Sector Comparisons

A spate of profit warnings from major contractors and muddled official statistics that clash with the industry’s own data have made it pretty difficult to figure out whether the construction industry is continuing its recovery or entering a downward spiral.

Certainly, construction output has been pretty patchy of late, rising some months but falling in others. And the Office for National Statistics isn’t much help when it comes to getting a handle on the situation. It has just been forced to execute a major U-turn, admitting that its previous construction output figures showing a fall of 1.1% for Q1 2015 were not just wrong, but very significantly so. Its revised figure is now a drop of only 0.2% for that quarter. The ONS also says that output fell 0.8% in April 2015 compared to March, although it was 1.5% higher than it had been a year earlier in April 2014. The chief culprit was repair and maintenance activity which suffered a 4.8% setback, while new work failed to compensate, rising by only 1.6%.

By contrast, the Markit/CIPS Purchasing Managers’ survey produced a raised reading of 55.9 for May 2015, up from 54.2 for April but still not sufficient to restore the momentum lost in April and nowhere near the figure of 60.1 reached at the beginning of the year.

The improvement was attributed to an acceleration in residential building activity, backed up by NHBC figures showing a 20% rise year-on-year in new home registrations for the three months to April 2015 and an even stronger rise of 31% in new housing starts in Q1 2015.

Having reviewed several different sub-sectors so far this year, we can now see a trend developing: falling profit margins as underbidding and cost increases bite. This is worrying, but the news from the RICS Building Cost Information Service - that tender prices had increased by 2.4% in Q4 2014 - will be welcome. Even more encouraging is the RICS prediction that tender prices will rise by 28% over the next five years.

The companies we have analysed for this month’s report are those commercial building contractors with annual turnover of £50m or more in their latest published accounts. These are, of course, the goliaths of a fragmented subsector; Companies House records show that there are 13,935 UK-registered companies claiming that their principal activity is commercial building.

Our sample consists of 63 companies, compared to 64 this time last year. One of last year’s selection, GB Building, has sadly failed and two others have merged with other companies. They have been replaced by three newcomers that have burst through the £50m turnover barrier, while one has fallen below it.

The Company Watch research reveals a significantly reduced level of profitability for the sector: 0.8%, down from 1.8% a year ago. That’s a fall of 56%. Profit margins this close to zero should be a major cause for concern, not just for the companies themselves, but also for their clients and their supply chains.

The misfortunes of two companies have had a major impact on this outcome. Sir Robert McAlpine and the relevant Balfour Beatty operating subsidiary between them declared losses amounting to more than £140m. But even discounting these two, the average margin for the remainder would still only be 1.37%.

Comparing this poor profitability with the other eight sub-sectors we analyse for The Construction Index reveals that commercial building contractors come almost at the bottom of the pile, just a whisker ahead of scaffolders with their negative 0.8% margins. They are outscored by M&E contractors (1%), demolition contractors (2.3%), road builders (3.8%), utilities and water sector specialists (3.9%), site preparation contractors (4.8%) and the profitability stars in house building (12.8%) and plant hire (14.9%).

Commercial Builders

The average return on capital has also fallen sharply, down from 13% in our 2014 analysis to a meagre 6% now. This too is the lowest of all the sub-sectors except scaffolders.

The trade-off between risk and reward varies across the construction industry, particularly where profits and borrowing levels are compared. For our 63 commercial building contractors, gearing is at 15%, compared to 17% last year – the only financial measure on which there has been any improvement. This makes them more conservatively financed than all of the other sectors apart from M&E contractors (7%) and the utilities and water specialists (6%). Just over half (32) of them have either no external borrowings, or debt of less than £100k.

Looking at the overall financial health of the 63 commercial building contractors in our sample, our calculations produce an average H-Score of 49 (see box). This is well down on last year’s average score of 52, but still comfortably above the norm of 45 for all UK companies of similar size.

The relatively low levels of debt play a part in this outcome, as does the fact that there are no companies with negative net worth (liabilities greater than assets). The current average H-Score of 49 is the thirdlowest of all the construction sub-sectors. Eight of the companies in the sample (13%) are in the Company Watch warning area, placing this sub-sector right in the middle of the league table with four sectors showing a higher percentage of laggards and four a lower percentage. 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, 59% of the sample have H-Scores of 51 and above, compared to around 50% for all UK companies. An unusually high proportion (54%) are in the second quartile with a score between 51 and 75. Worryingly, 14 of the companies (22%) are loss making. The marked deterioration in all but one of the key financial indicators for commercial building contractors over the past twelve months is a cause for concern and must be addressed.

Once again, we must point out that our figures cover only the few major players out of a market which also features thousands of smaller, generally undercapitalised and almost exclusively family-owned SMEs, either companies or unincorporated sole traders. Much more caution is needed about their finances.

It seems our sample of major commercial builders and their host of smaller brethren in the sector have much to ponder as we move through 2015 and onwards towards next year. They seem likely to be caught between the opposing pull of improved business confidence now that the election uncertainty has been removed and the impact of further government austerity measures stretching through the five years of this new parliament. But one thing is absolutely certain; they cannot possibly continue to court financial disaster by accepting (willingly or otherwise) such wafer-thin profit margins. Being a busy fool is one thing, lurching blindly towards the insolvency killing fields is quite another.

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