Construction

Annual Report 2005

AS A RESULT OF MAINTAINING THE PACE OF GROWTH IN SPAIN, EXPANDING IN STRATEGIC MARKETS AND FOCUSING ON PROFITABILITY AND CASH FLOW, FERROVIAL WAS ONCE AGAIN AMONG EUROPE'S LEADING CONSTRUCTION COMPANIES, WITH A PRESENCE IN ALL SEGMENTS: CIVIL ENGINEERING, BUILDING AND INDUSTRIAL CONSTRUCTION.

COMPETITIVE SITUATION

Spain

As has happened since 1997, construction was one of the Spanish economy's main growth engines in 2005 (over 17% of total GDP): the construction market grew by over 5%, several tenths of a point faster than Spain's economy as a whole.

This trend in the construction industry will foreseeably be sustained in the medium term: the outlook for 2006 suggests that the industry will grow by around 4%. Specifically, Spain's 2006 budget estimates a 3.8% increase and the more recent FUNCAS (Fundación de las Cajas de Ahorros) survey estimates 5.1% growth. The 2004-2008 Kingdom of Spain Stability Plan envisages that construction will continue to grow but at a more moderate pace.

This stable outlook is underpinned by several factors:

•The 2005-20 Strategic Transport Infrastructure Plan (PEIT), approved by the Spanish Cabinet in July 2005, with a planned investment of 249 billion euro. The size of the investments and the long period of execution lay the foundations for continued growth in the infrastructure sector.
In order to guarantee funding and deadlines and maintain budgetary stability, the Plan envisages that at least 20% of investments will be made by private initiative.
In addition to concession formulas, which involve demand risk, the PEIT envisages other formulas: PPP (Public Private Partnerships) and PFI (Private Finance Initiatives).

• The Environment Ministry's AGUA Programme, which includes an investment of 3.9 billion euro in the Mediterranean area. The main investment is to develop over 20 desalination projects worth over 1 billion euro, some of which were in the execution phase or were announced for early 2006 (e.g. a 6-plant project developed by state-owned company ACUAMED).

• Public administrations' budgetary stability and construction groups' financial soundness may offset the gradual decrease in other sources of infrastructure funding. The PEIT states that "it is envisaged, in principle, to offset the possible reduction in EU funds by increasing the allocation of funds in the General State Budget, subject to compliance with the current budgetary stability commitment".

Once again, there was a significant increase in government contracts in 2005 (+25%), reaching a new record high of nearly 40 billion euro, again driven mainly by a large volume of contracts from regional and local authorities.

Central government tenders rose 13% in 2005 after the logical slowdown due to the government changeover in March 2004. The increase was due mainly to greater activity by the Development Ministry (+14%) and Environment Ministry (+33%).

In 2005, residential building reached a record high of 800,000 of approved housing units, which ensure this segment's continuity in the medium-term, although growth (+5%) was more moderate than in previous years.

Public administrations, especially regional authorities, intensified their focus on privately-funded infrastructure projects in 2005: a large number of highway concessions were tendered under the shadow toll system and there was a growing number of non-residential projects (hospitals, conference centres, courts, police stations, etc.). This public-private collaboration is a complementary approach to infrastructure development since it increases efficiency in development and maintenance.

On 16 December 2005, the heads of the EU-25 states approved the 2007-13 budget which, though pending approval by the European Parliament, outlines how the structural and cohesion funds will be allocated between 2007 and 2013.

As expected, Spain will receive a smaller amount of structural and cohesion funds in that period, which might be offset with private initiative (around 20% of Spain's infrastructure projects in the last few years), in addition to budgetary financing. Nevertheless, this reduction in funds will not affect the construction industry in the short and medium term since the 2000-06 funds are applicable until 2008.

Moreover, Europe's construction companies are focusing on future growth in other markets (especially Eastern Europe, particularly Poland), which will receive significantly more funds to develop their infrastructure.

Other countries

The recovery that commenced two years ago in the volume of new contracts outside Spain continued in 2005, boosted once again by the situation of Spain's natural markets (Mediterranean Europe and Latin America) and the opening of new markets with growth potential, such as Eastern Europe. In 2005, Spanish construction groups also increased their interest in the US market: Ferrovial acquired construction group Webber, one of the leading transport infrastructure companies in Texas.

As a result of the entry into the European Union of several Eastern European countries and their need to develop major infrastructure, that region has become one of the main expansion areas for European constructors. Ferrovial has concentrated part of its growth plans in Poland, where it acquired subsidiary Budimex in 2000.

Poland is the largest new EU member, it has a similar population to Spain, its GDP is just 25% of Spain's, and its construction market accounts for just 13% of Spain's. With these conditions, its growth potential is estimated to be high, boosted by structural funds and foreign direct investment.

After a severe recession in Poland's construction market, 2005 confirmed the recovery in the industry: the construction market grew around 7% in real terms and outperformed GDP for the first time since 1999. The projections suggest that this trend will continue in the future: Euroconstruct forecasts 8% growth in real terms between 2006 and 2008.

The main growth driver in Poland's construction industry will be civil engineering. Poland will receive practically three times more structural and cohesion funds in 2007-13 than in the previous 2000-06 plan, through the Instrument for Structural Policies for Pre-Accession (ISPA) and Phare. Poland's 2007-13 National Development Plan envisages that it will receive 134.472 billion euro, half of which will be used for transport infrastructure and the environment.

In 2005, Ferrovial also reinforced its construction activity in the United States. In September, Ferrovial reached an agreement to acquire Webber, one of Texas' largest construction groups in infrastructure civil engineering, aggregate recycling, and extraction and supply of sand.

Although the US construction market is mature (8.5% of GDP), it has significant prospects for infrastructure investment, driven by substantial growth envisaged in GDP, Federal funds for transportation, and new extra-budgetary methods for infrastructure financing.

Texas is the US's second-largest infrastructure market, with annual investment of around 65 billion euro (7.5% of the US total), of which approximately 15% corresponds to transportation and the environment. It is also the second-largest recipient of funds under SAFETEA (Safe, Accountable, Flexible and Efficient Transportation Equity Act), which approved a minimum budget of 286 billion dollars (244 billion euro) for the 2004-09 period, a 38% increase on the funds under its predecessor, TEA-21.

The largest investor in transport infrastructure in Texas, and Webber's largest customer, is the TxDOT (Texas Department of Transportation), which is in charge of building and maintaining highways and improving transport infrastructure (airports, public transport, etc.). Recently, the TxDOT was authorised to promote new alternatives for infrastructure financing and to issue bonds. The TxDOT's 2006 investment budget amounts to around 4.7 billion euro.

STRATEGIC POSITIONING

Ferrovial continues to focus on the construction market as a strategic activity, based on sound growth and profitability and its considerable capacity to generate cash flow with which to fund the group's diversification and international expansion.

Ferrovial's main objectives in construction are as follows:

• maintain its leading position in the sector and seek greater growth based on:

- controlled growth in projects and increasing the number of new contracts with private-sector customers;
- increasing construction work through direct and indirect (other company businesses such as infrastructure and services) involvement in concession projects under the new private financing formulas;
- expanding a stable international presence in markets chosen because of their stability and future growth capacity;

• improve profitability by:

- carefully selecting projects, prioritising returns over volume;
- seizing opportunities and synergies through coordination between the various construction businesses and the group's other activities;
- creating value and gaining a competitive edge by providing solutions and technology;
- improving productivity by using new technology;
- always satisfying customer needs: improving quality in construction, environmental management, etc.

Outside Spain, Ferrovial's construction activity is focused on: Eastern Europe, by becoming the leader in Poland; the US infrastructure market's potential, after acquiring Webber; maintaining a stable structure in other countries, mainly Portugal, Italy, Ireland, the UK, Chile and Puerto Rico; and entering new markets with growth potential by creating stable, sound local structures or making selective acquisitions.

Ferrovial's strategy for bidding and choosing markets is based on:

• selective bidding for contracts in stable countries and projects without default risk;

• entering the US, UK and other markets, following the company's expansion into the concession and PFI businesses;

• using Budimex's position in Poland to enter other East European countries and Webber's position to enter other markets in the US.

Budimex's immediate objectives are to maintain its position as Poland's largest construction company; reinforce its position in industrial works, environmental projects and railway infrastructure; establish a stable presence in neighbouring countries; and boost businesses that generate induced construction work (infrastructure and real estate), based on Ferrovial's know-how.

Webber's strategy is to continue being one of Texas' largest construction companies by taking advantage of the opportunities afforded by a growth market and participating in infrastructure concession projects headed by other group companies such as Cintra; reinforce its leading position in the highway segment by entering new types of projects in the medium term; take advantage of new opportunities in the stable, profitable recycled aggregate business and in other construction materials activities; and strengthen its growth and profitability capacity through internal dimensioning and implementation of parent company practices.

SIGNIFICANT EVENTS

As a result of the pace of production and new contracts in Spain and elsewhere, Ferrovial continues to strengthen its position as a leading construction group. In 2005, production increased by 22%, boosted by the Spanish market (+14%) and other countries (+49%), especially Poland and the first-time consolidation of Webber (US) in the fourth quarter.

The backlog (one of the main barometers of future performance) ended 2005 with another record: 7.5 billion euro (+11.6% vs. 2004), ensuring 20 months' activity. The Spanish market accounts for 75% of Ferrovial's backlog. The backlog in other countries totalled 1.871 billion euro, primarily in Europe (60%) and, for the first time, in the United States (24%).

The main contracts in Spain include construction of the Ocaña-La Roda toll road in Toledo, re-routing through tunnels of the stretch of the M-30 road between the Segovia and San Isidro bridges (Madrid), the Polopos-Albuñol highway (Granada), Málaga airport terminal, two sections of the high-speed railway line in Galicia, between Lalín and Santiago and between Cerceda and Meirama (La Coruña), and the Abroñigal bypass sewer and the Valdebebas subdivision site development (both in Madrid).

Major projects outside Spain include the expansion of Dublin's M-50 ring road (Ireland) and the construction of the M1 crossborder motorway between Dundalk (Republic of Ireland) and Newry (Northern Ireland, UK). In Portugal, Ferrovial won contracts to build the Loureiro-Monte Novo canal and the Lisbon Music Conservatory; and in Chile, the Chillán bypass. Industrial construction projects include expansion of the Dhekelia desalination plant (Cyprus), the El Prat water treatment plant (Barcelona) and the expansion of the Munguía sewage treatment plant (Vizcaya).

In Poland, Budimex reinforced its position as the country's largest builder in terms of revenues, which grew by 37% to 672 million euro.

Collaboration with Cadagua (Ferrovial's water engineering subsidiary) resulted in Budimex obtaining the contract to build two major sewage and sludge plants (financed partly by ISPA funds). Budimex's real estate activity, which was small until now, will be boosted by the creation of a joint venture with Ferrovial's property subsidiary in order to develop and build residential projects in Poland's largest cities (Warsaw, Poznan and Krakow).

Budimex landed a significant number of new civil engineering and building contracts in 2005: the volume increased by 14% with respect to 2004. Budimex continued work on major projects such as the expansion of Warsaw airport (in cooperation with Ferrovial) and two sections of the A-2 highway, one of Poland's main road arteries, which links Warsaw with Berlin, Minsk and Moscow. The main contracts obtained in Poland include the construction of a sports centre in Krakow, the Trasa Siekierkowska-Bora Komorowskiego road, the A-6 Klucz-Kijewo highway, a residential complex in Warsaw, and site development for the Sendzimir steelworks.

Budimex continued to internationalise by obtaining projects worth around 80 million euro, mainly in Germany and Russia.

In September 2005, Ferrovial acquired Webber (one of Texas' largest construction companies) for 220 million dollars (179 million euro). The acquisition was highly strategic as it is a continuation of Ferrovial's strategy in international markets and is a new opportunity for growth in the United States.

Webber is one of the top three construction companies in Texas and is the leading producer and distributor of recycled aggregate. Webber, which posted 372.5 million dollars in revenues in 2005, has an excellent track record, a sound balance sheet and a lean, efficient organisation. Webber has good prospects for organic growth and will also provide synergy, market knowledge and support for Ferrovial's construction structure in future projects linked to subsidiary Cintra's operations in Texas, such as the Trans-Texas Corridor.

The company's two core businesses are civil engineering and production and distribution of recycled aggregate. Webber has good prospects, and its backlog grew 15% to a record high of 453 million euro in 2005.

The main contracts obtained by Webber after being acquired by Ferrovial are the refurbishment and expansion of the Hill County stretch of Interstate 35, south of Dallas, and the refurbishment and widening of road and structures on Interstate 45, south of Houston.

 

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