Infrastructure players remained resilient in the face of global pressures in 2Q 2022: A toxic mix of local and global economic headwinds have buffeted both construction and the infrastructure industry throughout the first half of the year, with players having to withstand raw material shortages, FX pressure, rising commodity prices, spiraling inflation, and fears that demand could slump. The second quarter of the year saw the full impact of the fallout hit local industry players, but they managed to offset the challenges to their earnings through their diverse portfolios and a proactive approach to managing inventory and working capital, according to analysts we spoke with.

IN CONTEXT- Soaring prices of commodities and building materials, rising global interest rates, and volatility in international financial markets have seen USD 20 bn in portfolio outflows from Egypt this year. This has also put pressure on the EGP, which has slipped more than 22% since March, and which is projected to fall further as the government embraces a more flexible exchange rate amid talks with the IIMF for an assistance package. Add to that import restrictions that have hobbled businesses from obtaining building and raw materials, and you have a pretty difficult quarter for contractors.

Today, we look at the two major players listed on the EGX: Elsewedy Electric and Orascom Construction (OC). Despite the obstacles, both companies performed better in 2Q 2022 than the first quarter of the year. Elsewedy Electric saw revenues rise 50% y-o-y to a record EGP 20.4 bn, with turnkey projects accounting for nearly half of its total revenues, according to its latest earnings release (pdf). Net income was also up 27% y-o-y to EGP 1.1 bn — a near 45% improvement to its bottom line over the first quarter of the year. OC saw an 8% y-o-y rise in revenues to USD 934.9 mn in 2Q 2022, with net income of USD 20.8 mn (down 13% from the same period last year in a high-inflation environment), according to its latest earnings release (pdf). However, its net income in the period was up nearly 60% compared to 1Q 2022 as its Belgian subsidiary Besix Group returned to profitability. Besix had seen its net income fall 45% y-o-y in 1Q 2022 on the back of rising energy prices and raw material shortages due to the Russia-Ukraine war.

Price hikes + strong margins helped both contractors adapt: In OC’s case, its EBITDA margin came under pressure in the Middle East and Africa at the same time as its margins in the US improved substantially, benefiting from the strength of the USD, Arqaam Capital Associate Director Noaman Khalid said. Elsewedy, on the other hand, enacted “significant increases in prices” for its wires and cables segment, which helped it grow its bottom line.

Inventory stockpiling offered an additional shield for Elsewedy: The company’s inventory came in at EGP 19.5 bn by the end of 1H2022, up nearly 50% from the EGP 13.32 bn recorded at the end of 2021, as it continues to build up higher stock in the midst of global supply-chain disruptions. “Inventory stockpiling protected Elsewedy’s operations against any disruptions [related to commodity prices and issues with imports],” EFG Hermes Associate Vice President Ali Afifi said. “Because of their stockpiling strategy from the beginning of the year, rising commodity prices were not captured in its costs this quarter,” he added.

There are key differences between the two contractors: Elsewedy Electric’s wires and cables segment accounts for more than half of its business, whereas OC’s main business segment is contracting, Mohamed Saad, vice president of research at Prime Securities, tells Enterprise. The export side of Elsewedy Electric’s business allows it to benefit from a weaker EGP, Saad explains, which does not apply to OC — though he notes that OC’s USD-denominated revenue streams still give it an advantage. The caveat: “With a large part of OC’s backlog being in Egypt, and with a lot of its needed materials being imported, more devaluation of the EGP is likely to have a negative net impact moving forward,” Khalid said.

Each company also has different priorities for growth: “While Elsewedy Electric has been making acquisitions and greenfield investments as part of expansions in its wires and cables segment, OC’s currently focused on maintaining business-as-usual,” Saad said. OC is focused on “project execution, controls, supply chain and collections,” CEO Osama Bishai said in the earnings release. “This is why OC is proposing making dividend payments to shareholders, while Elsewedy has not been paying them for a while,” Saad explained. OC proposed to pay out USD 27 mn dividends in 3Q 2022, equal to USD 0.2313 per share.

FX movements and shortages do not threaten either of the two: “Elsewedy’s operations are mostly dollarized and denominated in foreign currencies, which shields it from big FX movements,” Afifi said. For Saad, FX shortages do not pose a threat to either contractor because new contracts can be negotiated to accommodate for issues with the USD. He suggests that they can negotiate the use of different currencies, for example. OC is already in the process of renegotiating some existing contracts to help it mitigate the crisis, the company said in its earnings call.

Rising costs of executing national infrastructure projects could also have a slight negative impact on both companies’ earnings, since they both have a significant backlog of national civil and infrastructure projects, Khalid said. “The costs of these projects are rising and timelines are getting stretched as the government takes on additional public and social spending,” Khalid said.

The commodity price cooldown is good — but might not have a massive local impact: While global commodity prices have been cooling since June, with the price of oil falling by about 30%, the weaker EGP offsets this cooldown effect for Egyptian companies, Saad and Khalid agreed. Commodity prices will also likely only correct to up to a portion of their pre-war levels, Saad added. Still, the cooldown could relieve some of the pressure off of the working capital and debt that a company like Elsewedy has taken on (partially to finance its inventory stockpiling) by 4Q 2022, Afifi said.

The whole is greater than the sum of its parts when it comes to contractors: At times like these, what differentiates contractors from competitors is how different business segments perform to offset any challenges, like in the case of OC this quarter, Saad said. This means that, despite challenges threatening contractors moving forward, diverse portfolios and operational dynamics can still help them come out strong, he added. “The challenges will only begin to be addressed when USDs are redistributed, after we secure a package from the IMF and investments from the Gulf,” which is unlikely to reflect on company earnings before 1H 2023, Khalid said.

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