Payment crisis returns to Dubai construction sector

Dubai’s two biggest builders are turning to bank borrowing to help fund projects as a rise in late payments from their customers takes the shine off a booming construction market.

Arabtec Holding PJSC, the contractor that helped push Dubai stocks into a bear market in June, said money owed by clients rose to 8.8 billion dirhams ($2.4 billion) through the second quarter from 7.2 billion dirhams at the end of 2013. Drake & Scull International (DSI), the emirate’s second-largest publicly traded builder, took two term loans totaling about 199 million dirhams in the first half, according to its financial statements.

While both builders are benefiting from rising orders, the need to borrow from banks means costly interest payments and could slow the completion of projects, according to analysts. A rapid expansion of Arabtec’s backlog has added to the company’s arrears, while delays for redesigns and cost overruns in Saudi Arabia are hurting cash flow and profitability at Drake & Scull.

“The payment situation for contractors hasn’t improved since the beginning of 2013” even as the Dubai economy strengthens, Taher Safieddine, an analyst at Shuaa Capital PSC in Dubai, said by telephone yesterday. “Working capital is continuously under pressure, which is forcing contractors to go to the banks to cover the shortfall.”

Calls and e-mails to Arabtec (ARTC) seeking comments on their funding needs were not returned, while a public relations executive for Drake & Scull declined to comment when reached by phone.

Both Arabtec and Drake & Scull are getting term loans, facilities and overdrafts from their banks, Safieddine said. Arabtec’s debt climbed by 392 million dirhams in the second quarter to 1.29 billion dirhams.

“The majority, if not all, bank loans extended to contractors tend to be tied to specific contracts and projects,” Arthur Uluc, director of corporate finance at Mashreq Bank in Dubai, said by phone yesterday. “The loans are typically more expensive than those provided to other types of companies because recovery on a specific project can be tricky if a contractor isn’t paid.”

Arabtec will probably need to raise cash through debt or equity “within months” because existing authorizations to increase capital expire by the end of the year, Allen Sandeep, a Cairo-based construction analyst at Naeem Brokerage, said in a note to clients. Delaying fundraising into 2015 would create the need for new approvals from the board and the regulator, he said.

Arabtec “is in urgent need to raise more cash, and quickly” unless it’s willing to slow down its construction schedule, Sandeep wrote. The company is depleting cash at a rate of around 600 million dirhams a quarter, he said.

Arabtec’s backlog has surged by 70 percent to more than 23.8 billion dirhams since the end of last year, putting pressure on the company’s working capital at a time when a “good amount of subcontracting” requires the company to commit cash, Sandeep said.

“The issue is new projects that have come into the backlog in past year and half but haven’t turned into revenue yet” for Arabtec, Alia El Mehelmy, a Cairo-base equity analyst at CI Capital Holdings, said by phone. “The challenge is kick starting these projects.”

Uncertainty about Arabtec’s new management may affect confidence in its ability to execute projects amid restructuring, she said. Hasan Ismaik, the company’s chief executive officer, resigned and other top officials were purged in June. Arabtec shares dropped 59 percent in Dubai trading from June 5 to June 30, leading a 23 percent slide in the benchmark Dubai Financial Market General Index in the period.

The appointment “of a new management team credible within the construction industry quickly could reduce the risk of projects being taken away from Arabtec and moved to other contractors,” El Mehelmy said.

Arabtec probably won’t resort to a capital increase or bond sale, which would effect equity value at a time investor demand will probably be weak, she said. Bank borrowing, however, shouldn’t be difficult for the builder.

“The company’s balance sheet is lowly geared and it can easily resort to banks, which will be happy to fund it,” she said. Arabtec’s debt-to-equity ratio is around 22 percent compared with 54 percent for Drake & Scull, Shuaa’s Safieddine said.

At Drake & Scull, “significant” delays on projects in Saudi Arabia as well as cost overruns in general contracting in the first half are affecting operational margins and profit, Chief Financial Officer Mukhtar Safi said in an Aug. 10 statement.

Among the builder’s contracts in the country is a 2 billion-riyal ($533 million) order from state oil producer Saudi Arabian Oil Co., known as Saudi Aramco, in 2011 to develop part of the King Abdullah Petroleum Studies and Research Center in Riyadh.

The CFO expects clients to approve claims in the second half that will cover cost overruns. Drake & Scull also predicts a partial recovery of liquidity, as well as operating and profit margins by the end of the year as projects in the engineering and general contracting businesses pick up momentum in the fourth quarter and continue into early 2015, he said.

Shuaa’s Safieddine agrees. “I expect some kind of improvement, especially for Drake and Scull by the end of the year in Saudi,” he said. “We are looking at payment delays, not possible defaults.”-Bloomberg