UK Construction Sector

 

How has the global economic downturn impacted the British construction industry?

 

Housing: The UK construction sector has been in decline since the early part of 2008 – at first with the impact on private housing, brought about by the lack of liquidity in the market. Since then, different areas ofconstruction have declined at a varying pace because of the lengthy timescales involved in the construction process. Inevitably, the first to suffer have been the ‘first in’ sub sectors - groundwork contractors, brick manufacturers and the like - as most building companies took the decision fairly early to curtail new build and concentrate on finishing work in progress. This led to a ‘honeymoon period’ for some of those further down the chain (e.g. electrical contractors, window fitters etc) as buildings which had commenced before the credit crunch were being completed. But, with the lack of new build starts over the last 12 months, the ‘last in’ contractors and manufacturers are finding it extremely difficult.

Despite this bleak picture, there is some evidence that recovery in the housing market has begun. House builders are now building again after a long period of destocking. House prices rose month-on-month for the third consecutive month in September. Year-on-year data is mixed. For instance, according to the Nationwide building society, house prices are now back where they were 12 months ago, while the Halifax says that they remain 7.4% lower.

Mortgage approvals have been steadily improving month-on-month since the record low of November 2008.  However, the August figures show a slight dip, suggesting that the market may have reached a plateau.

Despite most indicators moving in the right direction, we shouldn’t become complacent. The number of housing starts in 2009 will be around 70,000, down from 170,000 a year at its peak, and the lowest since1924. Moreover, most house builders were generating cash during their destocking phase, with no building costs, and were therefore able to service/repay debt. They will now once more be incurring building costs which have to be funded. Banks will remain reluctant to lend, and we have already seen a number of the larger players turning to shareholders with placements and rights issues to fund land purchases.

 

Commercial/industrial construction: There is a large oversupply in commercial and industrial property, so that the level of speculative building is now virtually zero. The commercial market is a buyer’s market and heavily reliant on the retail/services industry. But the difficulties faced by retailers have often led to insolvency, which in turn means a significant decrease in occupancy rates and less demand for additional capacity. Construction output in the commercial arena is expected to decline by 53% during 2009, while factory construction is expected to fall by 28%.

 

Public construction: There is some positive news on public spending in the short term, with largegovernment investments being made in rail, health and education, and a strong pipeline of projects for the remainder of 2009 and 2010. This is tempered somewhat by the fact that social house building is expected to be down about 20% in 2009, as it often depends on accompanying private house building, typically on a shared site. Many construction companies are ‘hybrid’, with activities over a broad range of construction subsectors, and are thus exposed to many different areas of construction. So, as private house building has traditionally provided much higher margins than most other construction areas, a downturn in private housing has hit a number of these companies very hard. 

Any good news on public spending is expected to be short lived. With an election on the horizon, there are already fears of public spending cuts. It is inevitable that construction will be affected by this, with capital expenditure in the public sector under real pressure. Over the last 12-18 months, public spending has underpinned the construction sector through what has been a very tough period. There is a real danger that this will fade away before any meaningful recovery in the commercial / industrial / residential markets, leaving the sector as a whole in a very precarious position.

 

Unemployment in the sector is growing alarmingly, with the number of quantity surveyors and architects becoming unemployed increasing proportionally at way above the UK average. The Construction Products Association (CPA) is predicting a 15% contraction in construction activities during 2009, an upward revision of its earlier forecast of a 12% decline, and the steepest decline seen since 1980.  The CPA sees no significant positive outturn until 2012.

 

What is the current trend in payment delays, payment defaults and insolvencies and why?  Real estate and construction companies account for 25% of all insolvencies in the UK. In Q2 2009 1,573 companies in this sector became insolvent: twice that seen in Q3 2007, before the credit crunch. The level of claims paid so far this year by Atradius on construction buyers is exceptionally high, although they are now stabilising.

 

What should companies selling products into the construction industry pay particular attention to? The construction sector, by its very nature, is highly geared, with debt facilities historically provided by financial institutions based on strong cash flows and good levels of security. Now, covenant breaches on bank facilities have become the norm because of cash flow problems. This lets banks renegotiate facilities, inevitably with additional costs for the borrower in the form of an arrangement feeand higher margin - and in extreme cases withdrawal of facilities altogether. Securities on offer to banks are invariably in the form of land and buildings, which have declined in value over the last 12 months - and therefore offer the banks less security. Recent research suggests that banks have also been actively cancelling unused facilities which borrowers had earmarked as ‘contingency funds’ during the economic downturn. Because of this, suppliers into the construction industry should pay particular attention to a buyer’s debt profile, their ability to service the debt, and the amount of their available bank facilities.

 

What is Atradius’ short term outlook for the construction industry?  Insolvencies continue to rise. There is very little prospect of any meaningful growth in construction output for a number of years. Unemployment in the sector is growing at an alarming rate. The Atradius outlook on the construction sector in the short and medium-term is therefore negative.