Contractors face margin erosion as inflation starts to bite
The reduced value of the pound has led to the steepest rise in construction inflation for more than five years, the latest monthly survey of purchasing managers indicates.
The survey showed that the UK construction sector continues to rebound from the dip in performance in the months around June’s EU referendum, but input prices are rising.
Business activity and incoming new work increased at the strongest pace since March, although both rates of expansion remained much softer than the peaks achieved at the start of 2014. Greater workloads underpinned a further solid rise in employment levels and input buying among construction firms. However, average cost burdens rose sharply, with the rate of inflation the steepest since April 2011. This was overwhelmingly linked to supplier price hikes in response to exchange rate depreciation. Contractors' already slender profit margins could prove to be Brexit collateral damage.
The seasonally adjusted Markit/CIPS UK construction purchasing managers’ index (PMI) picked up slightly to 52.8 in November, from 52.6 in October, thus signalling an expansion of total business activity for the third month running. Reports from survey respondents cited improved order books, alongside resilient client confidence and strong demand for residential projects. There were again reports that heightened economic uncertainty was a key factor weighing on output growth across the construction sector.
Housebuilding activity remained the best performing segment, although its pace of expansion slipped to a three-month low. Construction firms meanwhile reported a marginal rebound in commercial activity, which ended a five-month period of decline.
Civil engineering work remained the weakest area of activity. Increased volumes of construction output were underpinned by an upturn in new work during November. The latest rise in incoming new business was the strongest since March, following a decline in sales throughout the summer. Some construction firms noted that their workloads had been boosted by a resumption of projects that were delayed in the aftermath of the Brexit vote but they also said that inflation was squeezing margins.
Paul Trigg, construction specialist at credit insurance company Euler Hermes, warned that inflation could push contractors to the wall. “We expect the number of insolvencies in the sector to climb through next year,” he said. “Low margin contracts continue to put serious pressure on company cash flows, with businesses unable to pass on further rises in input costs resulting from inflation. Pressure on cashflow will inevitably impact firms’ ability to pay on time throughout the supply chain and construction companies will need to be extra careful when managing their credit books.”
Tim Moore, senior economist at IHS Markit and author of the Markit/CIPS Construction PMI, said: “UK construction companies experienced a steady recovery in business activity during November, which continues the rebound from the downturn seen over the third quarter of 2016. The brighter picture reflected another solid contribution from residential building and renewed growth in commercial work, which some companies linked to a resumption of projects that had been delayed after the Brexit vote.
“November’s survey data revealed the strongest rise in overall new business volumes since March. However, lingering economic uncertainty and subdued investor sentiment meant that optimism towards the year-ahead outlook remained close to its lowest since early-2013.
“Input cost inflation accelerated to its fastest for five-and-a-half years, driven by sharply rising imported raw material prices. A number of firms cited uncertainty related to supplier price hikes as an emerging threat to the construction sector, with survey respondents commenting on difficulties forecasting project costs against a backdrop of rapidly changing inflationary pressures.”
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This article was published on 2 Dec 2016 (last updated on 6 Dec 2016).