Sector Comparisons

A year ago, the prospects for the construction industry could hardly have been rosier; indeed we predicted a good 12 months of sustained economic growth for the nation’s road-building contractors. That prediction was vindicated, though the picture now is far less certain.

The Office for National Statistics caused a storm of protest last month by publishing data that appears to suggest that the construction industry was technically in recession with output declining in both the last quarter of 2014 and the first quarter of 2015.

The ONS’ detailed statistics purport to show that output fell 0.3% in Q1 2015 compared to the same period in 2014 – the first quarterly year-on-year drop since Q2 2013. Nevertheless, there was some upturn in March 2015, which ONS says showed an improvement of 3.9% from a month earlier.

The gloomy ONS assessment contrasts sharply with virtually all industry surveys, which indicate that construction is in its best state of health for years. The Construction Trade Survey, compiled from data provided by five separate contractors’ trade associations and the Construction Products Association and released in the same week, revealed an eighth successive quarter of growth. The overall confusion is compounded by the latest Markit/CIPS Construction PMI survey, which suggested that growth had fallen to a 22- month low in April 2015 with a sharp drop from 57.8 in March to 54.2 in April.

Away from the growth controversy, the industry is afflicted by a number of ongoing negative trends. The worst aspect is declining profitability, with Sir Robert McAlpine becoming just the latest in a long list of major companies to take a huge hit from problem contracts and reporting a loss of £90m. Month after month, our recent Company Watch sector reports have been uncovering evidence of falling profit margins. Lowball pricing, rising input costs and critical skill shortages are all contributing to this problem.

The companies we have analysed for this month’s report are road building contractors with turnover of £10m or more and total assets of at least £1m. This produced a sample of 76 companies in all, of which 11 are set up as special-purpose entities to run specific PFI contracts.

These PFI contractors have a quite different business model from their counterparts undertaking general road building activities. A year ago, our sample using the same financial criteria amounted to 73 companies, also including 11 PFI contractors.

It should be noted that the detailed financial tables, and our analysis, omit certain major contractors, such as Amey and Skanska, which have substantial activity in road building but where it is not possible to separate out sufficiently comprehensive data relating to that activity to make a meaningful comparison with the specialist road builders which have been included.

Also, the overall financial position and strength of some of these larger contractors are too strongly influenced by their work in other sub-sectors. Taking first the larger sub-set, our 65 non-PFI road builders appear to have had a good year, with almost all of their financial ratios improving. Debt levels have fallen, with the average gearing ratio now at a modest 27% compared to 31% a year ago and 36% two years back. Profit margins, whilst still slim, have grown from 3.2% last year to 3.8% now. In May 2013, profitability was only 2.7%. Average return on capital is up to 30% from 26% in May 2014 and 22% a year before that. Comparing these financial characteristics with other construction sectors, road builders are working on margins which, at an average 3.8%, are in the middle of the range.

Road Builders

Plant hirers earn 14.9%, house builders 12.8%, site preparation contractors 4.8% and utility/water contractors 3.9%. Demolition contractors (2.3%), commercial contractors (1.8%), M&E contractors (1%) and scaffolders (-0.8%) are less profitable.

But in terms of return on capital employed, road builders top the league with their 30% beating site preparation contractors (27%) and plant hirers (26%) into second and third places. Gearing levels of 27% place general road builders in fifth place out of the nine sub-sectors we analyse.

Twenty five (38%) of the companies have little or no external borrowings, better than three other sectors. The full details are set out in the sector comparison table. Looking next at the overall financial health of the 65 non-PFI road builders, their average H-Score (see box) is 56, exactly the same as last year’s score and still very significantly above the norm of 45 for all UK companies of similar size.

Conservative debt levels play a major part in this outcome, as does the fact that there are only two companies with negative net worth (liabilities greater than assets). Only seven companies are loss-making and in every instance the losses are minor.

Seven out of the 65 companies (11%) are in the Company Watch warning area. Last year, 8% fell into this vulnerable category.

Across the economy as a whole, the expectation would be that around 25% of any sample would be in this financial twilight zone. Looking at the better performers, 69% of the sample have HScores of 51 and above, as compared to around 50% for all UK companies. Turning to the PFI contractors, the current picture is also more positive than it was a year ago. The 11 companies are now seeing a profit margin of 9.1%, healthier than most construction contractors and a handy improvement on last year’s figure of 7.6%. Stratospheric gearing is a feature of the commercial model employed by some of these businesses but, even so, there has been a reduction from 624% to 556% this time round. It was 784% two years ago. The average H-Score has shot up to 64 out of 100 this year, a rise from 56 in May 2014. The one disappointment has been another fall in the return on capital, this time a significant reduction to 23%. It was 32% and 36% one and two years ago respectively.

PFI contractors’ return on capital apart, the results of our research are encouraging, with a marked improvement over the past twelve months on every single measure. The financial health of Britain’s road building sector is strong and getting stronger. But we must wait to see how good our new government turns out to be at keeping its promises on infrastructure investment, now that the political thirst for throwing theoretical largesse at voters has been slaked.

Keeping construction’s very own boys from the black stuff accelerating down the road to financial prosperity in the years ahead will depend on how many of these pledges are turned into real spending on transport projects in the face of the reality of another five years of deficit reduction, public spending cuts and austerity.

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