Construction Contractors See Shrinking Margins

The Bureau of Labor Statistics (BLS) measures four building types and four specialty trade contractor output indexes. The construction trade indexes have just a little more than a year of history, making them more difficult to analyze; however, all four are trending lower. The four building-type output indexes have sufficient history at this point and can paint a clear picture of how contractors' margins have reacted to the fallout in nonresidential construction. These indexes began to decelerate year-over-year (y/y) during the summer, as nonresidential construction spending started to decline.

The index for new school construction has shown the most dramatic deceleration. During the first half of the year, the index rose in the double digits. Since June, however, the index has cooled and only increased 0.8% in September. We expect to see this trend continue through 2010 as state and local governments continue to struggle with smaller budgets, leaving contractors with fewer projects to pursue. The American Recovery and Reinvestment Act included $39.5 billion for school modernization, renovation, and repair, but it did not include any direct school construction funding. In order to remain competitive in the market, contractors will continue to submit lower bids in hopes of winning contracts, and margins will be slashed.

Output indexes for construction of industrial buildings and warehouse buildings have also indicated a slowdown since peaking at the beginning of this year. Nevertheless, neither of these indexes had increased as aggressively as new school construction prior to reaching their peaks. We expect both to continue to dwindle as corporate budgets remain under pressure through 2010.

The decline in construction activity has placed downward pressure on building-material prices as well. These prices, tracked collectively as an index by the BLS, have been decreasing since February, dropping a hefty 8.3% y/y in the third quarter. They had not declined on a y/y basis since the second quarter of 2002, and not this sharply since the index began in 1986. On a full-year basis, we expect the index to drop 4.8% this year and stabilize in 2010.

Lower input prices should provide some relief to nonresidential construction contractors during the current building slump. Still, this will not be enough to keep their margins afloat as they continue to see a tough road ahead.

by Arminé Thompson