º£½ÇÉçÇøapp

Construction’s stop-start trend continues to defy a generally positive mood about its future prospects. Output has been patchy for some time, rising some months but falling in others; a consequence, perhaps, of trying to track change on a monthly basis in an industry which is fundamentally long term in nature. The Office for National Statistics (ONS) says that output fell 1.0% in July 2015 compared to June and, for the first time since May 2013, it was also lower on a year- on-year basis, down 0.7% on July 2014. The main culprit seems to be weak public housing demand and a distinct slowing of the runaway private housing sector (although that remains strong overall with a 12% rise in NHBC registrations in July). The commercial building sector was also poor, falling 3.2% year-on-year.

By way of contrast, the Construction Products Association is more bullish about the future, pointing out that new construction orders were up 1.9% year-on-year and predicting at least four more years of solid growth. As the adage goes, you pays your money on these statistics and takes your choice.

The Markit/CIPS Purchasing Managers’ survey also produced a positive reading of 57.3 for August 2015, up from 57.1 for July - well above the neutral threshold of 50. Any reading above 50 on this scale indicates growth; anything below means declining activity. Positive though this is, we are nevertheless still below the peak of 60.1 reached at the beginning of 2015. As we review different sub- sectors during the course of the year, the overall trend in falling margins has become clearer as the realities of underbidding and cost increases have decimated returns on many long-running contracts. The good news for the M&E sector is that it is, like the private residential market, bucking the prevailing negative trend.

The latest trade survey by the Building & Engineering Services Association (B&ES) indicates that its members’ order, enquiry and turnover levels all increased in the first half of 2015. Its ‘net optimism measure’ rose to 45% from 39% six months ago. Firms in every region and specialism were positive about their future business prospects. Even better, the B&ES survey suggests that tender prices are rising for the first time since 2012, offering the hope that the substantial rise in profitability for M&E contractors, which we analyse later in this report, can be maintained and possibly even improved upon. The companies we have analysed for this month’s report are those M&E contractors with annual turnover of £50m or more in their latest published accounts. These are, of course, the goliaths of a highly fragmented sub-sector, with Companies House records showing over 40,000 UK- registered companies claiming that their principal activity consists of M&E activities.

One of last year’s companies, Imtech UK has been pulled down by the failure of its Dutch parent company. Fortunately, it has been rescued, but its financial position will be unclear until new accounts are published so it has been excluded from our sample this time around. Another company has been excluded after closer analysis of its activities revealed that it did not meet the criteria for the sector. Three more of last year’s sample have fallen below the £50m turnover threshold, but there are five new entrants that have burst through it. The Company Watch research shows a level of profitability for the sector of 1.9%, almost double last year’s paltry 1.0% and virtually back to the level of 2.0% in 2013. Despite this, nobody outside the construction sector would think that this level of profitability is acceptable given the scale of investment required and the many risks inherent in contracting.

Comparing this outcome with the other eight sub-sectors we analyse for º£½ÇÉçÇøapp, M&E contractors come third from bottom of the pile, only beating scaffolders with their negative 0.8% margins and commercial contractors who make 0.8% profit. They are outscored by demolition contractors (2.3%), road builders (3.8%), utilities and water sector specialists (3.9%), site preparation contractors (4.8%) and the profitability stars in house building (12.8%) and plant hire (14.9%).

Interestingly, their average return on capital has fallen despite the improvement in profitability; down from 6.7% in our 2014 analysis to only 4% now. This is the lowest in the industry, apart from scaffolders. The trade-off between risk brethren have a relatively brighter future to look forward to than many of their fellow construction contractors, if the B&ES and CPA predictions are fulfilled. But none of them should be complacent with profit margins of a meagre 1.9% to support the investment required to function in this stressful business and to deal with the higher borrowing costs that most economic commentators now believe are a matter of ‘when’ rather than ‘if’ and reward varies across the construction industry, particularly where profits and borrowing levels are concerned. For our 45 M&E contractors, gearing is lower at 19% than a year ago when it was 21%. This makes them more conservatively financed than all sub-sectors, apart from utilities and water specialists (6%), house builders (14%) and commercial contractors (15%). Significantly, 64% (29) of them have either no external borrowings, or debt of less than £100k. This is slightly better than last year when 60% (27) were debt free on this definition.

Looking next at the overall financial health of our sample of the 45 M&E contractors we find that their average Company Watch H-Score (see box) is 54. This is not only higher than last year’s figure of 52, but substantially better than the norm of 45 for all UK companies of similar size. The relatively low levels of debt play a part in this outcome, as does the fact that there are only four companies with negative net worth (liabilities greater than assets). This average H-Score of 54 is the fourth highest of all the construction sub-sectors.

Six of the companies in the sample (13%) are in the Company Watch warning area, placing the sub-sector right in the middle of the league table with four showing a higher incidence of laggards, three a lower percentage and one equal. Across the economy as a whole, the expectation would be that around 25% of any sample would be in this financial twilight zone. Looking at the better performers, 62% of the sample have H-Scores of 51 and above, compared to around 50% for all UK companies. There are eight (18%) loss- makers, compared to 11 (24%) last year. It is also worth repeating the comments from our previous reports that our figures cover only the few major players out of a market which also features tens of thousands of much smaller, generally undercapitalised and mostly family-owned SMEs, either companies or unincorporated sole traders. Much more caution is needed about their finances.

It seems our sample of major M&E contractors and their host of smaller brethren have a relatively brighter future to look forward to than many of their fellow construction contractors, if the B&ES and CPA predictions are fulfilled. But none of them should be complacent with profit margins of a meagre 1.9% to support the investment required to function in this stressful business and to deal with the higher borrowing costs that most economic commentators now believe are a matter of ‘when’ rather than ‘if’.

H-SCORE: MECHANICAL & ELECTRICAL CONTRACTORS QUARTILE ANALYSIS:

This article first appeared in the October 2015Ìýissue ofÌýº£½ÇÉçÇøappÌýmagazine. To read the full magazine online,

To receive you own hard copy each month in traditional paper format, you can subscribe at

Got a story? Email news@theconstructionindex.co.uk