In August 2017 the Federal Executive Council announced that the government had passed a bill extending local content requirements vigilant in the oil sector to the construction, ICT and power sectors. Since 2010 the Nigerian Local Content Act has specified that local independent operators should receive “first consideration” for hydrocarbons-related projects, and domestic service companies should be given “exclusive consideration” for certain contracts and services.

Speaking at a conference organised by the Nigerian Institute of Architects in Abuja in August 2017, Suleiman Adamu, the minister of water resources, said, “We intend to encourage not only consultants to rise through the value chain of the construction industry, but also manufacturers, so that a lot of emphasis will be put on Nigerians and we can develop our skills and strengths in such a way that we will dominate activities in the construction industry.”

In the same month, the government announced that it would expand the Nigerian Content Intervention Fund from $100m to $200m. The fund – administered by the state-owned Bank of Industry – provides low-cost loans of up to five years to domestic manufacturers with the goal of boosting local capacity.

Skills

As is the case throughout West Africa, skilled construction and engineering labour is limited in Nigeria. According to the Nigerian Institute of Building, 5m-10m construction artisans will be required by the industry in the coming 20 years. However, while the sector’s potential for job creation is significant, there is a need to improve training and development. Speaking at the annual general meeting of the institute in October 2016, Anthony Okwa, the project director of Construction Skills Training and Empowerment Programme, told attendees, “In order to salvage Nigeria from its decaying infrastructure and huge housing deficit, all relevant stakeholders – including the federal and other arms of government, construction companies, real estate developers, professional bodies and trade associations – must invest more resources in vocational training to boost the number, competence and quality of manpower in the construction industry.”

While the government has announced its intention to increase vocational training (see Education chapter), the private sector is launching its own initiatives. Construction Kaiser, for example, hosts summer camps for teenagers where key construction skills are taught.

Outlook

The recent recession has certainly had an impact on the Nigerian construction industry, but the sector is clearly rebounding and may even benefit from some of the changes brought on by the slowdown. The development of a strong domestic supply industry will take time, but the government is beginning to put in place the necessary reforms to incentivise local firms. Furthermore, the stabilisation of the naira and inflation mean that the ample pipeline of future infrastructure projects can be planned on a more secure footing.

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The Report: Nigeria 2017

Construction & Real Estate chapter from The Report: Nigeria 2017

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