If the construction industry in New Zealand is to continue to prosper, there are some thorny issues that need to be addressed
Margin call – By James MacQueen
BDO’s newly released Construction Survey Report reveals an industry under pressure.
Our construction team at BDO have just completed a survey of the New Zealand construction industry and released the report. Whilst containing a lot of
positive news, the report is also sobering reading, identifying many of the issues and challenges faced by the industry and the widespread extent of
some of these.
The good news is that there are a significant number of construction companies with sufficient financial strength to build many of the commercial buildings and houses that New Zealand needs, with 40% having more than 12 months of already confirmed and contracted work. However, there are too many that are not in good shape, and for some of these the issues will be terminal.
Cashflow and staffing challenges
A characteristic of those in a strong financial position is the adequacy of their cash reserves, allowing all creditors to be paid by due date and a strong buffer to allow for any delay in receipt of payment from their clients and for adverse events which invariably occur in this industry.
One-third of respondents that require performance bonds to obtain contracts have no capacity to provide further performance bonds, so their growth will be limited. This also means they have no financial reserves for an adverse event or major problem project.
Over a quarter (28%) find juggling cashflow a challenge, and 41% have clients that pay them late, despite contractual obligations to pay on time. Some 28% of those that deduct retentions and should be holding them in trust under the new regime were unable to confirm that they were holding the funds in trust, presumably because they simply did not have the cash to hold in trust. This availability of cash resources will be the defining factor between those that survive and those that are currently or becoming under substantial stress.
It was not surprising that the single greatest issue in the responses related to lack of sufficient staff, recruiting challenges and large skill deficiencies at most levels. Two-thirds are currently trying to find more staff.
The industry has grown 60% since 2011 and is forecast to continue to grow. With such widespread staffing challenges, rapid continued growth appears unsustainable. This is perhaps a good thing as it may reduce the impact of the usual boom-and-bust cycle behaviour of the industry and allow the current strong period to last longer for the benefit of us all.
A series of questions were asked about gross margins, and the report differentiates margins between commercial projects and housing projects, and also distinguishes subcontractors from head contractors. The report concludes that margins are inadequate for the risks taken and the longer-term viability of the construction sector.
Commercial construction margins on the projects that go well are often below 5%, and most companies will have one or two jobs that don’t go well, resulting in a loss and depletion of precious financial resources. Residential building margins are not much better, with around 36% of companies operating on margins below 6%.
There was concern from a high proportion of respondents about the increased transfer of risk onto construction companies since the last economic cycle. Based on a review of our own clients, profits are well below half what they were at the same time in the last cycle.
After overheads, many will not be making a profit and this is not sustainable. Quite simply, risk is not being adequately priced into the work and there is a race to win work at almost any cost, which ultimately will result in casualties.
Victims of circumstance
Subcontractors had a wider spread of margins which is to be expected, but 35% were undertaking projects below 10% margin, and another 43% were below 20% margin which is a significant decline compared to previous benchmarking.
When there are casualties, we need to look after the subcontractors. Most work for several head contractors. When one significant head contractor defaults, their subcontractors will be victims of circumstance, and the surviving parts of the industry desperately need them so that existing contracts can be completed on time and on budget, otherwise we risk a domino effect of collapses through the industry.
Poor margins and the lack of cash reserves in too many companies have left an insufficient buffer to absorb these challenges.
The retentions in trust regime is not working as it was intended. This will not be a surprise, but the extent of the problem may be. Almost three-quarters (74%) of those who have retentions deducted have not enquired to ensure they are held in trust, and for those who have checked, 36% found non-compliance which means they may not get paid their retentions at the end of the job.
That finding is consistent with our other findings that one-third are unwilling to confirm that they are complying with the law, presumably because they do not have the financial capacity to do so. Inspection is an easy way to gain some confidence that your customer can pay the retentions at the end of the job. Where it is unsatisfactory, this should create alarm bells as to whether you will happily get to the end of the contract and be paid for all progress claims.
The report identified a number of significant challenges driving a wedge between the strong and the weak companies. These include inappropriate risk transfer down the chain, lack of experience, poor project management, lack of skilled staff as well as lack of staff generally, council and compliance costs, availability of financial support, overzealous health and safety, substandard materials and desperate tendering.
Succession and exit planning is lurking beneath the surface of the industry like an iceberg. Over 50% of respondents who were over 50 had not started succession planning or simply hoped to sell their business in the future. Selling construction businesses is challenging and after the global financial crisis in 2008 there were virtually no transactions for many years.
Those that have not adequately addressed their plans well before the next cyclical downturn will be forced to struggle through the downturn, if they can, and remain working for a lot longer than they had wished. One of the most common areas with which BDO is currently assisting business owners in the sector is their succession planning.
In sum, if the construction industry in New Zealand is to continue to prosper, there are some thorny issues that need to be addressed by everyone.
James MacQueen is the national leader of accounting and advisory firm BDO’s construction and real estate team; to download the BDO Construction Survey Report, visit the website bdo.nz/constructionsurvey