UK Construction Market – serious challenges are being faced
The shape of the market
The UK construction market has long-established weak points in its various business models. Many of its sub-sectors suffer from being volume-driven and overly-competitive, plagued by lowball pricing. The prevalence of fixed price contracts in a time of rampant cost inflation is having serious implications for profit margins that were already too slim. Somewhat like food retailing, there has been a tendency for commercial pain to be transferred down the supply chain by main contractors, in this case to subcontractors.
Construction output was £122bn in 2021, recovering by 12 percent on the depressed level of only £108bn in 2020 but still over 5 percent below 2019’s pre-pandemic outcome. This represents 7 percent of total UK GDP. The industry employs some 2.15m people, equivalent to some 7 percent of the labour force. A higher proportion of the workforce is self-employed than in most other sectors. The total assets employed in construction are now over £200bn, with a total net worth of £85bn. The sector borrows £29bn overall.
Financial risk profile
We have used the database the financial health monitoring company, Company Watch, to analyse the latest published accounts of each of the 239,572 companies registered at Companies House as operating in the sector, so that we were able to examine the most up-to-date financial data available and compare this with what we had found when we last looked at the construction industry in May 2020. Because of the delays in the filing deadlines at Companies House, the May 2020 data effectively captured the situation prior to the pandemic, whilst the current data broadly covers first twenty one months of the pandemic period.
Over a third (82,110) of the companies were in the Company Watch warning area with a health rating (H-Score®) of 25 or less out of a maximum of a hundred. Statistics for the past twenty five years confirm that at least one in four of these businesses will fail or need a major financial restructuring during the next three years. The average H-Score of the whole sector is only 40 out of a hundred, which is well below par and lower than shown by our May 2020 data, when the average H-Score was 42.
10 percent or 24,167 companies are zombies, with negative balance sheets where liabilities exceed assets by at least a de minimis figure of £10,000. Their combined balance sheet deficits add up to £3.1bn. In May 2020, 9 percent of the companies were zombies, so this risk indicator has intensified.
We also looked for the first time at the working capital position of those businesses where ‘quick’ current assets such as receivables, cash, contract value and work in progress were lower than their short term liabilities. We found that 13 percent (30,667) of the companies had negative working capital. The shortfalls totalled £6.3bn. This is not a healthy statistic for the industry, indicating significant scope for short term financial pressure.
Size matters
Our recent reviews in other sectors have revealed a major discrepancy between larger businesses and their smaller, less well-capitalised brethren. We have stratified our analysis, segmenting the sector according to total assets per company.
The contrast between the major players and small businesses is stark. The average H-Score for construction entities with assets of more than £1m is 59 out of a hundred, against the sector average of 40. But for the very smallest businesses, the average is only 31.
The fragmentation and financial fragility of the sector is also apparent from the startling statistic that almost half of construction companies (113,175) have total assets of £50k or less and a quarter (56,785) have total assets of £20k or less.
Of the small companies with assets of £50k or less, a deeply worrying 42 percent (47,334) are in the Company Watch warning area.
Debt levels and repayment issues
At first glance, debt levels are not an issue. Overall borrowings have risen in the past year by 7 percent but gross gearing is only 14 percent and net gearing is acceptable at 34 percent. Unfortunately, the escalation in borrowings is far greater amongst smaller companies. For those with assets of £50k or less, debt has risen by 63 percent in the same period.
This steep rise reflects the heavy use of the Bounce Back Loan Scheme introduced by the government in 2020 to help viable businesses survive the pandemic. Just over 260,000 of these loans were made the construction sector, amounting to £7.7bn. This represents 17 percent of all loans made and 16 percent of the value of the scheme respectively, figures which are well out of line with the sector’s 7 percent share of GDP. Construction News recently reported that 40,000 of the loans had already defaulted by October 2022.
Business failures
Financial stability is a rare commodity for the construction industry. For many years and in both good and bad economic times, around 20% of all UK insolvencies have been construction companies, in stark contrast to its far lower share of GDP. In the first ten months of 2022, there were 3,434 construction company insolvencies in England & Wales, 19% of the total for the period.
Major issues faced by construction in 2023 and beyond
Falling workloads
Although construction output rose by 0.8 percent in October 2022, the fourth consecutive monthly rise, industry pundits are predicting a slow down in 2023. The Construction Products Association believes that new-build output could fall by up to 3.7 percent in 2023 before recovering by 1.5 percent in 2024. This forecast sits in the middle of a range of similar warnings.
Labour shortages and labour rate inflation
More than one in three construction businesses experienced a shortage of workers in late November, according to the Office for National Statistics (ONS). According to its business insights and impact on the UK economy publication, over 36 percent of firms are struggling to find staff. The tight labour market may be contributing to rising pay in the sector, alongside the cost of living crisis, with the study finding that 16.6 percent of firms with 10 or more employees had increased hourly wages in October.
Analysis by payroll services firm, Hudson Contract shows that labour rates for self-employed construction tradespeople rose by 1.3% in November 2022 alone, to an average figure of £992 per week. This is despite clear indications of slowing activity in the industry.
Labour unrest
As this winter of public sector discontent continues, the ONS revealed the impact of the autumn strike wave, with 12 percent of construction companies reporting that their business had been affected by industrial action in October. The disruption can only have increased since then as the industrial action has spread wider and threatens to extend well into 2023.
Materials cost inflation
The ONS reported in December 2022 that upward input cost pressures in construction may have peaked after their mid-2022 peak, but their construction material price index for October was 15.5 percent higher year-on-year.
Energy costs
Across the whole economy, energy prices are estimated to have risen by 200 percent or more for the business community. The government delayed until after Christmas an announcement on what level of support it will provide after the current arrangements run out in April 2023. Media comment suggests that it may cut its ongoing price cap relief by half. Such an outcome would be devastating for an energy-intensive industry, such as construction, but it is not clear whether there may be special arrangements for the worst hit sectors.
Pricing flexibility
Cost management consultants, Turner & Townsend’s latest forecasts of construction tender price inflation for 2022 are 9% for both real estate and infrastructure, which will go some but not all of the way to compensating for the soaring labour and material costs of the past year. Quite whether contractors will be able to continue to push up output prices in a tightening market in 2023 will remain to be seen.
Cash flow pressures
In addition to the issues with Bounce Back Loan repayments, evidence is mounting that HMRC has finally abandoned its ‘soft touch’ pandemic approach to collecting tax payment arrears. This is starting to hit construction companies, which are now receiving 21% of the escalating number of winding up petitions being issued by HMRC.
The Housing market
The latest survey of property agent predictions for house price falls in 2023 has just been published by the Times and the Sunday Times. These range from 10 percent to 1 percent, with an average of 6.1 percent, driven by higher mortgage interest rates and the cost of living crises. This can only increase the pressure on housebuilders, who were already struggling to justify some developments against a background of cost increases and significantly higher interest rates.
The prospects for 2023
There can be no doubt that many construction businesses facing a toxic cocktail of adverse factors are in for a pretty bumpy ride in the year ahead. Business rescue experts are forecasting a further increase in insolvencies, perhaps as high as 30,000 across the economy. This would be an all-time peak and more than a quarter up on 2022. This could mean 6,000 construction company failures and perhaps even more as lenders work their way through their recovery options for the 40,000 plus Bounce Back Loans already known to be in default.
The watchwords for 2023 should be prudence and feasibility. For the construction sector, this means being extra cautious, not taking unnecessary risks and being practical about what is possible with the resources you have. Reaching out for expert help as soon the going starts to get tough is the right thing to do.
There will of course be winners, especially those who resist the temptation to win work at the cost of cutting margins even closer to the bone. Controlling debt or hoarding cash will be essential strategies, which in turn means being constantly on top of cash collection. It’s going to need to be all about commercial and financial discipline.
January 2023
If you would like to discuss any of the points in the report or believe you have been affected by any of these issues, you can speak to one of our Partners who can discuss options with you. We have offices nationwide and by contacting us on 020 3326 6454, you will be able to get immediate assistance from our Partner-led team.