COVID-19 is sparking a major profitability crisis for SMEs in construction

The Euler Hermes analysis expects that insolvencies in the construction sector in Europe will increase by 14-24% in 2020, with Spain and France reaching the top, while the United Kingdom is at the opposite pole. Analysts expect the number of insolvencies to increase by + 24% in Spain, + 19% in France and the Netherlands and + 15% in Italy and the United Kingdom. Because of structural problems, the construction sector already accounts for 20% of total insolvencies, with Covid-19 exacerbating the vulnerabilities of SMEs, making them even more fragile; large companies are not immune either.

Covid-19 is sparking a profitability shock for SMEs in the construction sector. SMEs represent the lion`s share of companies in the construction sector, with about 80% of the sector`s turnover in Europe. But unlike large diversified companies, which are resilient and well positioned to weather the Covid-19 crisis, a large number of SMEs could face severe difficulties.

”Regarding Romania, if solely demand is concerned, the construction sector performed above expectations. The more than 22% growth (both in gross and seasonally-adjusted terms) of construction index for the first 5 months of 2020 coupled with positive rates for all sub-segments gives grounds for optimism. Without neglecting the impact of an election year in spurring demand, the evolution also signals the change in governmental policy from a heavy focus on consumption spending more towards stimulating investments. True, the major infrastructure projects do not yet appear in the statistics as the biggest increases – of more than 50% – appear under the sections of capital repairs and maintenance works.

In line with trends from other countries regarding remote working, the Real Estate Office segment had the lowest increase of all segments at 4% (gross terms) as of May20 and we expect the pace to slow down further as most of the initiated projects before the start of pandemic are being finalized.

Even if the RE residential segment advanced by more than 19%, the number of new buildings permit dropped 15% up to May20. Somehow to counteract the normal decline, the change of the state-loan guarantee program to include a much larger guarantee cover is likely to prompt the development of the residential segment growing also further than 2020. However, the potential side-effects are controversial as they could imply a significant inflation in appartment prices unless a shock to household revenues occurs. As to the large company vs. SME topic, the former are also likely to be favored in terms of profitability for Romania, too. This would be pinned not just on easier access to public and private bids/tender but especially in terms of access to financing. Even if the pandemic impact towards revenues of local construction companies was less than towards other economic sectors, strong competition coupled with highly fragmented market and the costs related to protection towards the spreading pandemic will put pressure on margins and on SMEs in particular.

Local SMEs – weakly capitalized and with low negotiation power have reduced acces to bank facilities, with a direct effect on liquidity and slowing down payment terms. Despite falling more than 30% vs May19 YTD, number of insolvencies in constructions still hold an un-enviable 2nd place after the vast sector of trade (wholesale+retail) in terms of weight in total insolvencies, actually rising a bit to 17% vs. 15% as of May19. We expect the number of insolvencies in constructions to rise starting with Q1 of `21 unless profit margins and solvabilities of buyers are salvaged,” said Mihai Chipirliu, CFA, Head of Risk Analysis Euler Hermes Romania.

Before Covid-19, construction was coming off a cyclical peak but still in expansionary mode, with the largest companies presenting a solid financial outlook. But as a sector dependent on physical activity, construction has seen significant business interruption from the Covid-19 pandemic, despite being classed as essantial activity in many countries. We expect Covid-19 pandemic to reinforce the already opposing dynamics between large and small companies in the sector.

SMEs represent the lion`s share of companies in the construction sector, with about 80% of turnover in Europe. Companies with less than 250 employees ake up 99% of the total, while the smallest companies, those with less than 49 employees, account for 98%