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Embattled M&E sector waits for light at the end of the tunnel

When Balfour Beatty attributed around two-thirds of its £30m profit warning last week to problems in its M&E business, it led to new questions over the sector’s slow recovery.

A year since Emcor Group and Mitie announced they would pull out of the UK M&E market, and after high-profile administrations in 2012 of firms such as Airedale Mechanical & Electrical and MJN Colston, the sector has yet to profit from the sense of confidence returning to industry.

Balfour Beatty’s profit warning, following an internal strategic review, brought the sector’s troubles back into focus, as its executive chairman Steve Marshall warned that its UK business saw another 12 to 18 months of recovery ahead.

It is a widely held view that more firms go under as the industry exits a downturn, with work won on low prices in challenging times becoming unsustainable as material and labour costs increase as industry recovers.

Light at the end of the tunnel?

So when will margins improve and help M&E firms to balance the books?

David Hurcomb, chief executive of NG Bailey, whose forward order book stands at around £640m, says: “We would expect to see in 2015 at some point we’d be able to put a better margin on the work.”

He adds that he expects “a number of small competitors having cashflow problems on the way out of recession”.

“We can see our own customers having a tough time and in turn that means we get a tough time”

Nick Pollard, Balfour Beatty

Balfour Beatty UK Construction Services experiences both ends of the spectrum as a main contractor, but also, as chief executive Nick Pollard points out, as a subcontractor through its M&E business Balfour Beatty Engineering Services.

He said: “[BBES] is a subcontractor not only to our own works on occasions, but also to many of our competitors… recovery hits [M&E] later than it does the building boys, later than it does the housing boys in the current situation, so it is still struggling with the market.

“We can see our own customers having a tough time and in turn that means we get a tough time.”

Mr Hurcomb adds: “In the last 12 months the UK economy has entered growth and there is confidence, but it depends where you sit in the cycle.

“Consultants tell me now they are all very busy, which means a year later the main contractors get busy and we do six months after that… so I think we are 18 to 24 months away from seeing true recovery in terms of there being better quality of work out there.”

Balancing act

Wates Construction building services director Jason Knights says many M&E contractors are faced with a choice of exiting problem jobs, or continuing and facing conflict later on.

He says: “Too many industry players have shown a willingness to underestimate the cost of difficult jobs, and as a result have encountered a series of problems further down the line when looking to cost projects appropriately.”

Spie UK has diversified its offering to the market through recent acquisitions, including FM firm Garside & Laycock in 2012 and transmission network engineer Electricity Network Solutions last year. Its main divisions are facilities management, building services and industrial services.

“Main contractors are working to reduced margins… when everyone is struggling at the top, everyone else is hard hit”

James Thoden van Velzen, Spie UK

But it has also reduced its reliance on work with main contractors, focusing on arrangements with end-users.

Its chief executive James Thoden van Velzen says: “My view is that main contractors have taken low-value work – they all played in a very small pond because there was little government work in the market.

“They are working to reduced margins… when everyone is struggling at the top, everyone else is hard hit.”

He says just 12 per cent of its UK business is now with main contractors, most of which is on airports, as it chooses to work more with end-users.

“Building services is really important to us,” he says. “We could very easily do what Mitie and Emcor have done [and exit M&E in the UK].

“But for us to remain a technical business we need to be able to design, build and maintain projects.

“This is not us saying we will never work with main contractors, because we do – we have some good relationships and we will do more work when the market returns.”

Supply chain risks ahead

For contractors that have brought M&E services in-house, some may find themselves experiencing more supply chain failure in the coming year, according to Mr Hurcomb.

“I think main contractors will see a lot of failure downstream on their projects or as subcontractors start demanding more money to finish the job”

David Hurcomb, NG Bailey

“Going into the recession, main contractors often want to break up M&E [services],” he says.

“That’s ok until those companies – if they’re not making money – won’t stand behind the price or the risk, the terms and conditions they gave you.

“I think main contractors will see a lot of failure downstream on their projects or as subcontractors start demanding more money to finish the job.

“You will see, particularly on the larger schemes, the tier one contractors wanting to partner up with the major M&E firms.”

Mr Thoden van Velzen says that while partnerships would be a good solution, he is “not sure main contractors’ worlds have evolved sufficiently”.

M&E work will come through in Q4 of this year that main contractors bid 18 months ago, but it will take time for margins to rise, he adds.

Cut its losses?

Mitie announced in February it expected to record full-year 2013/14 losses of up to £9.3m in M&E as it continued its withdrawal from the sector, which it said had been generating margins “well below average”.

Would Balfour Beatty consider cutting its losses, like Mitie and sell the division?

Mr Pollard, who has been named BBES interim managing director following the resignation of previous MD Phil McGuire, insists it will not, as the exit of market competitors like Emcor and Mitie will create opportunities for BBES to win work at greater margins as workloads steadily improve.

“This particular business is a sector where a lot of key competitors have died on the vine or pulled out during the course of the recession in the last few years,” he says.

“There needs to be a big structural change before M&E becomes an attractive place to invest again”

Adrian Pritchard, Nash Fitzwilliams

“It is instrumental to the return of the building sector in the UK and therefore the prospects should be bright downstream. We should be well positioned.”

Nash Fitzwilliams construction M&A specialist Adrian Pritchard says contractors are often more likely to exit the sector than sell their M&E divisions, which are currently unlikely to be attractive to investors.

“I don’t think you have seen a general contractor acquiring in M&E for a long time,” he says. “There needs to be a big structural change before M&E becomes an attractive place to invest again.

“Private equity used to be a backstop for exits in the sector, but even if the margins were acceptable, the working capital situation in M&E is still too unattractive for private equity to get excited.”

Balfour in focus

So what of Balfour Beatty, often described as the bellwether of industry?

It must rectify the M&E problems that heavily contributed to a third profit warning in 18 months. But its leaders argue performance in other parts of its £2.8bn revenue BBCSUK business should receive more focus than M&E, which accounts for around £300m.

But with a long period of recovery to come, M&E contractors face an anxious year ahead.

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