Bernard Busuulwa
1 January 2008
Nairobi — The unprecedented growth in Uganda's construction sector is being threatened by high financial risk, analysts warn.
Low liquidity, inefficiency in operations and quality assurance problems add to their fears as they portray the sector as risky for many credit institutions.
The sector has enjoyed an average growth of 12.8 per cent in the past five years, more than double the 5.7 per cent national growth average for the same period, according to African Alliance Uganda.
However, many banks view financing construction projects as risky, including those dealing in mortgage products. As a result, construction companies and manufacturers of building materials face problems in raising funds for their activities. This in turn restricts expansion of capacity, slows down projects and leads to low output of finished work.
The fact that financing of the sector is a sophisticated exercise, does not help matters either.
"For instance, when a company gets a contract to build a road worth Ush30 billion ($17 million), it has to look for financial institutions that can back it with financing as the government takes time to pay," said David Ofungi, chief executive officer of Dero Capital and investment adviser for Uganda Clays Ltd (UCL).
A recent report from African Alliance on the future prospects of UCL pointed out the high risks faced by financial institutions and manufacturers of construction materials.
The report, released in December, revealed that though UCL's share price is expected to rise by nearly 100 per cent to Ush10,990 ($6.3), the company is unlikely to pay dividends in the near future and might also suffer a cash squeeze in case of any delays in completing its new factory in Kamonkoli, eastern Uganda.
The company's net debt is expected to rise by 800 per cent to Ush9 billion ($5 million) and according to the report, it might not be able to pay dividends in the near future because of debt servicing pressures.
The latter can be attributed to high-risk perceptions among UCL's lenders, that usually allow very little time for repayment.
Though the net present value of the Kamonkoli project is estimated at Ush5 billion ($3 million), the report warned that the company might face a cashflow problem in case of any delays in its completion since the project is very capital demanding.
However, the report added, the company will register an increase of 48.7 per cent in earnings per share - about Ush389 ($0.2) - by the end of 2007. Nevertheless, the effect of the rights issue and higher financing costs are likely to lead to a drop in earnings per share of 52 per cent in 2008, or about Ush187 ($0.1).
Mr Ofungi hastens to add that despite the huge debt portfolio, UCL is still a good risk, being a listed company.
"Banks look at cashflows when determining ability to pay back a loan. Since UCL is listed, it is still a good risk because of its good performance record," he told The EastAfrican.
According to Renaissance Capital Ltd, a local stock brokerage firm, Uganda's construction sector is faced with significant barriers to entry due to the high capital investments required. Consequently, most players in the construction sector suffer from low liquidity because the high capital investment demands leave them with little money for working capital purposes.
The majority of locally owned companies engaged in construction work and production of raw materials are constantly affected by scarcity of resources, which makes it difficult to undertake activities in time leading to low output, revenue, and reduced growth in the construction sector.
The firms are also faced with high levels of inefficiency that affect the output and growth of the sector.
For instance, UCL's plant in Kajjansi, which is operated by machinery designed in the 1950s, incurs production losses of approximately 18 per cent. On the contrary, the Kamonkoli plant, which is expected to utilise modern equipment, will only incur two per cent losses.
Lack of strong industry regulations on maintenance of high quality standards could also be responsible for the high-risk perception associated with financing of the construction sector. Due to this, incidents of collapsing buildings under construction and selling of substandard construction materials have remained rampant in the sector.
As a result of the high risk associated with financing in the construction sector, most financial institutions in Uganda tend to charge high interest rates coupled with short repayment periods in order to mitigate the likelihood of default.
Some players in the real estate sector attribute the high-risk perception to political uncertainty.
Building a house is usually long term and may take 10 years at times. Within that time, anything could happen that increases the risk of construction," said Timothy Basiima, a private external auditor and real estate developer.
With such high risk, one mortgage institution finances only shell houses while another finances only real estate developers that it identified in advance," he added.
According to Edith Tusuubira, country manager of Oikocredit, a local development finance institution, the high risk is due to people's attitude and Treasury-bill rates.
"The Treasury-bill rate is quite high at about 10 per cent. A development finance institution will top it up by 4 per cent to make 14 per cent interest while a bank will push it to 19 per cent," she said.
However, she says with the increase in number of players in the industry, the rates will go down. Already, increasing competition has reduced interest rates among microfinance institutions.
In 2005, average interest rates among microfinance institutions were about 36 per cent but this year, they have fallen to between 25 and 30 percent," she told The EastAfrican.
Oikocredit intends to approve financing for two construction projects worth $6 million by the end of March 2008.
The construction sector is seen as key in solving Uganda's growing house shortage. Currently, the country is faced with a backlog of 1.6 million housing units - 211,000 units are needed in urban areas and 1,295,000 in rural areas.
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