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Administrations: Has the construction industry hit rock bottom?

Several high-profile administrations along with wider market uncertainty are raising fears that the long-term decline in failures risks being reversed.

Recent months have served the industry a timely reminder that even a few bad deals can have catastrophic consequences.

As hire specialist Hewden reportedly nears collapse, it becomes the latest big name to suffer this year, following concrete frame specialist Dunne Group, which headed for administration in July after reporting severe cashflow pressures.

Dunne was subsequently snapped up by Keltbray in August, a month that also saw administrators appointed at Cardy Construction– later found to owe its creditors £18m

In September, Leeds-based contractor Bay Construct entered administration after reporting “serious financial difficulties” due to dispute on its Cumberland Hotel development.

And the list of firms calling in the administrators in 2016 continues to grow, with Yorkshire contractor Management Cubed succumbing this month following significant losses on two major contracts.

Throw in heritage specialist William Anelay, logistics firm Elliott Thomas Group and ductwork contractor Galloway Group, and the roll-call of companies to have appointed administrators in the past six months appears stark.

Yet official statistics from the Insolvency Service show that insolvencies in the industry hit a five-year low at the end of last year, while numbers for the first two quarters of 2016 have remained comfortably below the five-year average.

Given the increased market uncertainty of the past six months, should we now expect more companies to find themselves in financial difficulty? And how can construction firms mitigate the impact of this uncertainty and shore up their financial position?

Shaking off uncertainty – for now

The longer-term impact of the Brexit vote and the recent slowdown in activity suggested by the Office for National Statistics are not yet fully clear, but initial indicators suggest a spike in industry insolvencies is unlikely.

Research from corporate recovery and professional services firm Begbies Traynor shows that the number of businesses in the construction sector experiencing ‘significant’ financial distress fell by 11 per cent in Q3 2016 compared with the previous quarter.

Begbies defines significant financial distress as firms that have reported issues including county court judgements up to £5,000 against them, or have shown deterioration in key financial indicators including working capital, contingent liabilities, retained profits and net worth.

“The construction sector is the first to show signs of distress when the tap of new developments is tightened”

Glyn Mummery, FRP Advisory

According to the research, construction saw the strongest improvement in financial health in the three months following the referendum of any economic sector.

Begbies’ findings mirrored official statistics from the Insolvency Service, which showed insolvencies dropping by 9 per cent between the first two quarters of the year; 610 construction firms were declared insolvent in Q2, down from 672 in Q1.

However, Q1 still marked the highest quarterly figure for a year, while insolvencies in the first half of 2016 – 1,282 in total – were 9.8 per cent higher than in the second half of 2015.

Glyn Mummery, partner at business advisory firm FRP Advisory, says this could be a sign that insolvencies in the industry are set to rise.

“Overall corporate insolvencies remain at historic lows, but the bottom now seems to have been reached… with construction insolvencies – led by administrations – back on the increase [in H1 2016 vs H1 2015],” he says.

“The industry acts as a canary for the economy with the construction sector the first to show signs of distress when the [flow] of new developments is tightened.”

Turning off the taps

It’s a warning that chimes with a number of developers, particularly those considering speculative development, with several projects put on hold in the past six months.

The Construction News Barometer in August showed that half of contractors had seen projects put on hold since the EU referendum. While some clients, including Derwent and Great Portland Estates, are taking a more bullish approach, particularly in the commercial market, more firms could be at risk of financial hardship if development pipelines are delayed or pulled altogether.

“SMEs are the ones who are particularly vulnerable, especially if they’re over-geared in the first place”

Julie Palmer, Begbies Traynor

Begbies Traynor partner Julie Palmer says it is not the larger firms that are hit by either slowing development pipelines or problem jobs, as they can maintain much larger cash reserves and the landbank to manage cashflow more effectively.

“The middle players and those at the lower end of the market are the ones who are particularly vulnerable – especially if they’re over-geared in the first place,” she says. “[It could be] a couple of contracts where they get it wrong, either in terms of margins or the classic mistake of buying turnover just to keep things moving forward.”

This was the case for Yorkshire-based firm Management Cubed, which cited losses on just two jobs as it went into administration, while Bay Construct’s dispute over a hotel job was the key reason behind its demise.

And in a more uncertain environment, managing contracts and cashflow effectively is becoming more important than ever – particularly with a devalued pound to contend with, Mr Mummery adds.

“Rising costs of imported raw materials can be priced into new jobs but when the pipeline of new developments slows – as is just beginning to be seen in the core London office market – competition on pricing to win business can hurt margins,” he says.

New ways of lending

So how can SMEs in particular insulate themselves from these impacts?

Ms Palmer says that, while banks are trying to give the message that they are open for business, their lending is more geared to larger firms with proven track records or long relationships, rather than SMEs.

“The problem for a lot of SMEs is that they don’t always have the asset base to offer the lenders to get money in,” she says.

But she adds that there are options including invoice discounting firms, who have become more sophisticated and willing to lend to the sector.

Invoice discounters and finance companies, which include firms like Tungsten and Aldermore, typically provide up to 90 per cent of the cash owed on an invoice, as a loan. When the invoice is settled by a customer, the remaining percentage is returned by the invoice discounter to the contractor, minus an agreed fee.

Anecdotal evidence points to more and more contractors using this method to keep cash flowing through their businesses - particularly with the statistics showing that bank lending to the sector is struggling to improve.

“In the past it was always a bit of a no-no, as they like a debt that they can take security over, whereas a contract debt is often subject to argument both ways as to what the final settlement of it is going to be,” she explains.

But she adds that these lenders are now a more feasible option for smaller firms and will help to manage some of the peaks and troughs of cashflow and turnover.

Whatever happens, the positive news is that insolvencies remain at relative lows, and the indication is that the industry should not expect a major spike in the next two quarters – even in an uncertain market.

But in construction, a year does not go by without a high-profile administration serving as a stark reminder that careful management and sustainable growth should always be the benchmark of any business.

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