The FTSE Construction and Materials sector issued just three profit warnings between January and June 2021 – the lowest first half total in five years – according to the latest EY-Parthenon Profit Warnings Report.
The findings reflect the current high demand for construction, with housebuilding leading the increase in activity. However, the growth in demand has outstripped the supply of raw material, haulage, shipping and labour. A supply chain and labour shortage – combined with a fall in activity in pandemic-hit industries – could impact both activity and margins, and increase stresses in the second half of 2021.
Ian Marson, EY-Parthenon UK&I Construction leader, comments: “While the historic low level of profit warnings and growth in demand give reasons for the construction sector to celebrate, a number of factors have come together to pose increased challenges for the rest of 2021. Brexit exacerbated an ongoing shortage of skilled labour. Essential raw materials are also in short supply, including timber and long steel products in particular. High demand in maritime shipping – which is still recovering from the impact of the Suez Canal blockage – has further impacted the supply chain.
“Existing projects are continuing but cost inflation may put new projects at risk. Companies with inflation clauses in their contracts should be able to weather short-term price increases but if prices remain high and shortages continue, project delays may become inevitable. Meanwhile, working capital pressures are increasing in the material supply chain, with credit insurance under pressure as prices rise.”
Focus on cash
The EY-Parthenon reveals a record low of just 32 profit warnings from all UK-listed companies in Q2 2021, the lowest quarterly total EY has recorded in over 22 years of profit warning analysis. The second quarter’s record low comes in stark contrast to the record high of 301 in Q1 2020 and the second highest ever total of 165 in Q2 2020.
EY recorded similar dips in 2002/3 and 2009 after 9/11 and the global financial crash, respectively. Analysis suggests that markets tend to over-correct and last year’s drastic expectations reset, combined with a better-than-expected recovery and Government support, meant that all but a handful of companies beat depressed forecasts.
But most Government support schemes came to an end or begun to taper at the start of the third quarter of this year. Falling levels of support and rising costs will increase the focus on companies’ need to plan and manage their cash positions carefully.
Meg Wilson, EY-Parthenon Partner, Turnaround and Restructuring Strategy, said: “The economic outlook is improving, but for many companies there is still uncertainty. Businesses reopening or expanding their trading are balancing the investment and costs needed to meet increased demand against the removal of Government support and the potential for setbacks. They also need to be mindful of how cash is flowing through their supply chains.
“Companies in rebuild mode need to be vigilant to their exposure to contingent or ‘soft credit’, be it direct or indirect, for example through credit insurance – an important but often overlooked element of liquidity.”
Through the framework of the Trade Credit Reinsurance (TCR) Scheme, which ended on 30 June 2021, the Government estimate that they have assisted over half a million businesses, protecting £575bn of business turnover.
Continuing, she said: “As trading rebuilds and exposures start to increase, engaging proactively with credit insurers now the TCR scheme has ended and other suppliers of ‘soft credit’ may be necessary to ensure continued support and preserve liquidity. In this delicate transition time, bringing all stakeholders on the journey is going to be key.”
Taking the long view
Ian Marson added: “Low margins and discipline over contract selection and execution have been long-standing challenges in the construction sector. Before this quarter, most profit warnings over the last year cited contract problems that pre-dated the pandemic. Cost inflation will only exacerbate the pressure and companies will need to maintain discipline and visibility over key parts of their supply chain.
“But while the construction sector contends with these immediate challenges, it also need to keep sight of the long-term picture. In particular, it needs to innovate to improve productivity, recruit and develop diverse talent, and play an integral role in supporting the net-zero agenda. These developments will be key for creating future sector stability.”