Analysis: Construction's winners and losers in 2008

Backed by strong results in 2008 and secured by long term frameworks, the UK's Top 20 contractors are set to pull still further ahead (see table below). With credit insurance evaporating fast, the rest of the pack are left contemplating a riskier 2009.

The Top 20 should find things will only get better in 2009. After a strong financial performance last year. Well, that's the view from the City.

It seems that the big players will get bigger, which is a remarkable prospect given that takeover bids are totally out of fashion at the moment.

"Market share will continue to consolidate onto these bigger players," predicts Andrew Nussey, analyst with stockbroker KBC Peel Hunt. "They have aligned themselves to public sector activity and are financially more robust than they previously were."

But the other side of the coin is that no matter how well the nextbiggest 200 construction groups fared in 2008 - and many also did quite well - their prospects going forward are far gloomier.

Below: financial performance of major contractors, 2008

Contractor	Pre-tax profit	Turnover	Contracting op. margin	Notes
Balfour Beatty	£270m	£9.5bn	2.1%	Excludes rail engineering
Carillion	£116m	£5.2bn	1.4%	Excludes £110m Mid East construction
Keller	£113m	£1.3bn	8.7%	World operating margins (3.2% UK)
Interserve	£80m	£1.8bn	4.4%	Excludes equipment and PFI investment
Morgan Sindall	£62m	£2.5bn	2.5%	Margins: 1.3% construction; 2% infrastructure
Costain	£23m	£1bn	1.8%	£18m profit from operations
Rok	£6m	£1bn	0.4%	£2.2m operating profit on £560m
ISG	£6m	£560m	1.3%	0.7% margin in regional construction
Skanska UK	-£43m	£1.5bn	-2.9%	Serious project write-downs
Construction and house building hybrid
Miller	-£170m	£1bn	2.2%	£14m profit on £620m sales
Construction and house building hybrid - interim results (6 months to 31 December 2008)
Kier	£32m	£1.1bn	3.6%	£29m pre-tax profit on £790m sales
Galliford Try	-£38m	£790m	3.2%	£17m pre-tax profit on £540m sales
All figures based on annual results to 31 December 2008, unless otherwise stated

There is a belief that players in the £30m-to-£500m turnover band are about to find the going will becomeextremely tough during the next 12 to 18 months.

They face two major issues. First, credit insurance brokers have backed away from the construction sector big time.

Lower insurance cover

The cover on offer is £10bn lower than it was 15 months ago, having dropped from a figure of £25bn to just £15bn.

That is bad news as it transfers risk into the heart of the construction industry. It means a client that failscan take down lots of others, particularly those that find themselves unpaid for work on one or more of their projects.

Second, many privatelyowned groups are being squeezed by their lenders as credit lines are reined in.

Funds needed urgently

So far the Government is all talk but little else. It sees the need to keep the wheels of industry turning, but has failed to provide conditions that work. Funds are needed today not after a thousands sunsets.

It is subcontractors that are in line to take the hardest knocks and larger contractors will need to work much closer with them.

One analyst says: "That £10bn drop in credit insurance cover means that big names will have to help some of their supply chain by improving credit terms. For example, the deal could be that they will pay 20 days earlier than previously in exchange for lower input costs."

Andy Brown, analyst with Pan-mure Gordon, also has concerns in this area.

"Quoted groups won't say a lot," he says. "There is pressure - publicly - to be seen to squeeze more out of subcontractors but they know they need to be careful as while it suits them to be seen to be taking cost out, quietly they recognise the need to actually be helping them."

Brown pictures big contractors making working arrangements with their supply chain's subcontractors, but not singing from the roof tops about what is actually happening at the operational level.

House builders, already on the rack, are seen as being unlikely to make any profits at all in 2009.

Their balance sheets are so abysmal that no-one wants to be dumped with the ownership of these once vastly profitable companies.

Fifty years ago, militant Labour Party supporters wanted to nationalise everything that moved, yet today, when Gordon Brown has this suppliant sector quivering at his feet, he is fighting hard to avoid being dumped with their ownership by way of the various banks that are now quasi-nationalised.

Big opportunities

Tony Pidgley, seen by many as the bellwether of the house building sector, has made his game clear. He scents massive opportunities and has already been to Berkeley's shareholders to build up an even bigger pot of available cash.

But Pidgley is yet to start spending. Land prices have already collapsed but he is believed to be keeping his powder dry, expecting further falls.

Consulting engineers have already surprised the City with the number of job losses. Dubai had previously been a 'get out of jail free' card for them but now, with the collapse in the price of oil, the construction spend has quickly evaporated. Mouchelhas even felt the need to issue a statement saying that it can't get paid for work already done. Hardly a healthy situation.

Despite all of that, most consultants reporting to a December 2008 year-end unveiled sparkling figures. Michael Parkinson, analyst with stockbroker Brewin Dol-phin says: "WSP showed amazing numbers that were ahead of what analysts anticipated."

Acquisition

Turning back to contractors, after a decade of struggles and false dawns, the Top 20 have got themselves into a position of relative strength,so much so that they look to be on track to lift their share of the UK construction market without even the need to factor in that most worrying of manoeuvres - the next acquisition.

In the City, the most positive view on the two big hitters, namely Balfour Beatty and Carillion, is that they are each doing such large projects that they have now established a momentum of their own. Their strings of multi-year framework contracts give them fire-power.

Their joint annual turnover stands at £14bn and the lion's sharecomes from Balfour, with £9bn, though one analyst notes that £1.5bn of this comes from Balfour's further foray into regional contracting at just the wrong time, Balfour having dived in for Dean & Dyball and Cowlin to add to its existingMansell business.

"Balfour gives the City a complete lack of transparency on its numbers," Parkinson observes. "Carillion's comparative advantages are that 50% of its turnover is now in support services and it provides a much greater transparency on its operations.

"Not only that, but Carillion has another £20m of cost savings from the Alfred McAlpine integration still to come through this next year.

"Nationally, the demand is still there for further outsourcing, but rather than offer that work to a re-badged contractor, it will go to someone seen as a specialist. Balfour's difficulty on that score is that it has not bought into services whereas Carillion has the capabilities that came in with both Mowlem and McAlpine."

Up-front cash

Carillion's debt level has fallen at a tremendous rate, aided -so onetheory goes -by its Arab clients with up-front cash.

Getting debt downto £300m at the year-end was seenas a challenging target, seeing that it actually dipped to £226m wassomething that raised quite a few eyebrows.

Pamure's analyst Andy Brown sees the two big guns (Balfour and Carillion) as now being in a separate ballpark to other contractors. "They tended not to issue downgraded forecasts during the past year," he says, "and their numbers [turnover and profit] were ahead of expectations."

By contrast the next pack - including Morgan Sindall, Kier, Galliford Try and Rok- all had a slipup during the past year. "But even so, they delivered results in line with expectations," says Brown.

"There were no major disappointments in 2008, it's just that the big two fared better."In general, construction players are more willing to talk about their numbers now although Balfour won't go into detail- and if they changed from that now we'd know something was wrong.

"The second-tier players are all trying to be more helpful, but when you're Balfour and you not only got a placing away [successfully asked shareholders to cough up a lot more cash] and also made acquisitions during the year, you don't need to start pandering to the City too much."

But even Balfour has changed. "The new finance director will pick up the phone and call me," reports Brown. "Rather than it always being the other way round, as previously."

Leslie Kent, analyst with stockbroker JM Finn, finds himself singing the praises of Costain.

"Costain had been in the casualty ward for a long time," says Kent, "It has taken a long time to get out of intensive care. Costain had been the nightmare of the City, but the present management team has been there for three years and Costain is on the road to better things.

"Its forward orderbook runs to £2bn and annual turnover has grown to £1bn. For Costain, a further 25% growth in turnover to £1.25bn is more achievable than it is for the likes of Balfour which would need a lift from £8bn to more than £10bn to achieve a similar percentage growth in size.

"But there are still two running sores in Costain: the land in Spain and the building division.

"Costain can't drop the building contracting operation as that would inhibit what goes on in its civils business and civils is a very nice operation that's logging margins of 3.5% to 4% - it's what has kept Costain going through the tough times."

Kent anticipates Costain will lift pre-tax profit in 2009 to approximately £25m.

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It was less a case of winners and losers and more one of losers and lost in 2008 share price stakes. Over the last 12 months Costain was the only firm to register share price rise, with the majority of firms recording falls of more than 50%.

Costain ruled the roost over the past 12 months as a result of being the only company in the Stock Exchange's construction sector to enjoy a share price rise.

The result was that Costain's shareholders enjoyed a 13% lift in the value of their investment.

Costain's uniqueness reflects the tougher times in 2008 compared with the previous period when 10 names enjoyed a share price hike. Back in 2007, the top three each rose by more than 10% - namely Connaught, WS Atkins and Renew.

But 2008 was harder and Costain's achievement gave it a 24% advantage over its nearest rivals - North Midland Construction and Mears, both with a share price fall of only 11%.

Elsewhere, the tumbles were even bigger than that.

Costain apart, construction companies divided into three broad bands:

• share price down by less than 50% - group of 19
• share price down by 50% or more - group of 24
• share price down by at least 75% - group of eight

Heavy-weights to be found tucked away mid-pack included Balfour Beatty (shares down 27%), Keller (down 31%) and Carillion (down 33%).

The industry's two quoted hybrids - thanks to them sticking to a belief in the value of running with both a construction and a house building operation - were to be found in similar territory. Kier's share price shed 34% of its value over the latest 12-month period while Galliford Try eased by 43%.

Some things never change, it seems, and Jarvis's abysmal share price fortunes continued to amaze.

Holder of the wooden spoon until two years ago, Jarvis showed its ongoing capacity to disappoint with a further 75% fall in its share price value in 2007 followed by.another 75% drop in 2008.

Not that Jarvis's shareholders will be impressed by this information, but at least their contender was not bottom of the class this time round as Waterman's shares also dived by 75% while Hyder Consulting suffered a slippage of 82%.

Going down further, both Tolent and Siteserv were hit harder, with shares slides of more than 80%, while closest to the very bottom three was a threesome made up of Styles & Wood (share price down by 93%), White Young Green (down 94%) and in last place of all Silverdell (down 96%).

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What the chiefs have to say...

Keith Miller, Chief executive, Miller

"Do I regret building our housing division up? No. On the contrary, our goodwill provision was modest with a write-off of just £20m.

"That shows we have built a strong house building activity without paying over the odds.

"I think the worst is over as reservation rates are 9% above those at the same time last year so I’m upbeat about prospects for this year and Miller’s construction operation is in great shape."

Andrew Wyllie, Chief executive, Costain

"There are fewer contractors out there and those that are still about need more horsepower to tackle the big projects.

"We raised equity last year with a view to tendering on bigger schemes and have made progress on that journey.

"The plan over the next three to five years is to position Costain as a Top 5 contractor. I'd currently put us in the Top 10."

Richard Adam, Finance director, Carillion

"Carillion is now the largest support services player in the UK which puts us in the luxurious position of being on almost every bid list."

Ken Gillespie, Managing director of construction, Galliford Try

"1,000 employees in our house building division have gone on to a four-day week.
"In construction, to stay competitive I can’t see us offering a pay award but a pay reduction is not being considered.  A neutral award is where I am with my thinking."

Justin Atkinson, Chief executive, Keller

"2009 looks challenging. Orders in the first two months were 20% down on the same period in the previous year.

"More names are appearing on tender lists – sometimes in America there could be as many as 10."