UK construction market – serious challenges are being faced
As reported by Opus LLP, the UK construction market has long-established weak points in its various business models. Many of its sub-sectors suffer from being volume-driven and overly-competitive, plagued by lowball pricing. The prevalence of fixed price contracts in a time of rampant cost inflation is having serious implications for profit margins that were already too slim. Somewhat like food retailing, there has been a tendency for commercial pain to be transferred down the supply chain by main contractors, in this case to subcontractors.
Construction output was £122bn in 2021, recovering by 12% on the depressed level of only £108bn in 2020 but still over 5% below 2019’s pre-pandemic outcome. This represents 7% of total UK GDP. The industry employs some 2.15m people, equivalent to some 7% of the labour force. A higher proportion of the workforce is self-employed than in most other sectors. The total assets employed in construction are now over £200bn, with a total net worth of £85bn. The sector borrows £29bn overall.
Financial risk profile
We have used the database of the financial health monitoring company, Company Watch, to analyse the latest published accounts of each of the 239,572 companies registered at Companies House as operating in the sector, so that we were able to examine the most up-to-date financial data available and compare this with what we had found when we last looked at the construction industry in May 2020. Because of the delays in the filing deadlines at Companies House, the May 2020 data effectively captured the situation prior to the pandemic, whilst the current data broadly covers first twenty one months of the pandemic period.
Over a third (82,110) of the companies were in the Company Watch warning area with a health rating (H-Score®) of 25 or less out of a maximum of a hundred. Statistics for the past twenty five years confirm that at least one in four of these businesses will fail or need a major financial restructuring during the next three years. The average H-Score of the whole sector is only 40 out of a hundred, which is well below par and lower than shown by our May 2020 data, when the average H-Score was 42.
10% or 24,167 companies are zombies, with negative balance sheets where liabilities exceed assets by at least a de minimis figure of £10,000. Their combined balance sheet deficits add up to £3.1bn. In May 2020, 9% of the companies were zombies, so this risk indicator has intensified.
We also looked for the first time at the working capital position of those businesses where ‘quick’ current assets such as receivables, cash, contract value and work in progress were lower than their short term liabilities. We found that 13% (30,667) of the companies had negative working capital. The shortfalls totalled £6.3bn. This is not a healthy statistic for the industry, indicating significant scope for short term financial pressure.
Cashflow pressures
In addition to the issues with Bounce Back Loan repayments, evidence is mounting that HMRC has finally abandoned its ‘soft touch’ pandemic approach to collecting tax payment arrears. This is starting to hit construction companies, which are now receiving 21% of the escalating number of winding up petitions being issued by HMRC.
The housing market
The latest survey of property agent predictions for house price falls in 2023 has just been published by the Times and the Sunday Times. These range from 10% to 1 percent, with an average of 6.1%, driven by higher mortgage interest rates and the cost of living crises. This can only increase the pressure on housebuilders, who were already struggling to justify some developments against a background of cost increases and significantly higher interest rates.
The prospects for 2023
There can be no doubt that many construction businesses facing a toxic cocktail of adverse factors are in for a pretty bumpy ride in the year ahead. Business rescue experts are forecasting a further increase in insolvencies, perhaps as high as 30,000 across the economy. This would be an all-time peak and more than a quarter up on 2022. This could mean 6,000 construction company failures and perhaps even more as lenders work their way through their recovery options for the 40,000 plus Bounce Back Loans already known to be in default.
The watchwords for 2023 should be prudence and feasibility. For the construction sector, this means being extra cautious, not taking unnecessary risks and being practical about what is possible with the resources you have. Reaching out for expert help as soon the going starts to get tough is the right thing to do.
There will of course be winners, especially those who resist the temptation to win work at the cost of cutting margins even closer to the bone. Controlling debt or hoarding cash will be essential strategies, which in turn means being constantly on top of cash collection. It’s going to need to be all about commercial and financial discipline.