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Selective strategies pay off

Leading companies have raised profits and margins by targeting the right work. They are now reaping the benefits.

Last year was a spectacular one for the UK’s largest 100 contractors. The average company in the league table raised its turnover by almost one-fifth and lifted pre-tax profits by over one quarter.

The Top 100 have, of course, been helped by a strong overall market, where total new orders rose by 3 per cent in 2006. The majors have enjoyed a healthy flow of new work from both public and private sector clients together with work generated by their own Private Finance Initiative investments.

The results of the largest 100 contractors based on their most recent annual reports shows the majority of companies translated this into a solid financial performance. Virtually all of the industry’s major names recorded increased turnover and the majority lifted pre-tax profits and margins. With work plentiful, many contractors also managed to report higher profits at the pre-tax than the operating level, suggesting they are doing well from interest earnt on cash held for payments in advance.

No sure bet

But financial success in a rising market is not inevitable. For whilst tender prices have risen, competition remains stiff and building costs have climbed relentlessly; up 14 per cent in London in the past two years and set to rise by the same amount over the next two, according to Davis Langdon.
Their success, particularly in raising and maintaining margins, has come from greater selectivity and by winning more work through partnerships and non-price arrangements. Freed from the struggle to keep their order books full, the larger firms have tended to focus on those markets, particularly building, which suited their skills-base and offered the best returns.

Yet some markets remain tough, particularly on the heavy civils side. After years of losses and indifferent results at its construction business, Amec became the most high profile departure from the Top 100 this year, following the sale of its property development and building and civil engineering businesses to Morgan Sindall.

Major players

Balfour Beatty remains easily the largest UK contractor by turnover – although its revenue is swollen by joint venture and associates, many linked to PFI. Judging by the £10.6 billion order book, which it recently reported, the firm’s position in the top slot is fairly secure.

But Carillion, whose turnover was boosted by the acquisition of Mowlem in February 2006, and Laing O’Rourke, the largest privately-owned construction group which has been expanding organically at speed, have both put on impressive rises in turnover.

Elsewhere, Wates and Newarthill (Sir Robert McAlpine) stand out among the unquoted contractors that have taken full advantage of the improved market conditions.

The recent wave of deal activity in the sector has inevitably impacted on the Top 100. Rok, now at 23, has continued to move up the rankings, and its acquisition of Tulloch Construction towards the end of 2006 should ensure it continues to climb.

We have also decided to use Taylor Woodrow’s figures for its construction operations following its merger with Wimpey rather than those of its house building parent, Taylor Wimpey, shifting it down the table. The de-merger of Gleeson Building through a management buy-out has created a new entrant to the table and inevitably MJ Gleeson, which has divested the bulk of its construction services businesses, inevitably slipped down the rankings.

Movers and shakers

Looking forward, Alfred McAlpine can expect to move down the table, as it presses ahead with the de-merger of its core business services and infrastructure operations and the sale of its PFI concessions and slate business.

Making comparisons between firms based on their margins is hazardous because the business mix can vary so widely between companies. At the head of the table the recorded group operating margins are inevitably affected by exceptional items and by volatile earnings from PFI. Separately, margins at Kier and Galliford Try benefit from the inclusion of their substantial house building businesses. Groups with larger support services operations have tended to maintain higher margins. Interserve’s pre-tax profits were marred by the accounting irregularities at the firm but the underlying operating margin at 3.15 per cent was relatively healthy. Other support services-orientated groups such as Babcock and Mitie have also tended to produce higher margins.

Margins may have improved, but at many companies they remain slim, underlining how competitive much of the UK construction market remains. At Galliford Try for example, despite a 75 per cent increase in its construction profit to £9.8 million, the combined margin for its building and infrastructure division only rose from 2.0 per cent to 2.1 per cent. With order books strong, the coming financial results season should see contractors showing signs of progress on raising margins.

Tight competition

Kier Group, which has been taking advantage of the buoyant market in prisons, supermarkets and hospitals, also recently highlighted the competitive nature of the UK construction market. Its first half figures showed despite increasing turnover by 12 per cent to £675 million with good growth at its regional and construction businesses and a £1,200 million order book, the group’s construction operating margins was unchanged at 1.4 per cent.

Despite the buoyant market, some of the majors have still faces some fairly spectacular losses on various fronts. The recent heavy provisions at Balfour Beatty, and Alfred McAlpine will impact on next year’s table. The £62 million pre-tax loss at Costain followed hefty provisions against the closure of its international division and contract losses.

Polarising market

But Costain’s losses mask an improving underlying situation at the firm under chief executive Andrew Wyllie. He believes the market is polarising into a small number of large contractors with the scale and resources to secure the increasingly large framework contracts and a smaller number of specialist subcontractors and regional players.

Elsewhere, maintenance and RMI work continues to offer better margins than new build. Rok’s recent interim results showed margins at its response maintenance business leapt from 2.9 per cent to 5.3 per cent, whilst the margin at its building arm crept up from 2.6 per cent to 2.7 per cent.

Margins are also pretty healthy at many niche specialist subcontractors. Here Sever-field-Rowen, the last quoted steel fabricator, probably leads the pack with operating margins which stood at 9.9 per cent last year and a share price which has reflected its sparkling performance.