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The collapse of Carillion 鈥� the UK鈥檚 second-largest construction firm 鈥� into liquidation in January was a huge shock to the whole building industry. Since then the repercussions of its downfall have been rippling through its suppliers, partners and clients, prompting lay-offs and chaos on unfinished sites. The head of the Insolvency Service, Sarah Albon, has said the estimated 30,000 firms thought to be owed a combined total of over 拢1bn stand little chance of seeing any of that back, while listed contractors such as Balfour Beatty and Galliford Try have had to write off 拢44m and 拢25m respectively to pick up the pieces on the troubled Aberdeen Western Peripheral Route contract. (Galliford Try has since had to complete a rights issue of more than 拢150m to cover spiralling costs on the project.)

However, as well as these direct repercussions, in the latest results from construction firms it is possible to pick up evidence that the collapse of the 拢5bn construction giant is having an even wider impact, affecting new orders coming into the sector. Last month materials firm Polypipe went public, saying the demise of Carillion was potentially leading to 鈥渇urther project delays as main contracts are renegotiated and the impact on subcontractors works through the market鈥�. 

Alastair Stewart, analyst at Stockdale Securities, says the reality is more serious still: 鈥淭he market鈥檚 undergone a serious hiatus since Carillion folded, with a range of major contractors reporting marked delays in contracts being signed off. Everyone鈥檚 going through massive due diligence and contracts aren鈥檛 getting signed.鈥� 

鈥淸The collapse of] Carillion is forcing people to rethink the culture of a tick-box approach to assessing financial stability鈥�

Mark Robinson, Scape

So, with evidence from purchasing managers that new construction orders have fallen in both of the first two months of the year, is there any danger of a Carillion-inspired downturn, or are other factors at play?

Stay alert

While few in the sector see as stark a crisis as Stockdale鈥檚 Stewart, there is widespread agreement that public sector clients are taking a second look at many contracts. While announcing strong 2017 results, Morgan Sindall鈥檚 chief executive John Morgan warned analysts in February that customers, 鈥渆specially the public sector鈥�, were looking more closely at their suppliers鈥� balance sheets in the wake of Carillion鈥檚 failure. He said: 鈥淭hey鈥檙e asking many more questions about the balance sheet and about movements of the balance sheet between reporting periods, which is interesting. It鈥檚 entirely logical 鈥� the changes in recent weeks will have cost the public sector purse dear.鈥�

Cenkos analyst Kevin Cammack says: 鈥淐ontracts are taking longer to let in the public sector as clients do somewhat more due diligence. It鈥檚 possible that might see certain firms lose out on work, too.鈥� 

Mark Robinson, group chief executive of Scape, which runs a series of public sector construction frameworks, says that while work is still coming through, public sector clients are doing a 鈥渄ouble check鈥� to ensure that contractors they sign up are not in any danger of going the way of Carillion. 鈥淐arillion has made them really think about who their projects are going to be delivered by, and it鈥檚 going to mean they鈥檙e a bit more sceptical,鈥� he says.

Indeed, Robinson says Scape is already looking at how it can introduce more detailed financial vetting itself into the procurement of its frameworks in order to detect any contractors with Carillion-style problems 鈥� while avoiding a crude 鈥渢ick-box鈥� approach that simply cuts out smaller firms. 

He says: 鈥淚t鈥檚 difficult because Carillion鈥檚 financials were presented in such a way you didn鈥檛 easily know what the true picture was. But we鈥檙e talking to our financial advisers about how we can ensure our public sector clients aren鈥檛 at risk of hiring people who go the same way.

鈥淐arillion is forcing people to rethink the culture of a tick-box approach to assessing financial stability.鈥�

鈥淭he big top-tier lenders are not lending as much as before, because they鈥檙e seeing greater risks鈥�

Blane Perrotton, Naismiths

Caution

Nevertheless, while these delays are acknowledged, many suspect this issue will simply push back the award of contracts by a few weeks or months but not hit workload in the long run. Cenkos鈥� Cammack says: 鈥淚t looks to be just a timing thing. Things are taking longer and customers are thinking harder, but there won鈥檛 be a loss of work.鈥� 

Moreover, for those firms that are well capitalised, the client focus on balance sheet strength could become a real selling point, as indicated by Balfour Beatty boss Leo Quinn鈥檚 recent claim his firm has 鈥渢he strongest balance sheet in the sector鈥�. Likewise, in his comments to analysts in February, John Morgan said: 鈥淲e see our balance sheet as a competitive advantage and we want to use that wherever we can.鈥�

However, the issue appears to not just be limited to public sector construction contracts, with long-term services work potentially even more seriously affected. Rupert Soames, chief executive of outsourcing giant Serco, recently called for a complete reset of the relationship between government and the private sector. He admitted that by putting at risk the delivery of several significant and sensitive public sector contracts, the collapse of Carillion 鈥渉as reignited the already glowing embers of the debate about the desirability of allowing private companies to deliver public services.鈥� Reporting Serco鈥檚 2017 results, Soames said: 鈥淭here is a very real risk that this [Carillion] will make the UK government more than normally cautious in dealing with its suppliers.鈥�

Cammack agrees that the Carillion situation has acted to exacerbate already existing incentives to public bodies to sit tight and not tender large services contracts. 鈥淲hat we鈥檙e seeing is that renewal dates are coming up but they鈥檙e not retendering, they鈥檙e just leaving the incumbent in place, because the process has become that much more complex. This is because of Carillion, but it鈥檚 much more about the costs of meeting the rising minimum wage and apprenticeship levy. The cost of providing these services has gone up.鈥�

Moreover, it appears to be not just public sector clients that are getting jittery. Blane Perrotton, managing director of surveying firm Naismiths, which acts to assess projects on behalf of banks lending to construction projects, says more and more lenders are employing their own agents to do separate due diligence before authorising loans. 鈥淭his is slowing down contract awards, definitely,鈥� he says. 鈥淭he big top-tier lenders are not lending as much as before, because they鈥檙e seeing greater risks.鈥� This testimony is supported by Andrew Dixon, head of policy at the Federation of Master Builders. He says: 鈥淥ur members say the banks are looking with a bit more reluctance to lend to construction generally. This is going to make borrowing more difficult.鈥�

Fog ahead

The problem is that this nervousness about contractor stability comes on top of a market already plagued by a large dose of uncertainty. Recent government figures from the Office for National Statistics show that new orders fell sharply in the last quarter of the year, while overall output has seen three consecutive quarters of decline, and fell again in the first month of the year (see Market Signals, previous page). The only metric at the time of writing to have reported on the period since Carillion鈥檚 collapse, the UK Purchasing Managers鈥� Index produced by IHS Markit and CIPS, has reported falls in new orders in January and February, while the sharpest decline since July 2016 happened in March. 

Meanwhile, 拢4bn-turnover contractor Kier was one of many to have signalled that project delays affected its results last year, and Morgan Sindall has told investors in its results presentation to expect construction revenues to fall in 2018. Investment bank Berenberg said in a recent analyst note that: 鈥淭he general consensus view among many investors we speak to is that the UK construction market is struggling at present.鈥�

Chief of the factors weighing on construction is seen to be the weak commercial market, held back by fears over political uncertainties such as Brexit. Commercial construction work accounted for nearly one-third of all new construction work in 2017, but saw a steep drop-off in new orders across the year, down 8% on 2016. 

For Stephen Rawlinson, analyst at Applied Value, this, rather than the Carillion fall-out, is the main concern he has for the sector鈥檚 health: 鈥淣one of this political uncertainty is going to be solved overnight. For example, Brexit has led financial institutions to review where they are based and, whatever the deal is, they seem to have concluded that the political and geographical risk of having so much business concentrated in London is too much, so they鈥檙e looking to gradually reduce exposure.鈥�

At the same time, says Simon Rawlinson, partner at consultant Arcadis, contract signing is also being held up as both clients and contractors seek to cover themselves in the event of a 鈥渘o deal鈥� Brexit that stops materials being brought into the country as expected. 鈥淐ontractors are inserting Brexit clauses and clients are asking for high levels of indemnity on fixed-price contracts. It鈥檚 really hard getting people to sign,鈥� he says.

Despite all this, residential development remains strong and few foresee an immediate dramatic downturn in the market. Naismiths鈥� Perrotton says the commercial and residential markets are being kept going on 鈥渆asy money鈥� from new-entrant lenders, which are taking up the space vacated by the traditional funders鈥� reluctance to lend. Given the strong headwinds, though, he wonders how long this can last. 鈥淪ome of these deals鈥�, he says, 鈥渁re frankly shit deals and shouldn鈥檛 be lent on. I think there鈥檚 a storm coming and we鈥檒l find there鈥檚 a backlog of reckless lending been going on.鈥� 

Whether Carillion, political uncertainty or Brexit is the main cause of the current malaise, it appears contractors are right to be cautious over prospects for 2018.