Industry Insiders Opine on ’09: Texans Share Strategies for Riding Out Recession

Texas Construction asked industry insiders from across the state in a variety of markets what each sees in their crystal ball for 2009. Here, in their own words, are their predictions and survival strategies.

Expectations for the Surety Industry

Joe W. Hale III is underwriting director for Travelers Bond Construction Services in Richardson:

While the surety industry is poised to show strong profits in 2008, we are becoming more guarded about the effects of the current economy on future results. Leading the challenges are issues related to liquidity and availability of work. Texas, however, is somewhat atypical and, given its strong energy sector, should hold up significantly better than most states.

The old cliché, “cash is king,’’ is certainly prophetic in today’s market.

Those contractors who have strong balance sheets and manage their debt structure prudently should be able to work through potentially difficult times.

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As for what the new year will bring, McGraw Hill-Construction recently released its “Construction Outlook 2009,” which not surprisingly predicts all sectors will decline. Overall construction starts are projected to decrease by 7%, which comes on the heels of 2008’s 12% decline.

In concert with stressed credit markets and the potential impact on public construction, issues that could impact surety premium production – as well as contractors’ revenue streams – include the ability of the public sector to obtain financing through the municipal bond market, and falling tax revenue for states, counties and municipalities. On the positive side, expected decreases in construction commodity pricing should positively impact the aggregate cost of projects.

Without question, sureties will be looking at a contractor’s top-line revenue and the potential for compressed gross margins to cover operating expense and debt service. Heretofore, a strong global construction market kept equipment demand and sales values high. More recently, however, values have begun to soften.

Banks will scrutinize contractors more closely and will be asking considerably more questions in the lending process. Sureties will want to follow the composition of financial assets on the principal’s balance sheet relative to liquidity and value. They will also want to assess the health of the financial institutions holding clients’ cash and loans. Therefore, it is important for contractors to be aware of the financial condition of their bank.

In general, Texas should continue to fare better than the national economy. In particular, school construction is quite healthy and will benefit from oil and gas revenues. Additionally, with funding from Propositions 12 and 14, highway financing is anticipated to be a positive for highway contractors.

Commercial Sector May Lose Momentum

Michelle Seward Davis is the chief financial officer for Joeris General Contractors Ltd. in San Antonio:

Due to uncertainty created by the economic downturn and a possible domino effect from the housing bust, commercial construction in Texas may lose momentum this year.

Across the state, commercial contractors will have their fair share of challenges. Recent bank failures have led to further scrutiny of construction loans. During October, for example, several projects were put on hold in private and public sectors due to funding. Contractors who have relied upon lines of credit to fund operations will be affected. With the projected slowdown, local contractors will have to cut margins to maintain their backlog of work and remain competitive with larger, out-of-town contractors.

The recent presidential election will have a direct impact on the construction industry in Texas. Immigration reform came to a standstill during the past two years, but will likely become a legislative priority this year – at the state and national levels. The fate of the Freedom of Choice Act, also known as Card Check, will likely be determined this year. If it passes, unions will have greater flexibility to organize non-union companies. The challenges are multidimensional with ramifications that could last well beyond this year.

In San Antonio, contractors have been fortunate since 2006 to compete on military construction programs. This year another $705 million in military projects is expected to be awarded. Green construction is becoming popular and LEED projects will continue to provide opportunities for commercial contractors specializing in sustainable construction. Such projects will not sustain the commercial sector, but will help stabilize the ups and downs of the market.

Historically, the San Antonio economy has remained stable regardless of national and state downturns. Contractors who have lived within their means by keeping growth and spending to a minimum will have a greater ability to weather the storm.

Contractors Need to Maintain Focus This Year

Matthew Hanna is president and owner of M. Hanna Construction Co., which has offices in Sulphur Springs:

The economic downturn that began in the residential market has now created a slowdown in the private commercial development sector. Projects dependent on a significant percentage of borrowed money are being delayed or cancelled. As this trend moves into the South Central states, contractors now must find work to replace that segment of their business.

Often contractors respond to this type of market with a strategy that includes taking work for low fees just to keep people – and other assets – working. Companies with a heavy burden of equipment debt might employ this strategy just to pay for equipment costs. This is a dangerous strategy that can backfire. What is more important is to keep key employees in place in order to protect business relationships with clients. At the same time, it is important to maintain focus on the company’s overall business plan, and to provide employees with some degree of security.

Over the past two years, our business plan has included markets that are more recession proof – such as energy and transportation. Currently our backlog is strong with new projects coming on line to replace work completed. Our target has been companies (usually general contractors) who are strong and have proven business development plans.

Troubling times can be an opportunity for companies that are prepared. There are numerous economists who each have their opinions of where our economy is headed. We believe that our markets will rebound fairly quickly because they were the last to feel the economic downturn.

Contractors Need To Control Expenses

Michael D. Smith is president of Texas Descon, a McAllen-based company that serves the commercial and industrial industry:

Even in the shadow of an economic downturn for the rest of the United States, the South Texas commercial construction market appears safe. In 2008 this region saw a 60% increase in commercial building permits.

As for the education market, four of the 5A school districts in South Texas are growing at a rate of 1,200 or more students each year. Two elementary schools per district must be built each year to keep up with population growth. In 2008 more than $300 million in bonds passed, and another $200 million will be voted on this year.

The economy is growing because new businesses are being built to keep up with the growth.

Across the board, the biggest challenge in the construction industry will be the residential market, which declined more than 50% last year. Consequently, a large number of residential subcontractors will try to enter the commercial market to offset their lack of work. What these contractors may not realize, however, is that the national recession is going to cause a slowdown in private commercial ventures. Financial institutions are going to scrutinize these ventures like never before.

Having said this, the quantity of proposed projects this year should make it possible for local contractors to be more selective in seeking out profitable projects. At the same time, it’s important that contractors control their expenses in the event this downturn lasts longer than the 15 months that analysts are predicting.

Highway Construction: ‘Opportunities Exist for the Best Companies’

Oscar Trevino, P.E., is president of O. Trevino Construction, formerly J.L. Steel. Trevino has served as mayor of North Richland Hills since 2002:

Addressing the economic stability – or status – of the highway construction market in the coming year can be likened to the proverb: “When you are up to your neck in alligators, it is hard to remember that your initial objective was to drain the swamp.”

The nation’s current financial crisis and results of the bailout are still unknown and will leave the financial market in flux for the short term. This flux will impact highway funding and the sale of bonds to finance transportation projects. We may find it difficult to come up with the funds needed to finance new capacity projects necessary for the projected growth of the North Texas region and Texas as a whole.

While this can be taken as a doom-and-gloom statement, it also presents a lot of opportunities. Our state leaders understand that continued economic prosperity in Texas is closely tied to our transportation system and the ability to efficiently move people, goods and services. The demand for maintenance of our existing system continues and, with the anticipated growth and continued prosperity in our state, the demand for additional capacity and varying modes of transportation will move to the forefront.

State leaders will come up with funding solutions to address these issues. This will provide the needed volume – and types of projects – that will help the industry stabilize its backlog, margin and workload.

With the stabilizing of the workload, there will continue to be some challenges for our industry. These include, at a minimum, workforce and immigration reform issues; air-quality issues with equipment; highway safety; and the education of management, engineers and our future workforce.

The financial instability will also force re-evaluation of individual contractors by the bonding and banking communities. These challenges will evolve into opportunities for those companies that have the foresight and leadership to address them in a proactive way. Those companies that work toward strengthening their position in the market and helping to find solutions to “drain the swamp” will continue to prosper in the upcoming year.

Backlogs Appear Healthy, But General Uncertainty Abounds

David Waddell is partner at Padgett, Stratemann & Co., Certified Public Accountants and Business Advisors. The company operates offices in San Antonio and Austin:

Among the many contractors we serve and talk to, most have a healthy backlog heading into this year and many are expecting reasonable profit margins. The decline in energy prices should enhance margins on projects bid in mid 2008 and prior. However, uncertainty about the price of energy and construction commodities will continue to challenge contractors, especially when they price bids.

A big unknown for contractors this year is how well they can replace their backlog.

We’re seeing increasing numbers of contractors on bid lists and probably will see more out-of-state contractors adding to the number. The effect of the economic crisis and the uncertainty of project financing, both in the private and public sectors, could have a significant impact on the number of projects available for bid. We expect to see declines in margins on new work.

Among the positives this year are the relative strength of the state’s overall economy, the continued need for educational and infrastructure construction, BRAC, and the expected stimulus spending in construction. Also, the construction downturn in other parts of the country may improve the availability of labor in Texas.

Contractors need to review the financial strength and commitment of their surety company. The recession has significantly impacted the capital of most insurance companies and may affect their commitment to their surety divisions. Contractors should be prepared for tighter surety credit.

The same review process should apply to banks and other lenders. Even with the increase in FDIC coverage, contractors don’t want to be tied into a weakening bank. In addition, contractors should be prepared for the possibility of a reduction in lines of credit and more covenants on loan agreements.

This year, financial strength and liquidity will be more important than ever. In a down market like this, financially strong contractors hold all the advantages.

Sunny Outlook for South Texas?

Dallas A. Cloud is co-owner and executive vice president of Moore Erection, L.P., a steel erection company based in San Antonio:

I travel around the country quite a bit through my involvement with Associated Builders and Contractors. In my talks with general contractors, subcontractors and specialty contractors, I hear varying stories about the economy. While the East Coast has seen a significant slowdown over the past year, the northern states have been struggling with a sluggish construction economy for quite a while now. But the southern region of the United States, especially Texas, remains the envy of the rest of the nation from a commercial construction perspective.

Commercial construction in the state remains strong overall due to contracts that are in the pipeline and higher public sector construction activity. Many expect that as investment capital starts to get scarce, the commercial real estate market will see a decrease in sales activity. With the loss of access to credit and the subsequent higher credit costs, commercial construction will naturally decrease. But when the markets stabilize, and they will, the credit problem should ease.

While the information I have seen from [some economic indicators] predict a 1% drop in nonresidential construction spending in 2009 and a 2% decline in 2010, I still see many opportunities for work, particularly in South and Central Texas.

San Antonio is fortunate with the large volume of work associated with Base Realignment and Closing, BRAC, contracts at the local military installations. The area closed out 2008 with $1.2 billion in contracts being awarded, and there is another $1 billion to be awarded in 2009. That alone, coupled with the $2 billion in construction related spending, will provide an even better opportunity for companies in the area.

Our company, Moore Erection, L.P., continues to experience a strong backlog of work in the Austin and San Antonio markets, where we focus on schools, retail development and government contracts.

A problem we are still experiencing, along with the rest of our industry, is the shortage of a skilled workforce. We are limited in the volume of work we can take on due to the continued shortage of skilled workers in our area. 

(Dallas A. Cloud is co-owner and executive vice president of Moore Erection, L.P., a steel erection company based in San Antonio.)

Material Costs, Accounts Receivables May Present Risks

Don Kuykendall is president of San Antonio-based Nathan Alterman Electric Co., an employee owned electrical contacting company founded in 1923:

During 2007 and 2008, the commercial, industrial, governmental and institutional markets were strong across the state. Even with a slowing economy, we expect these sectors to remain strong this year.

Commercial construction tends to be a lagging economic indicator. That is, the construction sector will stay strong even after the general economy begins to slow. This is because of the long lead time associated with large projects. Once a project comes out of the ground, it is usually completed. However, there have been exceptions to that rule. During the savings and loan bust of the mid-1980s, and again during the dot-com bust at the beginning of this decade, several construction projects were stopped in mid-stream, leaving contractors with unpaid accounts receivable.

The Texas construction industry began last year with strong momentum because many contractors had healthy backlogs. In addition, there were several large projects bid or initiated during the year. During the last few months of the year, however, we began to see a softening.

As we go forward, one of the most challenging issues for those in the electrical sector will be cost of materials. Last year we saw the cost of copper and steel skyrocket. Copper (the raw material) began the year at about $2.75 per lb and peaked at just over $4 per lb in July. Since much of our work is fixed-price and may go on for two years or more, we must try to anticipate the future price of our products.

Another major challenge this year will be obtaining motivated and skilled labor. Alterman helps  fund a five-year electrical apprenticeship and training program, an excellent source of new electricians. However, with the large amount of BRAC work and other large projects coming up, the apprenticeship program probably will not provide enough new electricians for the San Antonio market.

A challenge we have not seen yet, but with the slowing economy is likely to come up, is the collection of accounts receivable. We actually see this as our industry’s largest risk going forward.