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State of the Industry Report 2017


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Bill McConnell, provides his state of the construction and surety industries report.

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State of the Industry Report 2017

  1. 1. William J. McConnell PE JD MSCE CDT, Chief Executive Officer Andy Wallace, Engineering Intern THE VERTEX COMPANIES, INC. Forensic Consulting | Design Engineering | Construction | Environmental 2017 State of the Construction and Surety Industries 1 August 29, 2017
  2. 2. The Good •Booming Equities Market •Full Employment •Low Inflation •Low Rates The Bad •Moderate Economic Growth The Ugly •US Debt/Deficit Issues Continue Bottom Line: The US Economy is overdue for a minor correction, which will likely manifest in 2019 if not sooner. Part 1. State of the U.S. Economy
  3. 3. 8 years Equities Market Boom The stock market has been on a tear for the past 8 years, particularly due to the performance of technology companies.
  4. 4. P/E Ratio for S&P 500 Companies July 25, 2017: 26.22 Historical Average: 15.66
  5. 5. Equities Market Boom 6,443 on March 9, 2009 Note that the GDP line and the DJIA line had never intersected until 2017, another indication that a correction is near.
  6. 6. Inflation Inflation remains historically low in large part due to the compression of oil and gas prices over the past five years.
  7. 7. Oil Deflation Because of surplus inventories, oil and gas prices will likely remain flat for the next several years.
  8. 8. Employment The economy is at full employment, which will likely reverse once the next correction hits the US.
  9. 9. Interest Rates Interest rates are ticking up, albeit slowly. If there is a jump in inflation and/or a significant increase in GDP growth, the Fed will raise rates at a more rapid pace.
  10. 10. Nominal GDP Growth over the past seven years was slightly flatter than expected, which is difficult to explain based on the booming equities market.
  11. 11. Economic Growth Nominal GDP growth has been below historical average for the past decade.
  12. 12. Economic Growth – Real GDP On the other hand, Real GDP, which excludes increases due to inflation, has periodically met historical averages since 2010; thus, the lack of Nominal GDP growth is in large part due to low inflationary pressures.
  13. 13. Federal Deficit The US Government continues to operate at a deficit, which will likely be the case for the next several years at a minimum.
  14. 14. Federal Debt The federal debt level is concerning; US debt surpassed our GDP level several years ago.
  15. 15. The Good •Booming Private Sectors The Bad •Flat Public Sectors The Ugly •Lack of Skilled Workers •Cost Escalation / Thin Margins Bottom Line: Private sectors continue to boom while public construction remains flat. This trend will likely continue for the next year. Part 2. State of the U.S. Construction Industry
  16. 16. Overall Put-In-Place Construction Over the past five years the construction industry has realized a 2002 to 2006- like growth pattern.
  17. 17. U.S. Construction Industry Growth Rate Since 2011: 9% U.S. Nominal GDP Growth Rate Since 2011: 3.5% Construction is Outpacing the U.S. Economy by a Wide Margin
  18. 18. GDP v. Put-In-Place Construction Construction spending remains below GDP trend line, which suggests that there is additional room for growth over the next several years.
  19. 19. Construction starts have leveled off over the last year, largely due to the increase in land acquisition costs.
  20. 20. Private Construction Private construction is currently experiencing an epic bull run.
  21. 21. Residential Construction Fortunately, private construction growth is not primarily fueled by a surge in residential construction, which was the case from 2002 to 2006 due to subprime lending. Today’s private construction surge is more balanced.
  22. 22. Nearly 10% Escalation per Year since 2012 While CPI growth is flat, housing costs have soared over the past five years; it is unlikely that this trend will continue. Zillow Cost Per Square Foot Data
  23. 23. Apartment Vacancy Rates Despite the booming multi-family construction sector, vacancies continue to drop, which allows for a continued surge in apartment construction.
  24. 24. Office Construction Office construction has realized a bullish run since 2013.
  25. 25. Similar to apartment vacancies, office vacancies continue to drop despite the growth in office construction spending. Office Construction and Vacancy
  26. 26. Lodging Construction Hotel construction continues its surge since 2011.
  27. 27. Hotel occupancy rates continue to climb despite the growth in lodging construction spending for the past five years. Hotel Occupancy Rate in the US from 2001 to 2016
  28. 28. Retail Construction Retail construction has grown at a reasonable rate for the past seven years.
  29. 29. Again, retail vacancy rates continue to drop in spite of the continued growth in retail construction spending.
  30. 30. Manufacturing Construction Manufacturing is one of the few private sectors that has experienced a drop in spending over the past three years.
  31. 31. Manufacturing Output The drop in construction spending in the Manufacturing Sector is largely a result of flat output since 2013.
  32. 32. Health Care Construction Health Care is also a private sector that has experienced compression over the past seven years.
  33. 33. Lack of construction spending is likely attributable to massive consolidation of the health care industry.
  34. 34. Power Construction The Power sector realized significant growth from 2010 and 2014; however, growth has slowed since then due to depressed oil / gas prices.
  35. 35. Much of the construction spending in the Power sector is attributed to the conversion from coal plants to natural gas plants. U.S. Gas Power vs. Coal Power
  36. 36. Construction spending in the Power sector will likely be flat for the next several years due to stagnant demand.
  37. 37. Public Construction Public construction spending has been flat for the past decade.
  38. 38. As noted by the American Society of Civil Engineers, the infrastructure in the US is in desperate need of upgrades, so the demand certainly exists, but funding is the constraint.
  39. 39. It is likely that President Trump will have trouble passing his $1 trillion infrastructure plan based on the political turmoil that exists in Washington DC.
  40. 40. Construction Sector Review As noted above, nearly all of the predominately private sectors compressed during and after the Great Recession but since 2012 the sectors have rebounded. To the contrary, the predominately public sectors either grew or remained somewhat flat through the Great Recession, and have since compressed.
  41. 41. A troubling trend is that public construction as a percentage of the GDP is shrinking, which is boosting an already pent up demand for infrastructure repairs.
  42. 42. Sewage & Waste Disposal Construction Sewage and Waste Disposal construction spending has significantly decreased over the past decade due to a lack of local, state, and federal funding.
  43. 43. Water Supply Construction Water Supply construction spending has significantly decreased over the past decade due to a lack of local, state, and federal funding.
  44. 44. Public Safety Construction Public Safety construction spending has significantly decreased over the past decade due to a lack of local, state, and federal funding.
  45. 45. Educational Construction Spending within the Education sector has rebounded over the past three years.
  46. 46. Highway & Street Construction Highway and Street construction spending has grown at a moderate pace over the past decade, which is a bright spot for the public construction sector.
  47. 47. Transportation Construction The Transportation sector has trended slightly above flat for the past decade in large part due to large airport renovation projects.
  48. 48. Construction Workforce The construction workforce decreased by over 2 million, or 25%, after the great recession. Since then workforce has grown by over 1 million, but it remain significantly down from its peak in 2006. This is a major concern for the construction industry.
  49. 49. Average Hours Per Week In order to address the demand for craftsmen, the existing construction workforce is working longer hours.
  50. 50. Unemployment Rate - Construction The unemployment rate for construction workers has dropped by over 2% per year for the last seven years.
  51. 51. Construction Establishments Reduction of 120k companies The Great Recession caused a drop of nearly 150,000 construction establishments. Since then the number of companies remains low.
  52. 52. Construction Escalation Due to the growth in the Private Construction Sector, the average cost per square foot on multi-family, mixed use, and office construction have increased at an accelerated pace.
  53. 53. 8%/year since 2010 In 2010, the average cost per square foot of a multi-family project was $127/SF; in 2017 the average cost is $187/SF, which equates to an average annual increase in cost of 8% (4 times the CPI).
  54. 54. Although the construction industry has realized significant growth since 2012, the net profit margins of engineering and construction firms remain thin. Due to the shortage of public construction work, Heavy Contractor margins have cut in half since 2012.
  55. 55. 2004: 18% 2009: 26% 2016: 30% Over the past decade, the construction industry has consolidated. The number of overall contractors has dropped by 150,000 and the market share of the top 100 contractors (per ENR) has increased to 30%, nearly double the market share from 2004. Market Share of the Top 100 Contractors
  56. 56. The Good •A Decade of Low Loss Ratios •Expansion into international markets The Bad •Limited Growth •Soft Market Conditions The Ugly •Loss Cycle is Nearing? Bottom Line: Premium is flat and market conditions are soft yet loss ratios remain remarkably low. Part 3. State of the Surety Industry
  57. 57. Total US Insurance Premium: $2.1 trillion US Property & Casualty Insurance: $597 billion Surety: $5.5 billion The surety industry is niche product offered mainly by P&C carriers. The US premium of $5.5B represents 0.25% of overall insurance premium and approximately 1% of overall P&C premium. Insurance Market Overview 2015 NAIC Data
  58. 58. Breakdown of the P&C Marketplace As noted before, surety premium represents approximately 1% of overall P&C premium in the US.
  59. 59. Breakdown of the Insurance Industry
  60. 60. The Surety Industry Continues to be Profitable for the 12th Consecutive Year, Despite Modest Premium Growth. Premium growth in the surety industry has been flat since 2008, mainly due to flat public construction spending. The Surety Industry Continues to be Profitable 2008 Premium: $5.6 billion 2016 Premium: $5.8 billion
  61. 61. 2006 - 2016 Overall surety performance over the past decade has been spectacular, with loss ratios averaging between 10% and 20%.
  62. 62. Premium and loss figures have been consistent since 2006, unlike the volatility the industry experienced in the mid-1980s and between 2000 and 2005.
  63. 63. As shown above, surety premium trends closely with public construction spending. If public construction rebounds, the surety industry will experience an associated spike in premium.
  64. 64. Over the past 30 years, the surety industry has experienced massive consolidation. Only 4 of the top 15 surety providers from 1990 remain today.
  65. 65. • Berkshire Hathaway (#29) enters surety market (Jun 12, 2014) • ACE acquires Chubb (#5) (Jan. 14, 2016) • XL exits surety marketplace (Mar 7, 2016) • Markel acquires SureTec (#19) (May 1, 2017) • Intact acquires OneBeacon (#21) (May 2, 2017) Surety consolidation has continued over the past five years, albeit at a slower pace. Surety News
  66. 66. Market Share of the Top 10 Surety Providers In fact, the market share of the Top 10 surety providers topped out in 2008 at 68% and has since pulled back to 62%. 1980: 21% 1990: 42% 2004: 67% 2008: 68% 2014: 63% 2016: 62%
  67. 67. 1. Quality Issues 2. Labor Shortages 3. Lack of Growth in Public Construction 4. Inflation Top Risks that Face Contract Surety Providers in 2017