Low bidding rates were partly to blame for Balfour Beatty’s £50 million profit warning, its finance director has conceded.
Duncan Magrath and chief executive Andrew McNaughton gave in-depth insight into what led to the troubles in the UK regional business to City analysts on Monday.
They explained the problems were in six of the 21 regional operating divisions, and extended to some jobs in the major projects business.
An action plan has been set out to “protect” the company from failing sub contractors, and to ensure bids and operations are more heavily scrutinised.
The pair stressed the problems were about poor execution of projects and had not been “deliberate”.
They added the damage will be contained to 2013, with potentially some small impact on 2014, but they will also be looking at the risks of taking on new work while carrying out their action plan.
There could be some minor restructuring, depending on market conditions, and they may look at pulling out of certain businesses.
In stepping into the UK construction business, Mr McNaughton said elements of his international strategy will also have to be put on hold.
A worsening financial performance and “a select number of contract reports” highlighting delays, subcontractor failings or changes to forecast commercial outcome, set alarm bells ringing in March, said Mr McNaughton.
“The performance of the business overall seemed outside of our seasonal norm,” he said.
The root of the problem, he said, was last year’s restructure, which saw it realigned into four regional hubs and three business streams, completed by January 2013.
“It’s now clear that during the transition phase, the new management teams were slow to assimilate the complete project portfolio in their delivery units,” he said.
“It’s now clear that during the transition phase, the new management teams were slow to assimilate the complete project portfolio in their delivery units”
This led to “inadequate review of schedule risks and subcontractor selection at the bid stage, and some failures to address progress deficiencies at an early stage”.
This in turn led to a downgrade of outturn on schemes, exacerbated by “the prevailing economic environment, including increased competition, subcontractor strain and customer procurement trends”.
A month-long review “raised some significant concerns in our mind”, he said.
It looked at the existing book of work, the key prospects, the “awarded but not contracted” jobs and the target bids in hand.
Results arrived on Friday, and Mr McNaughton said an action plan was drawn up over the weekend.
Root of the problem
The main problems were:
- Additional contract risks, particularly driven through tighter schedules in a constrained margin environment
- Poor subcontractor selection or failure during delivery
- A low standard operational productivity or performance
- Poor commercial strategy
Mr McNaughton said there are concerns in six of the 21 operating businesses in the regional division, stressing that “it’s not uniform across our business”.
There are around 1,000 contracts across the £1.25bn regional unit, with the company adding £100m of revenue each month.
He said 950 projects were reviewed - 100 of those, representing 65 per cent of total value, were looked at in “great detail”.
Roughly 75 per cent of the issues were in the regional business, with 25 per cent in the building part of major projects.
“Roughly 75 per cent of the issues were in the regional business, with 25 per cent in the building part of the major projects”
These have been confined to building projects where margins are traditionally lower and where there is a higher reliance on the performance of trade contractors, he said.
Across all of the £50m, there was one contract with more than a £3m impact. The “vast majority” are below £1m, with about five somewhere between £1m and £3m.
There was “significant deterioration” in the south, focused around management, environment, market conditions and pipeline, but with better trading conditions in Scotland and the North.
“We’ve not been looking at this from here in central London. We’ve been out with the businesses, looking at their individual books of work. So we are confident that we’ve got to the bottom of that,” said Mr McNaugton.
He said delays in the power market and PF2 “inevitably…do have an impact on us”
But he added: “The issue we’re highlighting specifically on the regional business clearly is difficult to blame on those elements of it.”
The profit shortfall was “a combination of poor execution, which hopefully we will rectify, as well as the margin at which it was – and the rates at which it was bid at”, said Mr Magrath.
“The rates which we’ve bid at on those contracts we’re obviously stuck with now but in terms of improving onsite performance, we will fix that,” he added.
“[Problems arose from] a combination of poor execution, which hopefully we will rectify, as well as the margin at which it was – and the rates at which it was bid at”
Mr McNaughton said there will be fluctuations in volume as a result of actions to “ensure the discipline around margins through the bidding process”, while they will be “scrutinising carefully our ability to perform and deliver on schedule and other project risks”.
He said this means “there’s a high possibility” of more selective bidding.
‘Poor execution, but not deliberate’
Both directors stressed that the problems were with poor execution rather than anything intentional.
Mr Magrath said: “Basically we believe this is poor execution. There isn’t anything deliberate going on here in the sense of people misleading, so there’s definitely no recovery to come from any insurance.”
“Basically we believe this is poor execution. There isn’t anything deliberate going on here in the sense of people misleading”
Mr McNaughton added: “I’m going to be scrutinising and focusing on those areas where we’ve got particular issues and I have absolute confidence in the management in those regions where they’re operating exactly to the procedures we have.
“I’m absolutely confident that the regions and the projects have been striving to deliver results for this company.
“There is no question that the regions would not have been working in the best interests of the company and have that at their heart.”
‘People will be leaving’
But Mr McNaughton told analysts that “there will be people leaving the business”.
Steve Waite, managing director for the regional division and former Mansell MD, left with immediate effect.
He said Mike Peasland, who steps down from UK construction CEO to the regional MD position ahead of his retirement, “has extensive experience of running a regional business” and will focus on that for the “next few months”.
The pair will also be working on a succession plan, with Mr Peasland leaving the business at the end of the year.
Minor restructuring a possibility
Some elements of the business could be taken out depending on market conditions, Mr McNaugton said
“There are elements in the business that we are going to have to look quite hard at as to whether those are viable going forward, and we’ll do that as we go forward from here.”
Despite the extensive restructure last year, he said “there may well be more that we can and we should be doing”.
He said “regions fluctuate and change with the market conditions”.
“There are elements in the business that we are going to have to look quite hard at as to whether those are viable going forward”
Mr McNaughton said there will be a focus on more selective bidding, but stressed it will mean “fluctuations rather than a wholesale reduction” in volumes.
Asked whether there is some bidding team resource that could be taken out of the business, he added: “We’ve already been taking some action, through the cost structuring exercise that we’ve been doing, to bring together our bidding resource.
“Is there more we can do? There probably will be some but I wouldn’t anticipate it’s major because we’ve already anticipated that through the restructure we did.”
Mr McNaughton also highlighted a severe decline in the South-west market, adding “there has not been a consolidation in the market in terms of the number of main players, and so therefore that drives harder competition in the market at this moment in time”.
‘We must protect ourselves from subcontractors’
Asked why Balfour Beatty had not tackled the issue of sub contractor risk, Mr McNaughton said they have implemented “strong actions” over the last 12 months to ensure they are more closely aligned to the performance of key subcontractors.
He added “it is evident that the whole of the market is suffering concerns.”
He said all they can do while putting forward bids is to “increase the level of rigour and scrutiny on the financial position of subcontractors and to scrutinise their onsite performance of them to protect ourselves in selection of those subcontractors”.
Will 2014 be affected?
Mr McNaughton said due to the short-cycle nature of the part of the business affected, the impact is for 2013, rather than 2014
The average life of the contracts is nine months, but “there will be some contracts in the regional business that will be longer than that and that will be going into next year”.
Mr Magrath said there “could be an element” that is carried through to 2014.
But Mr McNaughton stressed it would be a “modest” amount as the company is bidding for 2014 work now.
2% margin target
Mr McNaughton told analysts the focus on economic infrastructure will help support a 2 per cent margin.
Mr Magrath said the underlying profitability means it is “about a 2 per cent business”.
“There are bits of the UK regional market that may not be able to support an overall 2 per cent business, but that’s certainly not all of it”
He added: “I don’t see any particular reasons why the business can’t go back to that [2 per cent] level of profitability”.
Mr Magrath added that working capital as a whole will broadly stay the same, “but the reality is that this profit impact will affect cash”.
“There are bits of the UK regional market that may not be able to support an overall 2 per cent business, but that’s certainly not all of it,” said Mr Magrath.
Debt rises to £276m
The company had already forecast a construction revenue fall of 20 per cent in 2013, driven primarily by a drop in major schemes.
Regional projects are up from 40 to 50 per cent of revenue. 40 per cent is in the major projects business and about 10 per cent sits in the mechanical and electrical engineering business.
The pair confirmed the UK construction business was making a loss.
Net debt is about £226m, and will rise to £276m as a result of the problems announced this week.
Mr Magrath also conceded it brings into question the goodwill – an intangible value – of acquisitions made between 2004 and 2007. They include Birse.
He said the events have triggered a review of the goodwill, but that there was “ a lot of headroom when we tested it at the end of last year, so I don’t think it will be a problem”.
An action plan has been developed and there will be “changes to specific regions where there remains inadequate assimilation of the project portfolio”.
“The incoming leadership will be tasked with the rigorous enforcement of bidding criteria and enhancing the quality of operational delivery and commercial support,” he said.
“The incoming leadership will be tasked with the rigorous enforcement of bidding criteria and enhancing the quality of operational delivery and commercial support”
Operational reviews will also be changed to provide “more intensive, intrusive scrutiny and early action triggers”.
Each building project has a specific action plan, but the firm is also “assessing the risk of continuing to acquire new work in each building sector whilst current market conditions prevail”.
Some international plans on hold
Mr McNaughton said he has been “freeing up senior management capacity around the group in order for us to drive forward” with international growth.
But he conceded “some elements of what we want to do…are going to have to be put on hold”.
“Some elements of what we want to do…are going to have to be put on hold”
“I particularly refer to, when we look at our country model, I’m focusing particularly in answering this to the organisational change in the UK towards a single-country model.”
Mr McNaughton added that he will be looking at whether the US plans are moving “at the right pace”.