The next 12 months could decide the new shape of the construction industry, as insolvencies peak, contractors pull out of markets and a fresh wave of restructuring takes hold.
A double squeeze of scarce bank finance and lengthy payment terms continues to hurt the smaller firms, while big contractors consider sell-offs and strategic cuts to their operations, which could in turn destabilise supply chains.
According to the latest insolvency report from PwC, the number of construction firms going out of business will peak in the next six months, while the National Specialist Contractor Council’s state of trade survey shows that just 5 per cent of companies said they were paid within 30 days in Q4 2012.
For smaller firms, one of the most lethal practices remains retentions.
The survey found that 86 per cent have retention monies withheld against them, with 12 per cent of these retention monies overdue for release.
PwC engineering and construction leader Jonathan Hook tells CN: “People have taken on work quite aggressively to keep going for the last year or so and there’s only so far you can go with that.
“I think there are quite a few people under a lot of pressure now.”
He adds that while bigger firms are “generally well financed” and have room for manoeuvre, when their cash reserves are under pressure “the only place they can squeeze is the specialist contractors and supply chain and people that work for them”.
“We are definitely seeing that in terms of payment terms,” he says.
But most big contractors are vocal about supporting their supply chain.
Ian Renhard, MD at top 10 construction firm Interserve, tells CN: “We have built a very strong supply chain over the years and we want to support and maintain them through the tough times, and make sure they are coming through it with us.”
Analysis by KPMG restructuring director Martin Kelly shows a trend of housebuilder insolvencies in 2008, stung by the downturn and high gearing, followed by property developers.
2010 saw social housing management firms Connaught, Rok and Kinetics all go out of business. Then it was contractors with steel costs – including Barratt, Pocklington and Robinson.
Into 2012, it was a large number of subcontractors with their own labour, such as Doyle and Kirkby & Gayford, and in M&E, MJN Colston, Rotary and Airedale.
Mr Kelly says the high level of financial and operational ‘gearing’ is at the root of the problem. Financially, this concerns the ratio of borrowing to assets; operationally, it means the level of fixed labour costs.
The latter begs difficult questions about how a firm deals with experienced and valuable staff.
“We should not be surprised if we continue to see businesses that have got higher levels of financial or operational gearing coming unstuck,” he tells CN.
Ernst & Young director for real estate, hospitality and construction Adrian Mulea says it is no surprise that M&E contractors are struggling, as the commercial development market remains depressed and bigger M&E providers are “suffocating the smaller, regional players”.
He says the fit-out market is similarly depressed, while facilities management “is another sub-sector where I would expect to see contractors to continue the feel the pain acutely”.
A lack of bank support has been a problem in the construction industry for a long time, according to Alan Cooper, who oversaw the management buy-out of Hewlett last week after administrators were called in on the £40m-turnover company.
“It’s all about getting cash in; there’s no attempt to support, not for the long term anyway,” he tells CN.
Mr Cooper says traditional banks “are just not interested in funding construction businesses”.
Mr Hook says the key factors are firms’ relationships with the banks, whether they “buy in to the management and strength in the plan”, and how confident they are in recovering their money.
“I still suspect that this sector will not be a priority for people to lend to, because there does not tend to be a lot of security,” he adds.
Just last week, news broke that Balfour Beatty is considering the future of its FM business Workplace, having already mooted a withdrawal from social housing in November following a profit warning.
Mr Hook says: “I think we are probably going to be into a new round of doing more strategic cutting and working out what bits of the business they can do without, they can sell off and what activities they don’t want to be involved in – and that means making decisions about holding onto particular teams of people.”
Contractors are likely to move away from sectors that are particularly price competitive or do not offer consistent margins, or where they have not operated historically. Instead they will focus on long-term relationships, better margins and lower bid costs, he said.
With the financial results season around the corner, he adds: “If construction output has shrunk somewhere up to 10 per cent, then you would think, everything being equal, that would have a similar effect on revenues and employment.”
Insolvency stats from PwC
Overall, there were 5,580 construction insolvencies since Q1 2011
There were 621 insolvencies in the final quarter of 2012, meaning it was more positive than others. the figure represents a 12 per cent drop in insolvencies compared with Q3 2012, making it the lowest quarter over the two years.
There were 2,743 insolvencies across the industry in 2012, compared with 2,387 in 2011, representing a 15 per cent hike.
Since 2011, 1,559 general construction/civil engineering firms have become insolvent and 373 were plumbing firms.
London remained the region with the highest number, at 125, largely due to the sheer number of firms in the capital. This was 5.3 per cent fewer than the previous quarter.
|INDUSTRY||2011 Q1||2011 Q2||2011 Q3||2011 Q4||2012 Q1||2012 Q2||2012Q3||2012 Q4||Grand Total|
|NE & Cumbria||42||29||26||29||34||34||34||26||254|
|York & North Linc||103||62||96||107||105||81||83||78||715|
Keys to weathering the storm
For bigger companies:
- Emphasising operational improvement/commercial excellence – keeping/making the supply chain efficient, weeding out in-house operational inefficiencies, managing project and other risks appropriately and maximising working capital advantages (the outlook remains grim for debt availability).
- Ensuring the strength of relationships and external networks, as well as being well placed to benefit from the key likely sources of opportunity (central/local government, larger corporates, utilities/infrastructure providers, etc).
- Spotting the emerging markets and opportunities and having teams on the ground to exploit them – there is volatility here, for example, the troubles in north Africa are leading to a refocusing on the UAE/Saudi etc. Allied to this is ensuring people (in particular) and assets are suitably mobile to enable quick tactical changes in strategy.
For smaller companies:
- Doing a quality job, delivering to expectations, delivering to budget – the larger players still need reliable subcontractors and fostering enduring relationships with partners is vital.
- Niche markets – whether products/processes/sub-sector areas, innovation can create competitive advantage and something the larger players might want to pay for.
- The importance of not overstretching – do smaller companies have the cash headroom or other resources to take on new work for the terms being offered?
Adrian Mulea, Ernst & Young director for real estate, hospitality and construction.