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Profit margins remain under pressure for contractors

Analysis of the CN100 contractors’ profit margins shows the industry is still feeling the effects of five years of downturn.

Despite seeing an overall increase in average operating profit margins across the CN100 this year, pressure on contractors has not abated as workloads have grown.

“An analysis of corporate profitability in the CN100 shows few signs of improvement and, overall, contractor margins remain under severe pressure,” EC Harris partner Simon Rawlinson says. 

The top 25 firms have recorded average margins of 2.5 per cent, down on last year’s 3.5 per cent, while the firms ranked 26-50 also saw a fall in average margins from 2.2 per cent last year down to 1.8 per cent this year.

“Nearly 50 of the CN100 delivered a lower margin than could be gained from an investment in a competitive cash ISA”

Simon Rawlinson, EC Harris

Total profits earned by CN100 contractors fell by over 10 per cent.

“Tellingly, nearly 50 of the CN100 delivered a lower margin than could be gained from an investment in a competitive cash ISA – an extraordinarily poor balance of risk and reward,” Mr Rawlinson says.

Top 10 CN100 firms by operating profit margins

The news is better for the bottom half of the table, where margins increased in both the 51-75 and 76-100 brackets, but again the rises of 2.5 per cent and 2.8 per cent respectively were marginal.

“Given the diversity of businesses in the CN100, it is difficult to draw too many patterns from the analysis, but the data suggests smaller firms have been able to deliver the best margins during the past year,” Mr Rawlinson says.

There are a number of factors putting pressure on contractors’ profit margins, which in some instances have been exacerbated by increasing workloads.

“Pricing is tough; many contractors are still having difficulty getting the prices they want and contracts are still being bid at a relatively low rate,” PwC partner Chris Temple says.

Skills shortage and rising labour prices

Part of the problem for contractors when pricing tenders is labour rates and the lack of skilled labour available in the market.

“One of the fears I have for the industry is that we don’t have that abundance of labour coming in that helps to keep those labour rates under control,” Mr Temple says.

This increase in the cost of labour will hit contractors’ profit margins, particularly for jobs bid and won at the bottom of the recession.

“The key point for contractors trying to get their pricing right is to take on board the fact we have margin pressure as a result of materials but also labour,” Mr Temple continues. “If you don’t have a lot of labour, the price per hour goes up.”

Rising materials prices

Labour is not the only cost that is increasing for contractors; materials prices are also on the up and these rising costs will have influenced the overall profitability of contractors over the past year.

“The other big influence at the moment is around materials costs and material costs variations,” Mr Temple says.

“There is still a feeling in the industry that there is excess capacity in comparison with demand”

Chris Temple, PwC

“If there are clauses in the contract that allow contractors to charge for the excess material then that’s fine, but if not then it’s going to be harder for them to deliver on these margins.”

Excess supply in the market is another concern for contractors, and one that may take some time to rebalance as the industry moves out of recession.

“There is still a feeling in the industry that there is excess capacity in comparison with demand, which doesn’t drive prices up in the short term but will do in the medium term as we work towards a supply/demand balance,” Mr Temple explains.

Who has done well?

When considering those companies that have maintained or grown their profit margins in the past year, it is possible to identify some central themes that apply to certain groups.

“There are only four firms with a turnover over £1bn in the top 25 [firms ranked by operating margin],” Mr Rawlinson says. These are Amey, Carillion, Galliford Try and Interserve.

“2014 may be the year when contractors can finally begin to raise their margins in bids for new work”

Simon Rawlinson, EC Harris

“Tellingly, all four are highly diversified and three have large FM businesses. Firms with a particular focus on the utilities sector have also done comparatively well.”

Several other companies with higher margins sit at the other end of the scale, being either smaller, regional or particularly focused on sectors such as housing.

CN100 2014 Profit margin by quartile

“For these companies, trying to focus on niches in the marketplace that allow them to concentrate on high-growth segments is probably going to be positive,” Mr Temple says.

Mouchel has re-entered the main table this year, after acquisitions and restructuring saw it become one of the UK’s largest infrastructure asset management companies. It also shot up the margin rankings, with a 7.3 per cent operating profit margin in its latest results.

“The impact of the election is worth mentioning; what will happen there is a big question”

Chris Temple, PwC

Hill Partnerships achieved a 7 per cent margin through undertaking housing renewal and refurbishment work, mainly in the public sector, while another new entry, Henry Boot, tops the profit margin rankings with an operating profit margin of 12 per cent for 2013.

The company, which works in property investment and development, land development and construction, increased its turnover by nearly 50 per cent in the year.

“2014 may be the year when contractors can finally begin to raise their margins in bids for new work, but the CN100 tables provide plenty of evidence of the long-term repair work needed to restore contractor profitability and financial health at all tiers in the supply chain,” Mr Rawlinson says.

Effect of the election

Each sector the top 100 contractors work across has a varied outlook for the next 12 months, but overall the sentiments are positive for growth.

“Each individual segment has a different outlook, but it is generally quite positive,” Mr Temple says.

“Cautiously optimistic is the way I would describe the industry. The general macro-economic indicators are all pointing in the right direction for construction growth.”

“The message from the CN100 is that contractors are likely to need to continue to challenge their own business models to increase profitability”

Simon Rawlinson, EC Harris

One area of uncertainty is around the upcoming general election and the effect any changes in government might have on spending in the public sector, as well as sentiments in the private sector.

“The impact of the election is worth mentioning; what will happen there is a big question,” Mr Temple says.

“Not necessarily for commercial or industrial but for infrastructure, and whether there might be more infrastructure spending in the future.

“There is the opportunity for greater infrastructure spending and some of the larger projects may well be accelerated if that is the case.”

Future prospects

This year’s tables reflect an industry that is still slowly recovering from the recession, with different sectors and areas moving at very different speeds.

“I suspect we will start to see enhancement of margins, not least because pricing pressure will start to drop off,” Mr Temple predicts.

Until contractors can get their pricing to reflect the increases in labour and materials prices, margins will not significantly improve.  

“Increased turnover and better utilisation of people and assets will no doubt contribute to improved profitability, but it is also clear margins will have to increase both in sectors which remain financially constrained as well as those that are booming,” Mr Rawlinson says.

“The message from the CN100 is that contractors are likely to need to continue to challenge their own business models to increase profitability – as well as relying on market forces to restore margins.”

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