Industry Trend Analysis - Few Drivers For Construction Recovery - DEC 2017

BMI View: Political turmoil, deep public sector budget cuts and economic weakness will continue to dampen construction activity in Brazil over the coming 12 months, prompting a further downgrade in our growth expectations for 2017 and 2018. Private investment into existing brownfield asset s will remain elevated, however, greenfield construction intensive projects will remain unattractive given a lack of confidence in the market.

Latest Updates

  • We have downgraded our forecast for Brazil's construction activity, with a 3.6% contraction now estimated for 2017 and growth of just 1% for 2018. The anticipated nascent recovery, primarily related to public sector investment and a revival in confidence, has not materialised, with leading indicators still firmly negative. A recovery is still expected in 2018, but growth will return at a weaker pace.

  • Brazil's construction sector will return to growth from 2018, accelerating in 2019 when the impact of the concessions programme - Projeto Crescer - will generate the greatest construction activity. The concessions programme was expanded in August 2017, to include 57 additional assets. We maintain our expectation that the airport, port and energy assets will garner the greatest interest from private investors.

  • Upside to growth is presented by the government's BRL50bn 'Avancar' (Advance) programme, intended to stimulate economic activity and employment through construction activity. The public works programme will provide capital for projects to be developed through to 2018. The lion's share (BRL20bn) will go towards transport sector projects. Limited concrete impact has been noted thus far, and with the transport industry value equal to BRL61bn, the impact is unlikely to offset the major public spending cuts the sector is suffering from.

  • Investment into the infrastructure sector is expected to remain stable, focused primarily on brownfield assets and therefore not supporting construction activity. Foreign direct investment into infrastructure reached USD11.7bn in January to April 2017, from USD1.9bn in the same period in 2016. Asset acquisitions remain popular amongst Chinese investors and developers and institutional investors, who are drawn in by the low asset prices and longer term growth prospects. In particular, transport, water and power assets have proven attractive to investors.

  • Two railway projects will provide a strong signal of investor confidence in Brazil with auctions due to take place over the next 12 months - the FIOL (H2 2017) and Norte-Sul (Q1 2018). Railways have been notoriously challenging to develop as concessions and therefore this will be a major test for investor sentiment toward Brazil and the regulatory changes made by the Temer government. Chinese companies have indicated they will bid on the FIOL project following investments into related port infrastructure.

Construction And Infrastructure Industry Data (Brazil 2016-2026)
Indicator 2016e 2017f 2018f 2019f 2020f 2021f 2022f 2023f 2024f 2025f 2026f
e/f=estimate/forecast, Source: IBGE, BMI
Construction industry value, BRLbn 305.03 307.07 323.29 345.64 370.78 398.87 427.90 458.73 492.62 532.67 575.13
Construction Industry Value, Real Growth, % y-o-y -5.16 -3.62 0.96 1.69 1.40 1.64 1.59 1.58 1.76 2.50 2.35
Construction Industry Value, % of GDP 4.9 4.6 4.6 4.6 4.6 4.7 4.6 4.6 4.6 4.6 4.6
Infrastructure industry value, BRLbn 96.02 98.96 104.75 113.02 120.56 129.69 139.37 149.96 161.65 174.94 189.13
Infrastructure industry value real growth, % y-o-y -5.3 -1.2 1.5 2.7 0.8 1.6 1.8 2.0 2.2 2.6 2.5

Structural Trends

2017-2019: Slow Recovery For Growth

We have further downgraded our outlook for Brazil's construction sector in 2017, with a contraction of 3.6% expected. Factors expected to drive growth in the second half of the year have failed to materialise owing to continued cuts to public spending, sustained economic weakness and the detrimental impact of the deepening political turmoil on investor confidence. Cement consumption is down 7.1% in the first six months of the year, whilst construction employment is down 9.4% over the same period - a significant deterioration compared to the 1.8% decline seen in 2016. With construction industry value registering a 6.6% contraction in the first half of the year, we have thus downgraded growth.

Sustained Weakness, No Signs Of Recovery
Brazil Construction Employment And Cement Consumption, % Chg y-o-y
Source: Bloomberg

Public spending has been a major drag on investment, and we expect limited improvement as Temer's government remains committed to improving Brazil's fiscal position and revenue generation is showing no signs of recovery. Public investment reached its lowest level in 10 years as of July 2017, with public works projects hit especially hard, such as those under the Growth Acceleration Programme (PAC), down 40% since 2013 (the last year of positive growth for the construction sector). One particular area that has dragged on growth is reduced investment into the Minha Casa Minha Vida public sector housing programme. Following an audit and several rule changes in 2016, the government was expected to revive investment into the programme (informing our more positive outlook previously), however, only 150,000 houses have been contracted in the first five months of 2017, against a target of 610,000 for the year as a whole, and compared to 763,000 contracted in 2016.

Potential upside to the construction sector is offered by the government's new public works programme (Avancar). In an effort to provide a shorter term boost to the economy and the construction sector - which has been one of the hardest hit - the government has launched the new BRL50bn infrastructure investment programme. The programme will direct public funds to infrastructure projects which can begin construction in 2017 and 2018 in order to stimulate the economy and generate jobs. The transport sector will see the greatest portion of funds - BRL20bn (with highways receiving the most at BRL16bn) - with 50 projects highlighted by the Ministry of Transport for inclusion. We have seen little sign of progress or impact on activity from this programme and therefore are maintaining it as an upside to the forecast rather than integrating it into our view.

Recovery Pushed Back
Construction Industry Value LHS And Real Growth RHS (2015-2026)
f=BMI forecast, Source: IBGE, BMI

With investor confidence waning and no sign of improvement in construction activity, we have also downgraded the pace of recovery in 2018 (to 1%), pushing back the greatest impact of a recovery into 2019 (1.7% growth). Improvements in both consumer and industrial confidence seen since late 2016 have started to wane as of Q2 17, largely owing to continued political turmoil - with charges repeatedly raised against leading political and business figures including President Temer and former Presidents Rousseff and Lula. We do not expect any marked improvement in confidence over the next 12 months in the run up to Brazil's 2018 election (in October). Approval ratings for Temer's government stand at around 7% raising the potential for an anti-establishment or outsider candidate to do well in an election that remains too early to call according to our Country Risk team.

Recovery Waning
Brazil: Consumer And Industrial Confidence Index
Source: FGV

Recovery Hopes Pinned On Projeto Crescer

In order to encourage infrastructure investment, greater focus has been placed on using the concession model to invest in infrastructure, however, this will take several months, if not years, to filter through to activity (indeed it is only factored into our forecast from late 2018 and primarily in 2019/2020). In order to attract investors and reduce risk, many of the concessions are brownfield and come with maintenance or upgrade requirements over the concession period, which can be multiple decades, meaning limited potential to provide a concentrated boost to the construction sector.

Indeed, while investment into Brazil's infrastructure sector will remain elevated compared to recent years this will have limited impact on construction activity. The infrastructure sector accounted for more than 50% of direct investment into Brazil in the first four months of the year, growing from USD1.9bn in Jan-Apr 2016 to USD11.4bn in the same period in 2017. The figures reflect the success of the initial auctions under Projeto Crescer, in addition to acquisitions by private equity companies and Chinese investors capitalising on low valuations as Brazil's indebted companies seek to offload assets. We do expect investment levels to slow as the new political crisis around President Temer evolves.

That being said, our expectation of a recovery in 2018/2019 is contingent on the partial success of Projeto Crescer, the government's concession programme, which in August was expanded by a further 57 projects. The programme has got off to a solid start and in line with our expectations - it has been expended twice as precedent and confidence has built. However, many of the early projects auctioned were in more attractive sectors such as energy, ports and airports. Riskier assets in the highway and rail sector have yet to be tested, where returns have been less appealing and investors have generally been domestic players, in addition, new miscellaneous assets such as the National Mint and Warehouses and Supply Centres have little to no precedent making their success questionable.

Private Housing Support For Non-Infrastructure Construction

Brazil's residential building market is expected to recover in 2018, supported primarily by private housing as budget cuts have hit activity in the Minha Casa Minha Vida public housing programme. Early signs that a nascent recovery is on the horizon for the private sector are supported by the central bank's aggressive interest rate cutting cycle. This, combined with a stabilisation in unemployment rates and consumer confidence, indicates demand is likely to return to the housing market. Indeed, the steep contraction in mortgage lending seen over 2015 and 2016 is easing (see chart below). However, with homebuilders focusing on reducing inventory, it will take several months for this to feed through to new construction and therefore we expect a recovery only in 2018.

Housing Market Making A Comeback
Mortgage Lending By Brazil's Savings & Loans Sstem (SBPE) & Growth
Source: Abecip