Financial review – 2004

01 May 2008

After a strong bounce — back in 2003, the stock markets were expected to grow again last year. This was certainly the case, although it was far from being a straightforward recovery.

This was best illustrated by the Dow Jones Industrial Average, which started the year well enough, but then dipped on the news of rising oil prices, rising interest rates and the inevitable uncertainty in the run—up to the US Presidential elections in November. As a result, it gained only +2,12% over the year.

Indeed, a simple mathematical average of the 53 end—of—week values of the year gives a figure of 10329 points, which is below the Dow's start and finish points for 2004, and gives some indication of the mid—year dip it suffered.

The major European Indexes enjoyed more stability than the Dow in 2004. Although they suffer from the same summer jitters as the Dow they were not as severely affected, and finished the year with bigger 12—month gains. The FTSE 100 was up +6,67%, very similar to the CAC 40 at +6,63%, while the Dax Composite was ahead a little more with a +6,86% gain.

By coincidence, the Japanese Topix 500 Index saw an almost identical year—on—year gain to the FTSE and CAC 40, with a +6,67% rise. Although the net result was the same, the Topix's shape over the year was different to the European Indexes, with an early surge that subsided over the middle two quarters.

Construction Shares

But while the gains of the major indicators may have been unexceptional, the construction sector had a sensational year. The CET Index rose an impressive +16,25% over the year, with the CEC Index for the contracting sector putting on a staggering +32,77% rise. The materials sector also performed well above the level of the general markets, with the CEM Index recording a +17% increase. The equipment sector meanwhile was more subdued, with a more sedate +6,26% improvement.

The biggest gainer in the contracting sector was Ballast Nedam, which saw its shares rise +190,46% over the year. This robust gain would seem to indicate that the company has recovered from a dark period that began in the summer of 2002 with major problems in its UK arm.

The company's share price collapsed from around €22,50 to around the €5—mark on the news, and stayed there for some 18 months. Things only really began to improve in the latter part of 2004 when Hochtief announced it had sold its 48% interest in the company to two Dutch investment companies. The sharp increase in Ballast's share price in the last few weeks of 2004 could indicate that these two investors are seeking to increase their holding in the company.

Other stars of the contracting sector in 2004 included BAM, Carillion, Eiffage, NCC, Veidekke and Vinci, all of which saw their shares go up +50% or more. Only Impregilo, Mowlem and Strabag saw their shares fall over the year. A few companies — Bilfinger + Berger, Hochtief and OHL — saw only marginal gains in their values, but the rest of the sector enjoyed double—digit growth generally ranging from +20 to +45%.

A further indication of the sector's buoyancy over the year is the fact that there were no less than three stock splits, with ACS, Eiffage and YIT all finding the need to increase the volume of their shares in circulation.

The question why the contracting sector was so buoyant in 2004, particularly in the final quarter is a difficult one, with no immediately obvious answer. Financial results were generally good, but there was no quantum leap that would seem to justify such a sharp increase.

The other generally positive factor was the continuing climate of low interest rates, which stimulates the residential sector in particular, and also gives contractors access to cheap debt to fund projects. But again it is difficult to see why this should have such a major impact. After all, interest rates have been low since late 2001, and while the Euro Zone rate was static in 2004, the UK Bank of England rate increased. So if anything, it would seem that the interest rate climate worsened slightly last year.

Financial results were generally good, but there was no quantum leap that would seem to justify such a sharp increase.

On the downside, contractors had to contend with rocketing steel prices last year. Even if some of this inflation were passed on to clients, it would be reasonable to expect the continuing commodity price bubble to impact on profits.

The final, most baffling factor is that this increase has come on the back of weak general conditions. GDP growth in Europe, particularly the Euro Zone, remains weak compared to the rest of the world. As a result, construction output probably only increased about +1% overall last year. A +1% increase in output would hardly seem to justify a +32,77% rise in stock market valuation.

Having been the star sector in 2003 it is perhaps unsurprising that equipment manufacturers’shares were less impressive last year.

But the point to remember is that share prices and stock markets reflect future expectations rather than the current situation. Shares are attractive purchases if investors believe they are undervalued in terms of the future dividends and growth they will yield. So one interpretation of the contracting sector's boom in 2004 would point to growing investor confidence in the sector and perhaps stronger profits and dividends in the near future.

Materials

With a +17% increase over the year, 2004 was clearly a good year for the materials producing sector. All the component companies of the CEM Index saw their shares rise over the year, with the clear pick of the bunch being Schindler's +46,03% increase. Most of the other companies in the index managed increases in the region of +20% to +35%. Hanson, Pilkington and Saint—Gobain were a little way below this level, while the only disappointments in the sector were Cimpor, Lafarge and Schneider, which managed only marginal gains over the year.

The biggest story of the year of course was Cemex's proposed acquisition of RMC. By valuing RMC at €3,38 billion, Cemex looks set to complete the biggest acquisition ever by a Mexican company. The valuation was a 39% premium on RMC's share price in the 30 days running up to the September acquisition announcement, and unsurprisingly, was warmly welcomed by the UK company's shareholders.

Such a large, and some would say over—generous takeover bid naturally sets investors thinking about which company is the next potential target in a consolidating industry. There was certainly a slight knock—on effect following the Cemex/RMC announcement with both Hanson and Aggregate Industries seeing their share prices rise a little. There was also a slight steepening of the CEM's growth line in the final quarter of 2004, which may indicate that investors were buying into the sector in the hope of more takeover offers materialising.

Europe's materials producers were affected by the same outside influences as its contractors over 2004. Underlying economic growth was weak, and the construction market expanded only marginally. Profits were forthcoming from the sector, but like the contracting sector there were no spectacular surprises. Against this backdrop, it is encouraging that the materials sector achieved a +17% increase in stock market value. Like the contracting sector, this could indicate a market sentiment that the future will be brighter for heavy materials producers.

Equipment

Having been the star sector in 2003, with a +35,86% rise, it is perhaps unsurprising that equipment manufacturers’shares were less impressive last year. Despite a surge in the early part of the year, 2004 saw the CEE Index gain just +6,26%. Much of this can be attributed to the fact that the sector is dominated by US—owned companies, which saw their shares follow the Dow's uncertain path throughout the year. However, there were other factors at play.

The big gainers in 2003 were the Asian manufacturers, which benefited most from the booming demand for construction equipment in China. However, 2004 was a quiet 12 months for these companies, most notably Hitachi and Daewoo, which were the only two manufacturers on the CEE to see their shares fall. Other manufacturers in the region did see their shares appreciate, but these increases were generally smaller than those of the European and US manufacturers.

On the positive side, there were impressive gains for Gehl, Palfinger and Terex, which saw their shares rise by more than +50%. Indeed, it was the second year in a row that these three companies have seen a stock market growth of this magnitude. Since the start of 2003 Gehl has risen +152%, Palfinger is up +199%, while Terex has achieved a +296% rise.

With the US double—deficit showing few signs of improving, the European Central Bank may have to start intervening on currency markets to weaken the Euro and help out the region's exporters.

While these three companies stand out from the crowd, it was a generally good year for the sector. Most of the CEE's constituent companies saw double—digit gains in their share prices, and many of the US manufacturers hit all—time highs.

The impact of these on the CEE would have been greater if it were not for the depreciation of the US Dollar. Many of the US companies’gains came towards the end of the year, as the Dollar began to plummet against the Euro once again. Since the CEE is a measure of stock market valuation in Euros, these price gains had a diminished effect on the Index. Indeed, this is another factor that explains the relatively poor performance of this Index over the year.

Currencies

After showing signs of a recovery at the start of 2004, the US Dollar collapsed to new lows against the Euro as the year drew to a close. The Euro finished the year valued at US$ 1,33, making the European currency +5,58% stronger than at the start of 2004. Although on average it weakened over the year against the Dollar, this sudden rise against the US currency in the final two months was a source of major concern for Europe's exporters.

The Dollar's slide began around mid—2002. In early May of that year €1 was worth US$ 0,89, so it has appreciated almost +50% in the space of two and—a—half years. The magnitude of this change is a problem in itself, but the steepness of the Dollar's fall at the end of last year is perhaps even more alarming. It spent the middle part of the year valued at around US$ 1,20 to US$ 1,24 against the Euro. However, the final quarter saw it drop just over —10% to finish at US$ 1,33 to the Euro.

While the Euro strengthened against the Dollar, it weakened against most European currencies throughout the course of the year. There were marginal gains against the British Pound and Swedish Krona, but otherwise it lost ground, particularly to the central & eastern European currencies.

Outlook

With the general economic climate looking likely to continue its improvement, 2005 should be another year of moderate gains for the world's stock markets. Whether the construction industry can continue to beat the mainstream markets remains to be seen. In the short term it may not, simply because it performed so well at the end of last year. Certainly the contracting sector is likely to slow and maybe even fall back a little in the first quarter following its robust rally at the end of 2004.

The key economic issues continue to be the weakness of the Dollar and high commodity prices. With the US double—deficit showing few signs of improving, the European Central Bank may have to start intervening on currency markets to weaken the Euro and help out the region's exporters.

The issue of commodity prices is a more complex one. Geopolitical stability in the Middle East obviously has a bearing on oil prices, but it is not just the supply side that is a problem. Booming economic growth in Asia, particularly China, is acting as a massive black hole for a range of basic materials, including oil, steel, coke and cement. If demand for these fails to cool, prices will stay high and inflation could start to head upwards.

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