黑洞社区

One year ago Balfour Beatty chief executive Leo Quinn was in no doubt as to the financial performance of the company he鈥檇 just taken over. Speaking in March after publication of the firm鈥檚 2014 results, he branded the numbers 鈥� a 拢304m pre-tax loss on revenue of 拢8.7bn 鈥� 鈥渁wful鈥� and 鈥渉orrible鈥�. He said they exposed 鈥渦nderlying weaknesses鈥� and 鈥減oor control鈥� in the group in terms of its lack of cost and cash management, and went on to set out a two-year 鈥渟elf-help鈥� strategy designed to turn the business around. Along the way he berated a 鈥渇ailure of leadership鈥� at the firm before he arrived.

One year on from that tongue-lashing, the UK鈥檚 largest builder last month announced results for Quinn鈥檚 first year in charge and 鈥� understandably 鈥� his rhetoric was much changed. Announcing plans to reinstate the shareholder dividend he cancelled in 2015, Quinn said the firm now had a 鈥渃lear direction鈥� and 鈥渦pgraded leadership team鈥�, and that its performance on bringing cash in had been 鈥渘ot short of stellar鈥�.

But while the rhetoric was much different, to some observers the actual results, which included falling revenue and another huge (拢199m) pre-tax loss, didn鈥檛 look much better. In fact, by some key metrics, such as the 鈥渦nderlying鈥� pre-tax profit/loss 鈥� which excludes one-off or exceptional costs and credits 鈥� the situation actually worsened significantly, with losses widening by over 50%. However, for objective observers the labyrinthine complexity of the global business鈥檚 group accounts make it all but impossible to work out whether Quinn鈥檚 backers or detractors are right. Here, 黑洞社区 uses an exclusive interview with Balfour鈥檚 chief executive to examine whether Quinn鈥檚 turnaround programme is really on track, and if he鈥檚 on course to hit his two talismanic self-imposed targets 鈥� to bring 拢200m of cash into the business and drive out 拢100m of cost.

Comeback kid

Certainly the generally accepted interpretation is that Quinn has made positive moves to stem the business鈥檚 problems. He says these problems stemmed from 鈥渇orced growth鈥� during the last decade, in which Balfour bought 45 businesses and grew revenue fivefold. This left the business a sprawling and uncontrollable giant, with responsibility devolved to unintegrated business units taking too many contract risks 鈥� and few would disagree. Following a string of profit warnings Quinn joined in January 2015 shortly after the firm had threatened to break its banking covenants if the sale of its consulting business Parsons Brinckerhoff hadn鈥檛 gone ahead. The crisis was confirmed by a KPMG review showing the business had 89 significant problem contracts.

We鈥檝e stabilised the outlook and people can get back on with their jobs, rather than thinking about what鈥檚 the next crisis that鈥檚 going to be announced from head office

Leo Quinn, Balfour Beatty

Quinn鈥檚 two-year turnaround plan put the promises to bring cash in and drive costs out alongside a wider culture change programme, entitled Build to Last, itself with four separate elements. The recent results mark the halfway point in this programme, and the assessment of analyst Howard Seymour, from Balfour鈥檚 corporate broker, investment bank Numis, is typical. He says the continuing losses simply reflect the 鈥渁cceleration of management actions to eliminate legacy issues鈥� and that Quinn is right in moving to cut out back office duplication, put in central controls over contract risk, and target larger, more profitable contracts. Seymour concludes his actions 鈥淸鈥�] will progressively provide Balfour with the strongest profit recovery profile in the sector鈥�.

Numis is by no means alone in its supportive take. Former Whitman Howard analyst Stephen Rawlinson, who is not known to shrink from critical assessments, says: 鈥淨uinn looks to be doing the right things, dealing with some of the poor operating disciplines. His approach has bought himself some time to deal with the really big problems.鈥�

Unsurprisingly, that is also Quinn鈥檚 assessment. Speaking to 黑洞社区, he says: 鈥淚鈥檓 quite pleased with where we are to date [鈥�] I do think that in a very short period of time we鈥檝e stabilised the outlook, and people can now get back on with their jobs looking after customers, rather than thinking about what鈥檚 the next crisis that鈥檚 going to be announced from head office.鈥�

Quinn has certainly been able to demonstrate progress on his cost reduction target 鈥� 60% of the 拢100m of overhead costs he promised to take out of the business have already been stripped away in the first year. 黑洞社区 Value analyst Tony Williams says the indication that the firm will reinstate its dividend shows that progress is being made, and points to Quinn鈥檚 track record in turning around previously struggling listed firms Qinetiq and De La Rue. 鈥淟eo Quinn is a breaker, not a maker 鈥� but that鈥檚 probably what Balfour Beatty needed. Reinstating the dividend is a lead indicator. It鈥檚 more than a PR exercise 鈥� I really don鈥檛 believe he鈥檇 do it if he didn鈥檛 think things were on the mend,鈥� he says.

Shaky numbers

Nevertheless there are a number who hold serious doubts as to progress at the firm. The case against is essentially that the recent results don鈥檛 show enough signs of progress to be clear Quinn鈥檚 prescription is working. The fact that underlying losses have grown sharply from 拢80m to 拢123m is key to this view. In the firm鈥檚 鈥渉orrid鈥� 2014 results, three-quarters of its losses didn鈥檛 come from the firm鈥檚 core business, and were instead due to one-off events or legacy contracts in parts of the business it was exiting. However, this year a large majority (62%) of its 拢199m pre-tax loss came from its core business, most particularly its Construction Services UK business, which made a 拢187m operating loss. Added to that its US construction business, which at 拢3.1bn turnover is now 50% bigger than the UK one, moved in to loss-making territory for the first time, recording a 拢22m deficit. This worsening picture comes despite the fact that 鈥� as Quinn himself has said 鈥� Balfour is operating in an improving market where there should be opportunity to make higher margins.

At this stage you鈥檇 think the management changes would settle down a bit. You鈥檇 expect change when he came in but it鈥檚 now looking like a negative rather than a positive

Kevin Cammack, Cenkos

Quinn鈥檚 answer to this is to point to the fact these underlying losses, caused by poorly performing contracts mainly in the UK, were taken in the first half of last year, and therefore that from six-month period to six-month period progress is being made. 鈥淚n the second half of the year, we actually make 拢7m profit underlying.鈥� Kevin Cammack, analyst at Cenkos, is one for whom the jury is still out on Quinn鈥檚 turnaround. He says Quinn鈥檚 鈥渃omfortably ahead鈥� of where he wanted to be on bringing in cash, but has concerns over the trading position. 鈥淚t feels like he鈥檚 behind the curve in the recovery of the overall business,鈥� he says.

For example, in January last year Quinn told 黑洞社区 that he expected the business to be 鈥渃omfortable, fully operational and performing well鈥� within 24 months. While he is not specifically contradicting this, he is saying it will be another 24 months from here before the firm will reach the 2-3% 鈥渋ndustry standard鈥� margins he is aiming for. He has also declined to promise that the business will not report another loss in 2016. But Quinn says the most important thing is that the business is heading in the right direction. 鈥淲e are certainly where we would want to be 鈥� we鈥檙e a little bit ahead; on some areas, you could argue we鈥檙e a little bit behind [鈥�] You could be plus or minus 拢10m either way. On an 拢8bn turnover its neither here or there, it鈥檚 a rounding error on a calculator.鈥�

However, some of the specific numbers held up by Quinn to exemplify the firm鈥檚 progress look less solid when examined. For example, the firm has identified 89 鈥渓egacy contracts鈥� which are the source of much of its pain, and which the business is currently working through. Quinn told 黑洞社区 60% of those are now 鈥渃omplete鈥�, and 90% will be by the end of the year. But in fact these figures include jobs that have only reached practical completion 鈥� only a third (29) of problem jobs have actually reached financial close. Practical completion, when the majority of the building work is done, does not mean further losses won鈥檛 be incurred, and Quinn will give no timeframe for when those remaining 60 accounts will be finally settled.

Quinn says: 鈥淭he reason we talk about practical completion is that we鈥檝e effectively handed over the facility 鈥� the fact of the matter is we鈥檙e off the job, so at least you鈥檙e not burning any more cost. In terms of financial close, some of those can close quite quickly, others will be a lot more arduous, some will actually be quite litigious, because unfortunately that鈥檚 the nature of some contracting.鈥�

Cash conversion

Quinn鈥檚 progress on cash also demands scrutiny. Any investors that assumed his 鈥溌�200m cash in鈥� pledge might see Balfour Beatty鈥檚 net cash actually increase, will be disappointed. Quinn says the metric he will actually be judged on is that of comparing Balfour鈥檚 cashflow since he joined with that in 2014. In 2014 an enormous 拢438m of cash flowed out of the firm鈥檚 coffers (excluding the impact of the sale of Parsons Brinckerhoff). Under Quinn鈥檚 leadership cash has continued to flow out of the business 鈥� but at a much-reduced rate, with 拢81m out in 2015.

The difference between the two figures means Quinn can correctly claim to have smashed his target one year early with a 拢357m improvement in cashflow 鈥� despite the fact cash in the business is still decreasing.

Quinn has introduced a 鈥淐ash is our Compass鈥� programme in the firm, and says this progress is 鈥減rimarily鈥� down to a resulting 鈥渂etter management of working capital鈥� through ensuring it gets paid and turns its inventory more quickly. But the 2015 figure was actually made much healthier by the 拢96m decision to cancel the dividend, and the fact Balfour hasn鈥檛 actually paid out the cash on most of its problem jobs, because their final accounts haven鈥檛 been settled. Hence 鈥� Quinn confirmed 鈥� there will be 拢100m-150m more flowing out of the business this year than in 2015. But he adds: 鈥淲hen we get rid of our legacy issues and we鈥檙e generating cash-backed profit from our projects, then you鈥檒l see that the cashflow will turn positive for the company on an annual basis.鈥�

Downsizing

At the same time as these group-level challenges, on an operational level there has been a continuing steady drip-drip of senior departures in the UK construction business. Cost cutting means numerous UK offices have closed, with the results stating the regional construction business is 鈥渞ationalising its management structure and offices鈥� and that the 拢300m fall in UK construction revenue to 拢2bn was 鈥減redominantly鈥� due to its contraction. Quinn said in 2015 that the 鈥渇ront office鈥� would be 鈥渞ing-fenced鈥� and 鈥渁ctively protected鈥� from cuts. Nevertheless, those who have left the business recently include former Multiplex, Mowlem and Lendlease director Paul Gandy, one of a six-strong senior team sitting beneath UK MD Dean Banks, who is joining Kier. Gandy鈥檚 regional director of operations for London, Jeremy James, is also leaving. 黑洞社区 understands Tim McCarthy, group commercial VP in the US and recruited last year, has now retired, while north-east MD Eddie Tribe left the business after the merging of the north-central and north-east delivery units at the end of 2015. Cenkos鈥� Cammack says: 鈥淨uinn鈥檚 been doing sensible things, but at this stage you鈥檇 think the management changes would settle down a bit. You鈥檇 expect change when he came in but it鈥檚 now looking like a negative rather than a positive.鈥�

In response, Quinn says he has made Balfour鈥檚 expertise one of the four planks of his Build to Last strategy and is confident he鈥檚 holding on to the right people. He said: 鈥淔irst and foremost, if the competition weren鈥檛 recruiting some of my leaders and my front line capability, then I think I鈥檓 doing something wrong. My job is to make sure we鈥檝e got the best people because I鈥檓 investing in them, training them and developing them.鈥�

The fact is it鈥檚 impossible to say definitively one way or another from the numbers whether Quinn鈥檚 recovery is on track 鈥� it鈥檚 simply too early to tell. Faith in the process comes down, primarily, to whether you have faith in the man himself. But it is clear that these are at best mixed results. 鈥淗e鈥檚 had his last chance, he鈥檚 used up his time period for making massive provisions,鈥� says Cammack. He looks likely to have to demonstrate more tangible progress at the half-year results in August in order that the City doesn鈥檛 lose faith.