2007 showed the big getting bigger in construction

Money talks which means more money should be something to shout about.

Certainly the talking got much louder in our sector last year. And for good reason, as the UK's top 10 biggest earning construction groups made an aggregate pre-tax profit of £650m (see Top 10 box, p13), almost double the tally of the £360m achieved in 2006.

The message that sort of performance sends out is that 2007 was quite a vintage year.

Why the upsurge? Well, for the first time none of the big guns suffered from financial blips or historic hangovers that refused to be pushed under the carpet and ignored. In 2006, neither Costain nor Interserve had quite got through their internal troubles. Both emerged smiling last year, however.

And of course the top 10 itself is not static. Predators abound and so the big get bigger.

The top end

The top end of the industry has been a moving feast. Carillion is now a combination of what once was three, thanks to its takeover of both Mowlem and Alfred McAlpine. The nimble-footed beast known as Morgan Sindall expands another notch whenever chairman John Morgan dives in with a timely move, the most notable recent swoop having caught the chunkier construction parts of Amec.

Rok's rapid growth has been fuelled by a regular stream of regional acquisitions. Also active on the same regional front are Balfour Beatty and Vinci UK.

So with contractors managing to step away from blunders of the past it might be expected that profit margins would now be comfortably up to the 3% mark, what with partnering and frameworks being the order of the day.

Well, things are not exactly as juicy as all that. Just look at Balfour and Carillion on that score: Balfour achieved a profit margin of 2.1% while Carillion ran out slightly higher at 2.4%.

Looking over into Europe, Dutch-based construction conglomerate BAM is crossing the line with a profit of £330m from turnover of £7bn, which indicates a margin of 4.7%.

A sign of things to come here? Perhaps not, perhaps that possibility has already gone.

"2007 was a good year," says Alec Comba, finance director at Vinci UK. "But that's as good as it will get. Workloads will probably start to fall soon. It all depends on how much work is placed by the government."

Andy Brown, analyst with stockbroker Panmure Gordon, was also happy with 2007. "The results were fine," he says. "With many firms putting out regular trading updates there were never going to be major surprises." Looking forward, he adds: "Orderbooks have held up but we are in a nervous market."

But the big issue today is whether or not the work in contractors' orderbooks can be replaced further down the line. The trouble here (in terms of companies' share prices) is that the Stock Exchange view is that it won't be.

Comba is succinct, saying: "I think it will get worse before it gets better. We'll be keeping our heads down and I anticipate everyone taking lower margins."

What is unnerving, even unjust, perhaps, is that despite profits surging last year, share prices in our sector went in the opposite direction.

The London Stock Exchange's All Share Index fell by 13% during the past year while the Exchange's Mid Cap group (made up of quoted companies ranked between 100 and 350 by market capitalisation size) was down 17% and within that group of 250 are the names of most of the construction and building firms.

Balfour, Keller, Rok and Carillion went with the flow, the only positive here being that some construction names actually fell by 1% to 2% less than the Mid Cap sector average.

However, others took bigger hits, with Wolseley sliding by 60% and Travis Perkins by 50%.

Housebuilders' gloom

Housebuilders' shares have had a woeful time over the past months though, looking ahead, Bellway is seen as having a rosier future than its competitors.

"Persimmon would love to buy it," explains one financial commentator, "as Bellway's management is one of the best. Yes, share prices have tumbled but as a sector, housebuilding is dynamic and we know that demand is not going to go away.

"The premium Persimmon would have to pay to get Bellway is very high, so Bellway will continue on its own organic growth path. It should retain its independence thanks to the fact that the others are now stretched for cash."

Bovis Homes hits the right buttons for Mike Foster, analyst with stockbroker KBC Peel Hunt. He says Bovis's shares have been oversold and that it has the attraction of a good landbank.

Galliford Try and Kier, which both operate a hybrid business model containing both construction and housebuilding operations, are seen as relatively attractive to anyone thinking of buying shares.

Of the two, Galliford has the better housing model, says Foster, and it is achieving higher margins in its social housing operation, thanks to value-added advice and land assembly, but it is carrying more debt.

"Kier has strong cash and the group has a strong support services operation with good prospects for broadening out through the growth in local authority outsourcing," adds Foster. "We'd buy both shares but are particularly happy about buying Kier."

A stockbroker's view

Geoff Allum, also with stockbroker KBC, offers his take on a further handful on firms.

"Ashtead remains a dog," he observes. "It's ironic because the company keeps coming up with good results yet until people can see the downturn having an impact, management's words are falling on deaf ears. Ashtead's numbers [ie anticipated profits] are still what we were forecasting two or three years ago."

Erinaceous is classed as "nearly bankrupt" and Allum thinks that a debt-for-equity swap, generally seen as the group's only route to survival, will be unveiled within the next three months.

Atkins is "going well" says the analyst. "It is buying back £100m-worth of its own shares, which signifies two things: it has a lot of cash and it is optimistic about its future prospects."

Atkins' involvement in Metronet could prove to be no more than a temporary embarrassment, leaving it with little more than egg on its face. Although it could turn into a longer-term problem should the government feel it appropriate to exact further punishment by barring Atkins from bidding for future PPP projects.

Of the two scenarios, Allum goes for the former. "There isn't that much total resource in the UK as we have a shortage of people to this sort of preparatory work. Anyway, the government policy is to give work to the right people at the right price. Balfour was also in Metronet and the government likes Balfour."

Allum's verdict on Jarvis is that it is doing well on reduced forecasts. "Work in rail will come in," he says. "The only trouble is that we don't know when. Which sector of its operations Network Rail will opt to be active in next matters a lot to Jarvis."

Should there be anyone out there with spare cash at the moment and who fancies a bit of bottom-fishing, then given Jarvis's low share price, it could well be the next item on the bargain counter.

The mantra that "cash is king" has been followed by Vinci's Comba ever since taking up his position. Other finance directors with a similar view of book-keeping and corporate prudency are to be found at Lorne Stewart and Condor Structures.

For each of them, there is every indication that their rigorous, down-to-earth philosophy will be paid back in spades in 2008.

"Cash, or should I say holding cash, will be the highpoint of the coming year," says one. "You can see it already: until recently we were offered bank rate and no more for our overnight cash but for the past three months anything you put on deposit has earned 6.02%. With the base rate at 5.25%, that's a good 0.75% higher.

"How come? Well that's because of the huge demand for our money as in today's climate banks don't want to risk lending to each other."

Just when you'd thought you'd heard the last of Amec, here it is featuring in the final paragraph of this feature. Having pulled out of construction, after a string of muddles, write-offs and annual losses, Amec has had its first full year as a pure oil-and-gas player and has logged a massive pre-tax profit of £171m. Steady on there. No need to swear.