The future is bringing opportunities for growth in the UK construction sector. Alistair Wardell explains how agile companies can make the most of these opportunities, and mitigate the risks.
There are several areas of the UK's economy that will bring new opportunities for the construction sector.
The most encouraging sign for the construction sector in the UK is that infrastructure projects that were delayed from 2020 are now being progressed. Many of these projects are for the NHS or in school construction. These opportunities will increase if, as I think it will, the government promotes an agenda of spending on infrastructure to drive growth in the UK economy.
There are also early indicators that European companies are looking to build new facilities, or repurpose existing structures in the UK so they can satisfy post-Brexit rules of origin criteria that require a facility based in the country.
What are the risks in 2021?
These opportunities obviously provide reason for optimism, but some subsectors will be impeded by headwinds. One client told us their understanding of the current circumstances:
"Despite the industry being 'open' throughout the pandemic, disruption has been significant. Delays in tender awards and project slippage owing to COVID have been universally felt throughout the industry. Furlough has been invaluable to many, but its costs, as well as reduced output due to social distancing measures on projects and remote working have significantly impacted employment, outputs, and consequently, turnover in the sector. Overtrading in the market is a risk given most businesses have changed so dramatically since a year ago, and margins are under severe pressure across the board."
For the retail and leisure sector there is, unsurprisingly, very limited new activity in the UK economy outside of tourism, which is largely driven by optimism in the staycation market. It is likely that re-purposing existing stock will become prevalent to compensate for the impact of the current circumstances on the occupier markets.
Suppliers have also been greatly affected by world events. Higher prices, particularly in steel, are affecting margins, while supply chain issues, principally due to Brexit, are reducing margins, causing project delays and inefficiencies.
So, in this light, we can identify several risks to companies in the UK's construction sector:
Embarking on low/no margin contracts that inflate revenue numbers and short-term liquidity, but leave little room for underperformance on contracts, or the ability to absorb increases in input prices
Long term contracts, which can result in unexpectedly low profits at the end of projects. Contractors and clients should be weary of entering into long-term fixed price contracts, especially as this is compounded by construction out-turn costs which are rising quicker than tender prices
Customers are often special purpose vehicles (SPVs), which increases the risk to the company should the customer fail; there is a heightened possibility of this in the current economic climate
Reluctance to enforce on contracts due to risk of customer insolvency (see SPV point), or the risk to immediate cash inflows if a contract comes to a halt
Disputes that lead to cashflow delays and profit erosion
Uneven cash receipts, leading to spikes in liquidity requirements and pressure on working capital
Power and/or weakness in supply chain
Loss of credit insurance
Employment of inexperienced workers (due to current labour shortages) with, at least in the short term, potential to reduce productivity and increase supervision costs before long term gains are felt
In addition to these risks to the construction sector, HMRC has introduced a change to VAT (effective 1 March 2021). VAT can make up to 30% of cash within a business so, depending on your business model, this may have a significant impact on cashflow and working capital. Details of the new regulation and its potential impact can be found here.
How can companies manage risk in 2021?
Fortunately, there are several steps that construction companies can take to mitigate these risks:
Ensure production of high-quality forecasts that map out the immediate and future liquidity needs of the business
Closely monitor individual contract profitability against tender and keep a close eye on the profile of profit erosion over the contract period
Review whether work-in-progress (WIP) and debtor balances are increasing, understand the causes of this, and establish whether this indicates a problem with either the contract or the customer
Fully understand the context of VAT obligations and the potential impact of the new VAT regulation on cashflow by undertaking robust forecasting (there are many permutations of this for every business)
Establish a suitable mix of customers and contracts
Assess the potential impact of customer failures on cash. Take steps to mitigate these risks by keeping exposures low during contracts and avoid leaving large exposures at the end of a contract
Assess the potential impact of delays and/or additional costs caused by supplier failures. Where this is high risk, focus on working with financially strong suppliers and/or having an alternative supplier lined up
Ensure access to adequate funding lines and short-term liquidity
Where can construction companies build success in the future?
It is important to look at the current financial status of construction businesses in the context of winning new work. Quite often customers (and frameworks) only require a light touch when it comes to financial due diligence when awarding contracts. This may only be sharing management accounts or evidencing ratios, such as gearing. However, businesses that have incurred significant losses, and taking on significant debt, such as Coronavirus Business Interruption Loan Scheme (CBILS) in the current circumstances may fail the relevant tests and be sifted out of the tender process. This may not be a common issue at present, but it may be one that becomes more relevant as we move forward.
Finally, this concern does not diminish the fact that 2021 is likely to bring significant opportunities for growth. Adequately funded construction companies, which take on the right contracts with financially stable customers will reap the rewards of the government's likely desire to reflate the economy through infrastructure spending, as well as projects delayed from last year.
If you would like to find out more about the future of the UK construction sector in 2021, please get in touch with Alistair Wardell.