BDO construction industry report says things are improving - but there are still big concerns.

Predictions of construction companies failing have come true in the past two years – and now one of the key gauges of the industry is still nervous about more trouble.

BDO's 2019 Construction Industry Survey has just been completed and James MacQueen, Advisory Partner and head of the construction and real estate sector for the business advisory and accountancy firm, says some indicators are trending positively.

But there remains lingering doubt about some of the factors at play which can send construction companies into the hands of receivers or liquidators.

MacQueen and BDO predicted company failures over the past two years – and since then a handful of companies have done so, the most high-profile being Ebert Construction, Corbel Construction and Arrow International. The former went into liquidation with $45m of creditor claims but few realizable assets. Arrow went into liquidation with debts of $40m.

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MacQueen says BDO's survey highlighted many of the challenges facing construction companies that could spell the difference between success and failure.

"I have to say that, overall, there is an improvement; good operators, with a sound financial base, are still the majority. However, there are still some businesses out there who are pitching really low prices to ensure they win contracts to keep their staff occupied."

At times, construction contracts were won with profit margins of no more than 5-6 per cent, he says, and even some below 5 per cent. Companies could squeeze by at that level but were vulnerable; an unexpected reverse could quickly trigger failures.

Last year's survey showed that 54 per cent of companies were winning projects at only 6 per cent profit margin or less. In 2019, only 35 per cent did that. Those obtaining margins of 8 per cent and over grew from 28 per cent to 42 per cent.

"Margins below 6 per cent are not sustainable," says MacQueen, "and while 35 per cent is better, there are still too many firms in that vulnerable position."

The survey, tracking over 200 construction companies and sub-contractors of various sizes, spotlighted other issues which could impact company health.

While the industry was getting to grips better with the new regime of retentions, there was still a worrying level of likely non-compliance.

Retentions are part of sub-contractors' pay, held in trust for a period to ensure any remedial work required is completed, even if the project is finished. Retentions payable typically comprise 6-7 per cent of construction companies' total turnover – a lot more than the profit for the year.

They are supposed to be held in trust but the 2018 survey showed that 74 per cent of those with retentions deducted had not checked to see if the monies were actually being held in trust. Of those who did check, 36 per cent found non-compliance – meaning they may not be paid their retentions at the end of the job.

Even more alarmingly, the 2018 survey found 28 per cent of construction companies were unwilling to confirm they were complying with the retentions law by putting that money in trust.

MacQueen said at the time that most of those companies could not confirm because they hadn't paid the money in – because they did not have it: "That was how close to the wind some were sailing."

In 2019, things had improved; now only 7 per cent "preferred not to confirm" but, of those who checked (70 per cent hadn't in 2019), 50 per cent of them discovered non-compliance. MacQueen says such non-compliance can, if a complaint is made, end in criminal proceedings.

"Cash flow in the industry also came out a little worse than last year," he says. "In 2018, 27 per cent were either on overdraft or were struggling with cash flow – this year, it's up to 35 per cent."

Cash flow also affects companies' capacity to provide performance bonds. The survey showed almost half those that need to provide bonds have no ability to issue additional bonds as they don't have the cash security banks require. MacQueen forecast this would be a major issue last year and expects this problem, which significantly constrains growth, to be accentuated this year.

Other key indicators from the report were:

Management reporting

MacQueen says the survey showed that 43 per cent of respondents said their management reporting was limited or lacking – almost double that of last year. "Most companies are preparing their accounts but they are either not accurate or do not give directors what they really need," he says. "We are finding that ourselves in the work we do for new clients in the sector."

Succession planning

Only half the people over 50 surveyed had a succession plan, affecting many businesses with revenues of $6m-plus: "It takes time to put together and implement a good succession plan but what typically happens is that people get too busy and don't make time for it. Then the economy can move into a low cycle or the main person has a health problem, creating huge stress without an easy solution."

Directors' liabilities

The survey found that 22 per cent of construction company directors did not have directors' and officers' liability insurance – meaning their savings and assets (including the family home), could be at risk. "Of those with insurance, 36 per cent had less than $2m cover which, once you add in legal fees, won't go far."

MacQueen says he is reluctant to forecast how many construction companies will crash "but some of the indicators in this survey means you wouldn't bet against a few. Overall, the industry is coping better than a year ago – but there are still too many causes of concern and indicators of vulnerability."

To download BDO's 2019 Construction Survey Report, go to www.bdo.nz/2019constructionresults