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Action needed to ensure industry opportunities outweigh the risks

Continued weak construction data, working capital pressure and a material profit warning from an industry heavyweight means it is no surprise to see the construction sector out of favour with investors at present.

There appears to be little to cheer about looking ahead, given past experiences of a UK government delivering plenty of rhetoric but very little in terms of facilitating work starting on the ground.

The recent profit warning from Balfour Beatty underlined the pressure in the UK building market: £50m was taken off analyst forecasts, business units were closed and further job cuts came to an industry which, according to the National Institute for Economic and Social Research, has shed some 89,000 jobs and shrunk by 10 per cent since the coalition government was formed.

While some caution must be ascribed to Balfour Beatty’s warning in terms of a wider picture across to the sector (some of it might well be company-specific), it is no doubt indicative of the current aggressive bidding strategies required to win work and the obvious risks this brings to an industry with already thin margins.

Cold figures

So what is the latest data telling us? The latest construction output figures from the ONS provide little comfort, with activity in February to April 2013 down by 4.7 per cent relative to 2012.

“Mr Osborne has surely got to realise that a strategy of sitting and waiting for private sector money to arrive is not working”

New work was 5.8 per cent lower, with large falls in both public other new work and private commercial other new work – down 17.3 per cent and 8.8 per cent respectively.

While May’s Markit monthly index (PMI) provided some cheer with a score of 50.8, this number was very much at the behest of the improvement in private residential construction work, with commercial and infrastructure work still under pressure.

Waiting game failing

Mr Osborne has surely got to realise that a strategy of sitting and waiting for private sector money to arrive is not working. Until the government makes firm commitments to this sector in order to attract the required investment, there is an increasing risk of more ‘Balfour Beatty moments’ ahead.

Of course it is not all doom and gloom. It is important to remember that the UK construction industry is still worth some £100bn and clients are still spending.

Rail and utilities are two obvious examples of the growth opportunities which still exist and if you can afford to be selective, profits can still be made.

However, at present the risks probably outweigh the opportunities. Contractors still have to bid against a backdrop of declining volumes, clients exerting more onerous payment terms and a supply chain that cannot absorb more pressure.

This means the main concern has to be on cash: working capital pressures are prevalent in the sector and this looks to be emerging as more of a structural issue, rather than just a function of the current trading conditions.

While forecasters predict a better 2014, this isn’t looking likely at present and given the risk of inflation, the next concern for UK construction companies will be the old adage of ‘winning today’s work at tomorrow’s prices’. Watch this space.

Andrew Gibb is analyst, investment banking & securities, at Investec

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