Construction: the hazards of hitting a brick ceiling

Growth continues albeit at a more moderate pace, but concerns are growing over cost pressures

By Michelle Perry | CFO UK | Published 00:01, 07 May 14

A surprise profit warning from the UK’s largest construction company Balfour Beatty on Tuesday offered the first dose of reality of what many have been suspecting – that the sector’s growth may still stumble.

Until the most recent data from the Office for National Statistics showing a slight slowdown in growth in the construction sector, most data has revealed a buoyant industry in the three main areas – housebuilding, commercial construction and civil engineering.

First quarter results from housebuilders such as Taylor Wimpey, Bovis and Persimmon have all shown double digit growth in both profit and sales, with predictions of more of the same for the year ahead.

But concerns have been bubbling under particularly over the housing market, where growth in London and the South-East of England has been accelerating so fast that a typical house in the capital now costs around £458,000.

Research shows that house prices in some areas have now surpassed pre-recession levels and house-buyers are borrowing ever larger mortgages. Much of the growth in the market has been driven by first-time buyers who have been given a helping hand by the government’s Help to Buy scheme, which offers a mortgage guarantee. But a lack of housing is also a major factor in the surge in prices.

Buoyed by its success and a strengthening economic recovery chancellor George Osborne announced in his March Budget that he would extend Help to Buy, launched in England last spring, until 2019.

Housebuilders like Taylor Wimpey, Bovis and Persimmon have all benefitted from the scheme attributing much of their growth to the government’s scheme.

Indeed Taylor Wimpey group FD Ryan Mangold told CFOWorld that the company’s strategy – drafted during the recession – has accelerated 18 months ahead because of the government’s help to first-time buyers and growth in the market.

But with a predicted 1.1 million shortfall of homes in England alone by 2022 and London making up around a third of that deficit, the biggest cause for concern is not so much a housing crash – although that outcome is always a worry – but the need to build more and the costs associated with building projects.

Unrealistic pricing

On Tuesday Balfour’s Steve Marshall – who has taken over as executive chairman following the resignation of CEO Andrew McNaughton – blamed the company’s £30 million profit shortfall on its UK construction division, which is heavily reliant on large-scale infrastructure projects.

The cause of Balfour’s profit warning chimes with a new report by auditors at the ICAEW who warn that construction companies and their clients must end “the vicious cycle of pricing contracts unrealistically low”.

The report – Audit Insights: Construction – from an ICAEW working group warns the sector to strengthen its understanding of the supply chain and avoid cutting corners when delivering on contracts.

This insight would have served Balfour well last year. Balfour’s UK construction division has faced growing costs because of financial penalties and other expenses due to project delays. Problems with sub-contractors and supply chains have also aggravated those problems.

Phil Westerman, a member of the ICAEW working group and a partner at Grant Thornton, says: “Construction firms have to bid realistically and responsibly; they need to get the costing of bids for contracts right. They have to factor in how changes in one end of the supply chain could impact further down.”

Westerman adds: “Without sufficient margins, they won’t be able to invest and innovate, which is critical for the sector to fulfil its potential as a key contributor to UK growth.”

And that’s the rub. If companies aren’t getting the basic pricing right then management won’t be able to sustain growth in the sector in the long-term. This is not just bad news for business, but for everyone.

The auditors’ report highlights five critical areas that need most attention from the government, construction companies and investors. They include dealing with the “politicking” over the government’s spending and procurement policies, providing clarity over long-term plans, and the skills squeeze in the sector.

In a recent exclusive interview Taylor Wimpey’s group FD tells CFOWorld that one lesson he’s learned from the recession and turning around the UK’s third biggest housebuilder is the need to invest for the future and ensure a sustainable business.

“We want to be top quartile operating margin in the sector. We want to be the most efficient and effective on the hygiene side of the business – that’s manufacturing, selling and planning homes,” he says.

Mangold is all too aware of the issue on pricing and supply chain. “We do know we’re not going to get it right necessarily every single time. There are going to be issues that surprise us. Either the planners turn against us for whatever reason in terms of the engagement we’ve got with them. … Or the planners have a different philosophy to what we have. We might get a surprise that means the margins get squeezed. And if the margins get squeezed then you end up impairing the asset,” Mangold explains.

The latest research from financial data company Markit shows that the construction sector – which accounts for just over 6 percent of the economy – expanded for the twelfth consecutive month in April, albeit at the slowest rate in six months.

Markit’s senior economist and author of the survey Tim Moore says growth has started to moderate but strong rises in new work and payroll numbers “provide ample optimism that output will expand strongly over the course of 2014”.

Taylor Wimpey’s finance chief is equally effusive on prospects: “As the housing market continues to cheer up so we would expect the volumes to be positive this year thanks to the government’s Help To Buy. And in that environment the trades and some of the core items that go into new build houses come under strain so it’ll be good to understand those cost pressures better, and give us the opportunity to mitigate those and become more efficient.”

But Markit’s Moore also has a warning: “Set against the tightening supply chain backdrop, a difficult challenge lies ahead for the housebuilding sector to make sure it doesn’t hit a ‘brick ceiling’.”

Of all the industry sectors construction suffered one of the most bruising recessions. It benefits no one – not even home buyers – for the sector to hit the rails. What we need now more than anything is for builders to price realistically on quality homes and buildings to earn good but not excessive margins. That way companies will be in it the long-term and Britons can look forward to more homes at reasonable prices and better infrastructure projects that benefit all.

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