Construction Companies Desperate for Financing... Emergency Due to Profit Margin Deterioration

Continued Economic Downturn in the Second Half

Revision of Profitability Maintenance Strategies Inevitable

[Asia Economy Reporter Kim Min-young] Construction companies facing rising raw material prices and concerns over a construction market downturn are now encountering red flags in financing due to rising market interest rates. Consequently, worries about deteriorating profit margins this year are growing. In particular, as forecasts predict the construction market slump will continue into the second half, an increasing number of construction companies are expected to find it unavoidable to revise their management strategies to maintain profitability.

On the 7th, Lee Eun-hyung, a research fellow at the Korea Construction Policy Research Institute, analyzed, "Long-term corporate bond (CP) rates and corporate bond rates (BBB-) continue to rise," adding, "The increase in corporate bond and CP rates, which are financing costs, will exacerbate financing difficulties in the construction industry and are expected to worsen profit margins."

The Bank of Korea has raised the base interest rate five times since August 2021. There are projections that if additional rate hikes occur in July and August to keep pace with the U.S., which has pledged a giant step (0.75%), South Korea's base rate could also rise to 3%. The interest rate hikes increase the burden of financing, and combined with concerns about the economic downturn and rising raw material prices, construction companies are now forced to revise their management goals for the second half. When market interest rates rise sharply, the interest rates payable on corporate bonds issued also increase, raising the portion of interest expenses in total costs and thereby eroding profitability.

The problem is that these risk factors are unlikely to be resolved in the second half. Research fellow Lee stated, "The sluggishness in the construction market has continued in the first half, and expectations for recovery in the second half have been dashed," forecasting, "It is highly likely that the construction market will remain sluggish in the second half."

In fact, the Construction Business Survey Index (CBSI) for June recorded 64.7, down 18.7 percentage points from the previous month. This is the largest drop since January 2020 (20.5 percentage points) during the COVID-19 outbreak, and the index itself is the lowest since April 2020 (60.6). Although the July forecast is 73.6, indicating a slight increase, it remains low compared to last year and early this year, reflecting the poor sentiment in the construction sector.

The upward trend in raw material prices, which worsens construction companies' profitability, shows no signs of abating. Concerns are growing over construction delays, extended construction periods, and deteriorating profitability due to soaring construction material prices and supply disruptions. Conflicts over increased construction costs between clients and contractors are also intensifying.

The site manager of D Construction Company working at an apartment site in Cheonan, Chungnam, said, "The surge in construction costs due to rising material prices is a typical example of conflicts like those seen in Dunchon Jugong." He added, "Subcontractors are demanding that the increased material costs be reflected, but the main contractors also lack the capacity to accommodate these demands." Although the volume of orders has increased compared to before, to avoid becoming 'poverty in the midst of plenty,' individual construction companies must maintain the cost ratios they have internally set.