Profits up - share prices down

The construction industry's stream of financial results for 1999 made encouraging reading because profits were up almost everywhere.

And the players that have expanded from mere construction groups into all-round service providers have been rewarded for taking a wider one-stop approach.

Forward-looking contractors have stepped away from cutthroat competitive tendering, recognising that securing partnerships with good clients that offer stable workloads is a better way forward. As a result, bumper profits have been announced left, right and centre.

At long last margins are on the move. Running at a wafer-thin 0.5% two years ago, they are now averaging 1.5% and are expected to hit 2% by the end of this year before moving further ahead in the medium-term to 2.5-3%. Some partnership deals are already offering an open-book margin of 4%.

Performance in the housebuilding sector has been equally rosy, if not more so. With landbanks typically running to three years, the leading housebuilders have pushed margins two percentage points higher, the sector average now being 13%.

With the construction industry emitting such good news, it could be expected that companies' share prices would have jumped up in response. Not so. Lack of interest in the sector has sunk to an all-time low. Companies that are neither high-tech or internet-related have been shunned for the best part of a year. A reversal of fortunes has been long overdue.



On top of that there has been a dimming of City interest in mid-cap (ie companies with an annual turnover of less than £500m) groups with the result that even well-known players in the construction sector have found themselves suffering from a double whammy. All they can do is grit their teeth, press on and wait for the tide to turn.

Taking an individual look among the various publicly quoted contractors, analysts working in the City for the major stockbrokers give Amec the most plaudits though some are rather backhanded compliments.

Amec's strategy of building a one-stop service for global clients is seen as being a forward-looking approach. Carillion is "a developing story" that has made an impressive case over its strong involvement in PFI, while Peterhouse has jumped from nowhere and enjoys a well-regarded position on the City's radar screen. Balfour Beatty is still seen by some as "confused" and "unclear going forward", while the verdict on Mowlem is "trying hard".

Housebuilders' 1999 results earned 5% upgrades by many analysts. At the top, the names of Wilson Bowden and Redrow appear, while Wimpey and Barratt bring up the rear.

With its three-year-old Spie deal now delivering benefits, Amec strode further on to the world stage with the recent announcement of the agreed £220m acquisition of Agra, the international professional services group in Canada.

Mike Foster, analyst with stockbroker Credit Lyonnais, says the horrendous performance of Amec's share price since announcing its Agra link-up is because the City thinks Amec paid 20-30% too much. "Strategically, however, it is the right move," Foster declares.

The second reason behind Amec's share price tumble comes from its muted performance in the service sector: the 7% rise in profit from services was "steady rather than exciting" given that the services orderbook was up slightly in excess of 7%.

"The market wants to see an acceleration in profits growth in Amec's services division," says Foster.

Might Amec's decision to beat a path on to the world stage provide an example for other UK contractors to follow? No - the rest are too small to follow suit. Players such as Taylor Woodrow and Laing are moving in the opposite direction and are in the throes of downsizing their construction divisions. "They are looking for less business but more profit," says Jonathan Timms, analyst with Charterhouse Tilney.

But what about mergers as an avenue for building world presence. "The City would like it," Timms agrees, "but I'm not sure the companies' management would, as the consequence of merging is that heads would roll."

Even the lure of golden handshakes has, to date, prevented contractors from setting about any meaningful round of mergers and if Alfred McAlpine and Bryant can't do it, then who can?

McAlpine and Bryant were brutally honest when they said "we must get bigger", but their best endeavours fell apart as soon as their private talks became public. The reasons for that are shrouded in mist. Bryant did not have a management problem to resolve: not only was chief executive Andrew MacKenzie about to retire, but his finance director had just retired, creating the most ego-free zone imaginable.

So what other company-specific views are being expressed by the City? John Carnegie, analyst with Schroders, offers a congratulatory slap on the back to Balfour Beatty managing director Mike Welton. "He's doing a good job," says Carnegie. "He's got a prudent management team that hasn't grown up in the construction sector, which is a plus."

Carnegie believes there are still too many died-on-the-wool senior managers about with a mindset for turnover and volume rather than profit. And we thought they'd all been retrained!



To stay serious, Costain chief executive John Armitt is one who readily admits that the old attitudes are still about. After making a strong push into partnering, Armitt finds some of the people working at the coalface - for both Costain and for its better clients - are uncomfortable with the open-book methodology now coming into vogue.

OK then, these people exist, so how does Armitt resolve this problem? The preferred route is to shift the mindset. If the blockage just can't be moved, however, there are two choices: either the employee leaves, or is asked to run conventional projects.

It all boils down to a problem of age. New graduates are free from any such blight: arriving with an open mind, they can be steered into partnering teams without any problem.

However, back to Balfour. Carnegie's enthusiasm for the group isn't shared by fellow analyst Foster. After listening to Balfour's results presentation he found it to be a "company still in transition". Foster says that Balfour's explanations were confused and it was unclear that the group was going forward. He believes that more information is needed.

Laing takes a mild panning for results that were dubbed "bad, but not as bad as expected" by Foster, while Timms believes that the fundamental restructuring of Laing's shares, with voting rights now being enjoyed by 100% of its shareholders rather than just 50%, means that Laing has been opened up to commercial pressures for the first time.

If Laing's management fails to perform, there is at last something investors can do about it - they can vote individuals off the board and can also, in an extreme situation, sell out to a bidder seeking to swallow up Laing. "It was something Laing needed to do," says Timms.

The City sees a dramatic tension between Mowlem chief executive John Gains and the highly profitable scaffolding group SGB, floated by Mowlem in June 1997. Releasing 49% of SGB put £55m in Mowlem's pocket. Mowlem still has a 51% stakeholding in SGB where the management is said to want a complete parting of the ways.

Laing and Taylor Woodrow both have housebuilding divisions, businesses that utilise the cash from their construction division very effectively. Tilbury Douglas has an equipment services wing that provides the same outlet, while Carillion and Balfour Beatty's equivalent cash lock-up route has been to build up a PFI equity and property portfolio.

"They are all investing their cash well," says Timms, "and Mowlem is similarly investing its cash well in SGB. If I were a Mowlem shareholder, however, I'd worry about Mowlem selling the SGB stake and going into something else.

"Mowlem has to prove it can use its cash more effectively elsewhere than in SGB. It has already sold off half of SGB and reinvested it - and would have done better to leave it in the scaffolding business."

John Gains is very positive about the group's overall figures, notes Timms, but adds that Mowlem's new initiative, of servicing insurance clients, is losing money." The City recently met up with Gains to ask questions, so how did he answer them? "Adequately," says Timms.

In the past Carillion has been criticised for being opaque, but that is all water under the bridge. Foster says: "Its results were in line with expectations and it made an impressive case on PFI.

"Carillion's numbers are now more conservative. Trade debtors were £40m in 1998 but were £10m at the end of 1999, a figure that is acceptable. It had been aggressive in its accounting in the past - very dodgy. But the investment quality of Carillion has risen," says Foster. In other words the group's 'grey hole' problem has been tidied up.

Timms is similarly impressed. "We are getting more information than when it was in Tarmac," he says. "Carillion is doing well: it gave a good presentation and senior staff have tried to be pro-active, showing that they have changed their spots."

And just when everyone says that medium-sized players are unloved, particularly those in construction, along comes Peterhouse to disprove the maxim. Two years ago WSP was construction's exception to the rule, now it's Peterhouse the fast-growing £220m/year turnover player from Yorkshire.

Two thirds of Peterhouse's profits come from services and by using share price ratios based on a comparisons with Amey, one analyst calculated a target share price for Peterhouse of £4.

"It's a very good company," says Foster. He believes Eve was a good acquisition, so much so that Peterhouse could have paid 20-30% more than it did.

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