BMI View: Our view has been that the UK's rail sector will continue to outperform the rest of the country's construction sector. This is playing out with Network Rail's CP5 GBP12bn investment package being pre-tendered after a review from rail regulators. Whilst the opportunities for contractors may be limited due to the framework used to implement Network Rail projects, that same framework will allow for work to commence swiftly and provide a boost to growth in the rail sector and related industries.
The Control Period 5 (CP5) investment package planned by Network Rail, which has been a major part of our positive view on the UK rail sector since it was published in 2012, continues to move forward with the announcement that Network Rail Infrastructure has started pre-tendering for alliance partners to deliver the London North East and East Midlands area improvement programme. The works are estimated to be worth at least GBP240mn, rising to GBP1.2bn over the CP5 depending on project approvals.
The UK's rail sector has been a bright spot in an otherwise bleak construction sector over the last few years. The level of investment earmarked to expand and improve the country's railways, including megaprojects and maintenance, is creating opportunities for European infrastructure companies and driving our outlook for strong growth in railways infrastructure industry value. Network Rails CP5 plan to invest GBP12bn in new infrastructure between April 1 2014 and March 31 2019 further reinforces the long term potential of the sector.
|Railways Leading The Growth Story|
|Construction Sector Real Growth Rates (% Change Year-on-Year)|
Whilst we maintain our positive outlook for the sector, there are some issues dragging on the potential for high growth. Firstly, as we previously noted, the CP5 plan was subject to approval of the Office of Rail Regulation (ORR) has set out the final draft of its proposals for rail funding and performance over the next five years. Cost reductions were expected and the ORR suggested cost cutting measures to the CP5 are to see GBP1.7bn shaved off the budget, although GBP2bn was the initial estimate. Network Rail have until February 7, 2014, to either accept or reject the ORR's proposals, but we believe that the majority of the CP5 GBP4bn allocation to be spent annually on upgrading railway infrastructure should escape cost cutting, although those projects in the very early stages of planning may be targeted. As the government is heavily pushing for increased rail capacity, it is likely that efficiency within Network Rail will be the main target for cost cutting.
A second factor limiting the opportunities in the rail sector is the framework being used to tender the projects. The multi-asset framework agreement (MAFA) allows Network Rail to pre-qualify contractors who are then allocated a region - and will be handed all contracts in that region over the framework period, consequently there is no need for tendering and work can commence in a matter of weeks rather than months. Whilst the speed in which projects can be implemented should help create activity in the sector, the MAFA agreements do limit the opportunities for contractors to get into what is a high growth market. By pre-qualifying only a handful of companies for a five-year period, competition in the rail infrastructure market is somewhat limited - at least for Network Rail contracts.
That said, for the partners that do make it on to the framework, which will include more Tier 2 contractors for CP5, the London North East and East Midlands area improvement programme should prove lucrative. Indeed, also for those companies who supply the rail infrastructure industry, the drive to improve rail capacity should also see an increasingly positive outlook. For example, Tata was awarded contracts to provide tracks for Network Rail until at least 2019. The London section alone of the pre-tendering projects include:
Lot 1 signalling: GBP53-273mn
Lot 2 track construction GBP89-459mn
Lot 3 station and structures GBP62-322mn
Lot 4 overhead lines GBP36-£186mn
One risk we highlight with this project is its technical nature, which could impact rewards offered for punctual delivery of new infrastructure. During the upgrade and improvement programme European Train Control System signalling is to be introduced on the East Coast Main Line. This presents a performance risk during the construction period as the changes to current operating methods are bedded in. That said, working with Network Rail adds an element of security to contractors due to their push to deliver on time and on budget projects in light of government pressure. Network Rail has met or exceeded its targets for upgrading the network and delivering major projects over recent years, such as the GBP550mn redevelopment of King's Cross station in London.