Following on from the success of last year’s nationwide Construction Survey, BDO’s recently released 2019 Survey has been eagerly received by the industry, bankers and professional advisers. The 2019 Survey had more than twice the number of participants as last year and builds on that existing data to provide meaningful insight into current trends and issues in the industry.
The common theme to emerge from the surveys is the existence of a two-tier construction sector comprising experienced operators with robust businesses and management practices and fragile businesses with low margins and inexperienced operators. This fragile group is highly vulnerable to the pressures and constraints operating within the industry.
Forward work position is decreasing
The industry is in the longest and strongest growth phase we’ve seen in our lifetimes but there are signs that things are slowing down. While the industry is still forecast to grow there is a noticeable downturn in forward work. Companies with more than 12 months of profitable forward work has decreased significantly from 39% last year to 19% this year while companies needing more work has increased from 6% to 17%.
Drilling down further into the figures reveals that the forward work position in Christchurch is weaker than other areas of the country with 45% of Christchurch respondents having less than 3 months of forward work. Less than 10% had over 12 months of forward work. The picture in Auckland was more encouraging with 24% having more than 12 months of profitable work lined up and 60% having more than 6 months.
By size of firm, the larger businesses with turnover over $10m generally had more confirmed forward work than the smaller operators, as might be expected.
Finding and retaining quality staff is a major challenge
Staffing was the greatest challenge identified in the survey with 47% of businesses actively looking for staff. This is down from 69% last year but the skilled labour gap is still a very real issue for the construction sector. This is particularly noticeable in Auckland compared with the rest of the country and is contributing to increasing wage pressure. Those using recruitment agencies are having more success in finding suitable staff but there is a reluctance to pay recruitment fees and most businesses are still relying on their own advertising or word of mouth.
Margins are still too low to be sustainable
Overall, gross margins have improved in the sector with 42% of head contractors achieving margins over 8% compared to only 28% last year. On average, margins in the housing sector are slightly better than the commercial sector and this may be due to the larger scale and higher risk associated with the commercial sector. Feedback from advisers indicates that rising land prices and the use of house and land packages may be providing a buffer to the housing sector.
Subcontractors are also seeing an improvement in gross margins with the number of respondents with margins under 20% falling from 78% to 53%. The average gross margin for subcontractors sits at around 16-20%. Despite this, too many subcontractors are still competing for work at unsustainable gross margins. For many, the race to the bottom is still on.
Transfer of risk
A feature of the current construction cycle is the allocation of risk. Customers push risk down to the construction company as much as possible and the construction companies in turn try to push that risk down to the subcontractors.
The survey asked participants to estimate how much the inappropriate or unreasonable transfer of contractual risk had cost them in the last year. 60% of businesses did not identify any cost with many of those respondents noting that they are not prepared to accept unreasonable risk, in some cases due to hard lessons learnt in the past. Of the 40% who identified a cost to their business, 15% valued that cost at over $1m.
Where to now with the Retentions regime?
Now that the retentions regime has had time to bed in, there has been a significant improvement in the number of companies saying they fully comply with the regulations. There is also an increased awareness of the need to do due diligence and inspect client records to make sure retentions are held securely. However, too often this awareness is still not translating to action with a staggering 70% saying they have not asked to inspect their customers’ records.
Recent high profile insolvencies have increased industry awareness of the risks they face and the survey identified these risks and the strategies businesses are adopting to mitigate those risks (refer graphic).
Is the industry adopting sustainable practices?
Sustainability is a hot button topic at the moment and the survey included a new question this year on sustainability practices. Overwhelmingly the response that was that clients want to be sustainable but are just not prepared to pay for it. It will be interesting to see whether this finding changes over time as environmental concerns gain momentum.
Internal Management Reporting is a concern
The frequency and quality of internal management reporting was concerning. Given the pressure on margins and cashflow, timely and accurate reporting is crucial for sound management and decision making. 43% of survey participants indicated that their management reporting was limited or lacking. These business are likely to be missing out on opportunities to recognise and address issues early and take steps to improve their business’ performance.
Succession Planning – take advice and start planning early
As the baby boomers enter the retirement phase there are a large number of business owners looking to sell. In the construction industry this can provide a challenge, in finding a suitable purchaser who is willing (and has the financial resources) to pay a price that rewards the departing owner for their lifetime of work. Of those surveyed, only half of those aged 50 or over had commenced a succession plan. This presents a huge risk to the industry as those owners look to leave. When the industry enters a downward phase the values of those businesses will drop and buyers will be scarce. This will present major challenges for those who have not planned ahead.
There is no doubt that the industry is under pressure with significant challenges ahead. In addition to the issues identified above there were important concerns raised about bureaucracy, the economy, lack of infrastructure and the future workflow outlook. As these pressures start to bite the gap between the robust businesses and the fragile businesses will become more apparent and there are likely to be some casualties.