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The residential construction party is over. And the hangover looks severe

On the back of a six year property construction boom fed by rising house prices and an under-supply of housing stock, the construction tap was turned off quite abruptly when prices for houses and apartments started to fall about 18 months ago.

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For Adelaide Brighton, Wednesday’s earnings downgrade is its second over the past six months – suggesting that conditions have deteriorated faster than it expected when it issued its first warning back in May.

While some 40 percent of Adelaide Brighton’s profit downgrade is the result of company specific issues, the remainder reflects market based issues.

The company now expects full year net profit to come in at between $120 million and $130 million – a major decline on the $190 million it earned in full year 2018.

It looks to be brewing into a perfect storm for building materials companies who are being hit with the combination of lower demand in numerous geographical pockets, increased competition (which affects the prices received) and a hike in raw materials costs.

Equally disturbing was Adelaide Brighton’s announcement that it would take a writedown of up to $100 million in the value of its business.

As part of its exercise to shore up the balance sheet the cement maker has decided to withhold its 2019 second half dividend. The company also felt the need to assure investors that after any balance sheet impairments it would remain inside its banking covenants.

None of these building materials companies have yet reported results for the second half. But in the first half of 2019, Boral Australia delivered earnings before interest tax amortisation and depreciation of $271 million which was down 8 percent.

At the time, Boral Australia said growing infrastructure activity had offset residential construction.

Adelaide Brighton, however, noted on Wednesday that it had seen a further softening of conditions in residential and civil construction (infrastructure) markets.

(While infrastructure construction markets are considered to have held up relatively well – there have been signs of recent weakness which experts have put down to the timing of new projects rather than anything more sinister.)

The construction slump was outlined clearly in June economic statistics released this week which showed building approvals fell -1.2 percent to be 25.6 percent lower than a year ago. Trend approvals are now annualising 174,000 which is the lowest since June 2013.

Year on year building approvals for houses has fallen 14.5 percent while approvals for apartments have plunged 38 percent.

And given there is a backlog of property supply still sitting in the pipeline there is an expectation that the building approvals numbers will get worse before they get better.

Supply will get tighter as this backlog washes through the system but that will take some time – some economists suggest as long as two years.

In the meantime, building materials companies will wear the pain of operating during this cyclical low. According to UBS the outlook for local building materials remains mixed.

‘We estimate that the known decline in housing approvals will lead to 5 percent decrease in demand for concrete over the next 12 months. But surplus capacity will not just be limited to cement companies. In our view, over the past five years the building materials industry as a whole has built itself around a 225,000 approvals rate.’

A note to investors JP Morgan issued on Tuesday ( before the Adelaide Brighton announcement) warned that CSR and Adelaide Brighton were most exposed to residential construction activity – accounting for 53 percent and 32 percent of group revenue, respectively.

It seems that not only is the construction party over – the hangover looks to be more severe.

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