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Cost cutting looms as industry chief warns good firms will go under

Construction Inudstry Council chairman Keith Clarke has warned 2009 will see a massive shake up in construction and civil engineering as consultants begin to take drastic action to cut costs.

Clarke was speaking to NCE on the day city analysts reported consultants bringing "significant rigor" to cost-cutting in the form of redundancies, pay cuts, bonus freezes, four day weeks and cuts in training, travel and recruitment.

"This is a manifestly different crisis to all those previously," said Clarke. "I don’t think we have seen the half of it. There is going to be a massive shake out in our sector, in engineering and contracting.

"There are good companies out there that need banking facilities to get them through to month end or over the next six months – banking facilities that aren’t there – and it means good firms will go under."

Clarke's view was echoed by city analyst Numis which fears that some stock-market listed consultants will not survive the downturn.

"We have a stress test standard exercise which sees profit and earnings per share halving and all the companies emerge soundly except White Young Green and to a lesser extent Waterman," said Numis director Francesca Raleigh.

"Our analysis shows the strongest companies on net debt are Atkins, Hyder Consulting, RPS and Scott Wilson."

Clarke said his own firm, Atkins, would not be making the mistake many businesses did in the recession of the early 90s when firms laid off their young trainees only to struggle with a huge skills shortage when the economy turned round.

"At Atkins we are taking steps to ensure that where we have given commitment to graduates, we will honour that commitment," he said. "But then we have been prudent about our growth.

"It would be nice to say that the whole industry will protect its graduates but the reality is that the lack of bank finance means that there are firms in the supply chain that will go bankrupt.

"Around 95% of firms are 40 people or less and the idea that they can all afford to keep their graduates on just won’t happen unless they have great clients and great cashflow and that happens in a very different market to the one we are in."

Numis' forecast for the year ahead echoes Clarke's view, with the expectation that consultants will move to trim "fat" accrued as a result of the recent boom years.

It said cost reduction measures in the sector are taking the form of:

  • Redundancies: Labour is the largest cost for consultants, representing 50-60% of turnover, and redundancy costs have a 4-6 times payback. Numis cites WSP’s decision to cull 5% of its workforce as a £2.5M cost that releases an annualised cost saving of £15M; similarly Scott Wilson’s move to make cuts in commercial private sector is a £0.5M cost that releases £2M.

  • Pay cuts: in some cases these are Group wide, on average in the order of 10%

  • Bonuses: account for 1% of turnover or 5-15% of profit before tax.

  • Moving to a 4 day week: valid in certain sectors

  • Cutting training, travel and recruitment spend: recruitment spend had been as high as 1% of sales in some companies

  • Reducing back office costs: For example IT and human resources

"We believe UK Plc contains a number of viable long term players in the engineering consultancy space," concludes the Numis report. "Balance sheets are generally sound, companies are already cutting costs and prepared to be as rigorous as is required and many of the companies have attractive market positions in the UK and/or internationally making them very well placed in the upturn.

But Numis' report warns that the downturn is likely to deepen before any upturn.

"The US is planning to spend billions/trillions of dollars on new roads, bridges, schools and repairing existing facilities and on an energy investment programme. In the UK however, in our view, there are risks and uncertainties on public sector funding initiatives. The latest Construction forecasts are anticipating public sector spend will be up in 2009 but flat in 2010 and down in 2011.

"Will the UK borrow its way out or will projects get mothballed/deferred/cancelled? The recent pre budget report (£3bn spend targets) has not been plain sailing with companies expressing concerns about the funding for the schools & hospitals programs (which require bank finance) and the fast track £1bn transport projects do not all have guaranteed funding. The Crossrail project is underway (design framework providers announced 9/12/08) but could the timing be delayed/phased? Design work has begun on the M25 DBFO but financial close has been delayed and is anticipated in early 2009."

Numis also raises concerns for public spending cuts post a General Election.

"The new build/upgrade characteristics of the public sector could fundamentally change for a while: from being across the board to just the “must do” projects such as the Olympics, finishing off the LU upgrade and the Energy sector. We however believe the increasing Internationalisation strategy of the consultants stands them in good stead longer term if the UK market becomes less dynamic for a prolonged period."

Numis also warns of undercutting on price. "Evidence is emerging that framework work and new tenders are becoming more competitive as an increasing number of companies chase Government work."

It also warns of maintenance spending cuts. "We see a risk that longer term maintenance contract work is trimmed as local authorities and Central Government prioritise spend in a cash constrained environment.

"We believe Water (a regulated sector) emerges well as there are must do programmes and the funding is there."

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