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Top 100 2015 – Who’s up and who’s down?

21 Sep 15 A year on from the confirmation of a sustained growth trend for UK construction activity, the mood has turned from rampant optimism to deep concern at the profitability of contractors. Recent months have seen a steady flow of bad news from the industry’s major players.

Several major businesses have issued profit warnings, some have announced eye-watering losses and – worst of all – a handful of significant businesses have collapsed, such as GB Building Solutions, or declared their insolvency, for example the Dutch parent company and German fellow subsidiary of the UK operations of Imtech.

The half-year figures posted in mid-August by the UK’s largest contractor, Balfour Beatty, were truly shocking, adding a further £150m loss for just six months to the £304m loss declared for the calendar year 2014.

Observers could be forgiven for wondering just how many skeletons there are in Balfour Beatty’s financial cupboard, while Carillion shareholders will be heaving huge sighs of relief that last year’s attempt to take over Balfour Beatty failed. Meanwhile our third largest contractor, Interserve, has just reported that margins in its UK construction business have fallen from 1.9% to only 1.1% in the first half of 2015.

Against this background, our survey of the financial results of the Top 100 contractors repeats the gloomy message we delivered last year; revenues may be rising but profits are falling sharply. Profit margins are paper-thin and prospects remain uncertain because of the continuing downward pressure on tender prices from savage competition and because of the profit pincer effect caused by skills shortages and rising input costs.

A year on from the confirmation of a sustained growth trend for UK construction activity, the mood has turned from rampant optimism to deep concern at the profitability of contractors. Recent months have seen a steady flow of bad news from the industry’s major players.

The financial statements we have analysed mainly cover trading for part of 2013 and most of 2014, so it may be that the few tentative voices now suggesting that price pressures are easing will turn

out to be the first indicators of less painful financial times ahead. Unfortunately, contracting is a long- term business; the profits from new work won are often realised only several years down the line, and it is often even longer before they can be turned into cash or reduced debt.

 Over the next seven pages, Nick Hood of corporate financial health monitoring specialist Company Watch analyses the latest figures to see who have been the winners in the past year, who have been the struggling stragglers and how the UK’s leading contractors are performing.

When we reported a year ago, we had found that overall turnover for the Top 100 contractors was static and that there had been only the slightest improvement in profit margins, up from 1.4% to 1.5%. Hopes for the future rested very largely on promises of increased infrastructure spending made by politicians with an eye more on the forthcoming general election than on the financial reality in deficit-ridden Britain.

Now we see how wise it was to be cautious about the medium-term prospects. Overall industry revenue may have risen by 7.1% but profitability has almost halved, with our Top 100 making an average pre-tax return of a laughable 0.8% (£462m) on a combined turnover of £59bn.

Two companies have had the greatest impact on these unacceptable numbers: Balfour Beatty and the UK operations of Vinci. Their combined losses were £520m. If you eliminate their figures from both this year’s and last year’s calculations, the extent of their influence is dramatically illustrated: the remaining 98 contractors earned £983m on revenues of £49.6bn this year, a return of 2.0%. This compares with profits of £831m on last year’s revenues of £43.4bn, a margin of 1.9%.

The business risk in this sort of financial profile is well illustrated by the fact that these construction leviathans are deploying total assets of £35.7bn, have a combined net worth of £9.2bn and are carrying debts of £4.3bn. That equates to a return of just 1.3% on total assets and 5% on capital employed. This compares with 2.65% and 10.4% last year, a second successive year of significant deterioration.

It should be remembered that these are supposedly the most efficient operators in the sector, with the greatest bargaining power on tender prices and input costs. This poses real questions about the validity of the entire UK construction business model. If these businesses are struggling to make a sensible profit, what chance is there for the poor bloody infantry, the tens of thousands of smaller businesses lower down the construction food chain?

The best profit margins were earned by a top five of Robertson Group (13.3%), Barr (10.6%), Bechtel (10.1%), Thomas Armstrong (8.2%) and Mulalley (8%). The risers outnumbered the fallers; 52 had better margins, 42 had worse and six saw no change. As noted elsewhere in this report, the overall figures are skewed by the huge turnaround to losses at Balfour Beatty and Vinci UK, confirming what many pundits know: when construction companies have a bad year, they rarely indulge in half measures.

We comment in more detail elsewhere in this feature on the trend towards consolidation in the industry, but it seems clear that the increasing pressures on margins and profits continue to drive some weaklings into the arms of stronger contractors and make others huddle together for mutual self-protection.

As we noted last year, deals in the short and medium term within the sector are more likely to be acquisitions of mid-market UK players by bigger rivals, either domestic or international. Fortunately, only one of last year’s Top 100 (GB Building Solutions) has succumbed to formal insolvency since then.

Within the Top 100, there has been considerable movement in their relative performance. Forty-two companies improved their turnover ranking, while 40 dropped down the league. The biggest companies have largely held their positions but the major gainers are to be found lower down the table.

Buckingham is the biggest winner, gaining 17 places to 37th, followed by Lakehouse (up 14 places), McLaughlin & Harvey (up 12), Carey Group (up nine) and Mulalley (up eight). The losers are led by Emcor, which drops 13 places to 50th, Northstone NI is down 12 places to 46th and Dawnus also drops 12 places to 72nd. Other major fallers are Eric Wright (down 11 places), ISS (down 10) and Severfield (down nine).

Turning to the part of any income statement that really matters – profit – we see greater volatility in our results tables. While there are 18 unchanged rankings for turnover, only 12 have remained static with regard to profits. Curiously, there was the same number of risers (42), but significantly more fallers (46 compared to 41 profit losers last year).

This reflects the commercial reality that fortunes can change rapidly, quite often as the result of the outcomes on a limited number of successful or, conversely, problem contracts. Some of the changes are striking. Robertson Group was the biggest climber, up 82 places to 7th.

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Other significant gainers are Lakeside (up 79), Lend Lease (up 65), Emcor (up 64) and Mabey (up 50). The biggest faller is Vinci

UK, which has plummeted 68 places to 99th, while other significant changes are Sir Robert McAlpine (down 62), Lakehouse (down 48), McLaughlin & Harvey (down 47) and Stepnell (down 46).

The research highlights the fascinating interplay between turnover and profits for contractors. In more stable industrial sectors, the assumption

is that a rise in turnover may generate higher profits while a fall will curb the bottom line.

Among our Top 100, we have

67 companies whose turnover rose and 32 whose turnover fell. On profits, only 59 companies achieved increases, while 40 saw them fall. But when it comes to those with contrasting outcomes, we have only 15 winners that saw turnover fall while profits rose. By comparison we have 22 busy fools, for whom turnover rose but profits fell. Most of these were in the top half of the table, whilst the

winners were most heavily concentrated in the middle and lower end of the table.

So which contractors have had the best year since our last report? As with last year, the biggest profit was made by Balfour Beatty’s rejected suitor Carillion which raised its pre-tax profit by 29% to £143m. Next came Amey UK (up 36% to £107m) and Galliford Try (up 28% to £95m).

Interestingly, four of the top 10 fell down the profit rankings, five were unchanged and only one (Morgan Sindall) rose.

Looking across all the key measures, Willmott Dixon was the most consistently successful among the bigger contractors. It not only grew profits by 246%, but rose 15 places up the profit league and two for its turnover, which grew by 23%. Its profit margins doubled.

Honourable mentions must go to Costain (profit up 75% on a 17% turnover gain and a 54% margin improvement) and Lakeside 1 which turned a £21m loss into a £16m profit on only a small (5%) turnover increase.

There has been relatively little movement in the constituents of the Top 100. Four companies have been removed since last year because a closer review of their activities in relation to the entry criteria excluded them this time round. One appears to have ceased trading and, as noted above, one (GB Building Solutions) has failed.

Altogether there are six new entrants who occupy the bottom places in the turnover rankings.

So where might the construction industry and its Top 100 contractors be when we report again next year? Growth remains patchy and the statistics contradictory. Despite all other evidence to the contrary, the government’s much-maligned Office for National Statistics maintains that output in May 2015 was 1.3% lower than in April 2015, although it was higher than a year earlier by a similar percentage.

In contrast, the Markit/CIPS Construction PMI for July showed a rating of 57.1, although this was a little lower than June’s index of 58.1. Any reading above 50 indicates rising activity levels.

However, as our research shows (and many examples from recent trading announcements back this up) that the problem is not growth but profitability. Construction company bosses will argue that what we are seeing right now simply reflects under-bid long-term legacy contracts, which made

insufficient allowance for the sharp rise in material and labour input costs experienced over the past 18 months.

Recent data from RICS supports this view, showing that tender prices rose 0.8% in Q1 2015 and by 4.5% compared to the same quarter in 2014.

But one thing is for sure: the industry simply cannot continue to suffer the slow death of ever-shrinking profit margins. Even adjusting for the financial debacles at Balfour Beatty and Vinci UK, an average margin of 2% across the other 98 major players is a totally unacceptable business risk model.

The 2016 Top 100 table will reveal how successful the sector has been in steering itself into less rocky commercial waters. We look forward to highlighting another year’s winners and losers this time next year.

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