In the past year, there has been a 45 per cent increase in the number of construction companies experiencing significant distress. According to Begbies Traynor, in the first quarter of 2015, over 20,000 construction firms were experiencing financial distress and an overwhelming majority of these, 97 per cent, were SMEs.
One might argue that is not surprising, given the release of figures from the ONS suggesting the construction sector entered recession at the beginning of 2015. According to the Office for National Statistics, construction output declined for both the last quarter of 2014 and the first quarter of 2015, even though there was 3.9 per cent month-on-month increase in March.
However, the Construction Products Association (CPA) has taken issue with these statistics, pointing to a body of evidence from itself and a number of industry sources including Experian and Markit / CPS that suggest the construction sector has, in fact, been expanding. A statement from the CPA says that even the Bank of England in its latest Inflation Report has highlighted concerns with the ONS’s comparative figures.
Interestingly, talk within the industry over the course of May has focused on opportunity and growth, with very little despondency that might be expected in the light of a down-trending outlook. In fact, many key operators are seeing hope on the horizon; with a majority government in power - and a Conservative one at that, a party seen as favourable by construction - the industry as a whole is feeling increasingly confident about the future as talk of uncertainty falls by the wayside.
So if the broader picture is indeed one of growth, then what's holding back the thousands of significantly distressed businesses in the construction sector and how can healthier construction companies and business buyers, perhaps typically involved in other sectors, benefit from the situation?
Behind the Rise in Distressed Construction Companies
The Begbies Traynor Red Flag Alert report monitors the financial health of UK businesses and the latest round of distressed company figures clearly highlights some quite alarming changes in the construction sector in comparison to the same three-month period in 2014. But what caused them?
Firstly, it's worth noting that it clearly isn't the entire sector that is experiencing these problems. It doesn't take much digging to see that it is overwhelmingly SMEs that are struggling with financial distress, while larger competitors are experiencing far fewer problems.
There is also a regional bias effect with construction activity almost feverish in London. In the last six months the capital has experienced the second largest increase in office space construction in twenty years, with around 9.5m sq ft of building in progress.
The main reason for heightened distress levels in small to medium construction businesses outside London appears to be difficulty in accessing funding. Julie Palmer, partner and property expert with Begbies, elaborated: “At the heart of the problem is a general reluctance to lend to this important group, which is seriously obstructing their growth and contributing to the rising levels of financial distress that we are seeing today.”
She added: “The construction sector has always proved difficult to lend to as many elements of their contracts are complex, subject to dispute and suffer from lengthy payment terms, making them high risk investments for the cautious banks, who had their fingers burnt during the last financial crisis.”
But there are other problems for these businesses that are putting insurmountable pressure on their cashflow. Firstly, historic financial problems along the supply chains have meant delayed payment on major jobs are coming to a head for small businesses without extra access to cash to keep things moving. Secondly, unwanted commitments to big jobs, made back in the days when the recession was still being felt, have left firms struggling to deliver on long fixed-term high-risk contracts and they're really feeling the stretch as the rest of the market picks up with higher costs and faster turnaround times.
Southdale Enters Administration
Southdale was one such construction company to succumb to administration in a 'perfect storm' of market conditions worked against the firm.
The major North East construction company was providing work on two big building sites in North Yorkshire but work paused when the company entered administration in April 2015 after struggling to keep business going with a “significant number” of loss-making contracts.
Chris Dancer, chairman of the Civil Engineering Contractors' Association in the North East, cited the “fragile state” of the recovery in the North East, cashflow pressures and the loss-making contracts as the main contributors to Southdale's collapse.
He noted that the problem is not exclusive to Southdale: “A number of construction firms – particularly the larger ones – have become victims of fixed price, high-risk, longer-term contractual arrangements.
“Such arrangements were taken on board during the recession when margins were non-existent. The chickens have come home to roost for some of these firms as costs have increased, putting them into heavy losses and eventually seeing them run out of cash.”
There is now some concern about the potential scope of the fall-out from this administration and others like it as project deadlines are forced back and suppliers and subcontractors are forced to look at wiping off unsecured debts associated with the collapsing companies.
Forecast for the Construction Sector
Circumstances have conspired to prevent recovery among a significant number of smaller construction companies. Simply put, the uplift in the industry has come too late to save them now. Their futures could well see them enter administration or limp on until they finally run out of steam and are wound down naturally.
But in an increasing number of cases, healthy players in the construction industry are intervening to rewrite the destiny of some of these firms through mergers and distressed acquisitions.
The latest CIPS/Markit Construction Purchasing Managers' Index showed continued levels of growth at 54.2 in April; a dip from the previous month's 57.8 but still comfortably in growth territory. As Tim Moore, senior economist at Markit, remarked: “Despite experiencing pre-election risk aversion among clients in April, construction companies indicated a strong degree of confidence regarding the year-ahead outlook … Taken as a whole, the latest survey presents a far more upbeat picture than the curiously weak official construction output data for the first quarter of 2015.”
Indeed, as the air of hesitation clears post-Election, spending decisions that had been delayed by the recession are kicking into gear again and with a clearer path ahead companies are looking to their distressed competitors for assets and bolt-ons to help them expand and take advantage of the more favourable market conditions.
In the case of Southdale, Kier Living was able to do just this when it jumped in to buy it out of administration. For Kier, the deal formed part of its strategic vision for growth.
John Anderson, executive director at Keir Living, observed: “Today represents an important milestone for Kier Living as we expand our presence in the North of England in order to deliver our growth plans, as set out in Kier’s strategy Vision 2020.”
He added: “Not only will we be able to use the combined capability and expertise of the two teams to deliver existing developments, we will also be able to expand our offering to a wider range of clients, and deliver projects of an increased scale. I would like to take this opportunity to welcome Southdale employees to Kier and look forward to continuing our journey of growth with them.”
Clearly there were some great staff, contracts and business at Southdale and Keir saw the advantage in this. By snapping up the distressed company, it can hopefully implement a successful turnaround plan to strip the business of any unprofitable contracts while using the firm's assets and healthy contracts to push forward with growth.
However, other companies are taking much simpler approaches when seeking profit from distressed competitors within the construction sector. Buying assets in the wake of a liquidation is one of the most straight forward approaches entrepreneurs can take and if the timings are right, a great way to fast track growth plans by getting hold of machines, equipment or assets such as warehouses and work space at below-market rates.
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