Over the last few years several contractors and consultants have changed their workload mix in pursuit of long term profit growth. Contractors like Amey, Carillion and Interserve have dumped low margin, competitively tendered construction work in favour of long term outsourcing work.
Tired of trying to convince the stock market that they can make sustainable profits from conventional contracting, they have got into long term framework and outsourcing agreements. Now, these firms are increasingly concentrating on multi-year maintenance contracts and privately financed public private partnership (PPP) concessions. Some bigger consultants like Atkins, WSP and Mouchel have also entered this market, snapping up highway and property management deals with local authorities and bidding for PPPs.
And the stock market has loved it. These long term contracts have stabilised the earnings of previously unpredictable companies that investors were afraid to touch with the proverbial barge pole.
Last week the City's romance with these firms looked as though it was heading for the rocks as shares in Carillion, Amey, WS Atkins and WSP plunged amid doubts about the future profitability of these contracts. Shares hit record lows, affected to a degree by the realisation that bidding for such work, especially PPP contracts, is not cheap.
The truth started to dawn in March when Amey announced that it was changing its accounting practices to account for the cost of negotiating private finance concession contracts in the year the money was spent.
Previously it hadn't bothered, arguing that once the deals were signed it earned the money back. Amey's announcement meant it had to scale down reported pretax profits of £27.3M in 2000 to £5.7M. Last year the company reported a loss after taking bid costs into account and it has since warned that future profitability could be affected until major deals like the delayed London Underground PPP are signed. As a result the Amey share price plunged from a 12 month high of 414p to a low of 87p last week.
Carillion followed suit last Thursday, announcing that accounting for these bid costs would knock £12M off profits over the next two years. Its shares dropped from 166p to 142p on the back of the news.
To be fair to these companies, the stock market's love affair with outsourcing contractors seems to have been one of blind infatuation. Investors appear to have been seduced by the prospect of long term stable earnings without considering the fact that extremely complex contracts like PPPs are expensive to set up. This is common knowledge to those in the financial sector who put together PPP deals, many of whom work for the same financial institutions which are downgrading these contractors and consultants' shares. Perhaps the merchant bankers should talk to their stock broker colleagues more often.
Things may look bad today but once the market gets its head round the fact that outsourcing companies are genuinely in it for the long term, and with good management should produce good returns, the shares will rise. Consider buying while the prices are low.
Andrew Bolton is NCE news editor