UK CONSTRUCTION MARKET VIEW AUTUMN 2018

Transcription

1 UK CONSTRUCTION MARKET VIEW AUTUMN

2 MARKET VIEW AUTUMN 2018 NEGOTIATING UNCERTAINTY The construction sector is gearing up for an uncertain five months in the run up to the UK s departure from the EU. Political tension is high but key figures on both sides of the negotiation indicate that 95% of the deal has been agreed. However, the threat of a no-deal Brexit remains and this edition of Market View introduces a 5 Point Plan to build readiness for whatever outcome emerges. This provides a guide to building detailed project-level knowledge about exposure to Brexitrelated challenges, helping to inform contingency planning and provide a firm foundation to support an agile response to changes as they occur. Events over the next six months may materially affect the outlook for construction sector activity and inflation. Our central view currently assumes that a pragmatic solution to the outstanding points of disagreement in Brexit negotiations will be reached - paving the way for a transition period spanning at least 18 months. Construction activity flatlined in the first half of 2018 and recent orders suggest a weak outlook overall, but this conceals wide regional and sectoral variation. London has suffered the greatest impact from Brexit reticence. Agreement of withdrawal plans, and confirmation of a transition period, may provide the certainty required for shovel-ready schemes to get the green light. Construction cost inflation remains stubbornly high. Going forward, risks of upward input cost inflation outweigh deflationary factors, but metals prices have started to fall as the US-China trade war affects market dynamics globally. Wage inflation has moderated slightly but continues to exceed 3% and net migration has fallen sharply. Capacity is returning to tranches of the market particularly in the commercial sector - and this will help to ensure tender price inflation is contained at a level below input cost inflation. However, the strength of input cost inflation, coupled with the general weakness of contractors financial position, will limit the extent to which this is absorbed. Project specific factors will continue to be increasingly important in contractors pricing decisions and this should be taken into account. 1

3 TENDER PRICE FORECAST TENDER PRICE FORECAST Contractors tender pricing decisions are influenced by direct and indirect factors. Directly, expectations about future materials and wage inflation have an impact. Indirectly, a raft of other influences from the achievement of an organisation s strategic objectives to building or maintaining client relationships also have a bearing. How contractors weight the array of direct and indirect factors influencing their pricing decisions varies project-byproject and, at this time of heightened uncertainty, indirect factors are having a significant influence, creating wide tender spreads and very different pricing dynamics from project to project. The backdrop to our latest tender price forecast is discussed below. INFLATIONARY FACTORS Materials costs. Construction materials inflation remains bullish at around 5% per annum. Inflation is currently driven by rapidly rising input costs, which the manufacturing supply chain is struggling to absorb. The recent appreciation in oil prices poses a further upside risk. The extent to which the supply chain can absorb these increases is limited. However, some relief may stem from reduced traded prices of key metals used in the construction sector in recent months potentially a consequence of the escalation in trade tensions between the US and China. Labour costs. Construction wage inflation slowed to circa 3% in the third quarter, bringing it back in line with the trend in the wider economy. Net migration for the EU has reduced by 50% since the UK voted to leave the EU and, in early 2018, a greater number of nationals from EU8 nations (the Czech Republic, Poland, Hungary, Lithuania, Latvia, Slovakia, Slovenia and Estonia) left the UK rather than vice versa a trend that is unlikely to change following government confirmation that the UK s new immigration system will make no specific concession for EU nationals. Supply chain profitability. Financially, the contracting market remains vulnerable and insolvencies are rising. During 2017/18, the ten largest contractors made, on average, a pre-tax loss of 0.9%. The top 100 contracting organisations achieved an average pre-tax profit margin of 2%. This is better, relative to the abysmal performance of the top ten, but still a meagre profit margin relative to other industries and given the huge risks taken. The precarious state of contractors finances stokes risk aversion and restricts the supply chain s ability to reduce or hold pricing. Risk. We anticipate that the attitude to risk will generally continue to harden. For much of the supply chain it is likely this will manifest itself as higher prices. Additionally, the timetable of Brexit now means that the supply chain are pricing projects that will commence on site after the Brexit deal has been made. However, because they are pricing them with no visibility of what the Brexit deal will be and therefore what the operating environment will be, they are likely to factor this into the price as a risk allowance. Contracting capacity. Capacity has returned to tranches of the main contracting market but pinch-points can still be identified in regional hubs. The volume of residential and commercial-led developments in cities such as Birmingham and Manchester continues to weigh on available contracting capacity. Elsewhere the picture is mixed. In London, a sharp reduction in commercial orders and residential starts has generated some spare capacity. However, pre-empting slightly leaner demand conditions, contractors have taken a strategic decision to reduce turnover targets for 2019 and 2020 rather than risk engaging in aggressive price competition. Operations have been rationalised accordingly. 2

4 MARKET VIEW AUTUMN 2018 DEFLATIONARY FACTORS Industry performance. UK economic expansion has slowed since the country voted to leave the EU. The consensus among independent forecasters suggests GDP will grow by just 1.3% in 2018 a significant reduction compared with 2.3% achieved in 2015 but still comparable to expectations for some other EU countries, including Italy and France. Against this weaker economic backdrop, construction activity expansion is also forecast to slow. The Construction Product Association s latest industry forecast suggests overall activity will be broadly static this year and next, before returning to growth in 2020 when infrastructure mega projects build up a head of steam. Near-term, prospects across the sectors are mixed. Residential activity is forecast to continue to expand, albeit at a slower rate, whereas commercial sector activity is expected to contract by 12% between now and Contractors will become increasingly uncertain about the stability of future workload and this may weigh on pricing decisions especially within the sub-contracting world where profitability has been stronger in recent years. Demand Labour OHP Plant Risk Materials The above diagram illustrates the construction price mix. It illustrates the blend of factors influencing the movement of tender prices. Some are having an inflationary effect on tender prices whilst others are having a deflationary effect, resulting in a net inflationary or deflationary balance depending on the sector. Other influencing factors are explored in more detail in this tender price forecast section. Supply chain attitudes to risk allowance remain the main swing factor in defining tender prices. 3

5 TENDER PRICE FORECAST ASSUMPTIONS TENDER PRICE FORECAST ASSUMPTIONS Our tender price forecast assumes a central scenario in relation to Brexit. This entails: Economic growth of 1.3% in 2018 and 1.5% in 2019 (HM Treasury Consensus Forecasts). Construction output rising 0.1% in 2018 and 0.6% in 2019 (CPA) remains close to $1.40 and A Brexit deal is struck with transition period. A bespoke Brexit deal is agreed, included a free trade agreement for goods. We also assume that: Global economic growth continues to be positive e.g. annual growth of 3%+. That industry capacity broadly remains at the current levels e.g. workforce of approximately 2.3m. YEAR REGIONAL BUILDING CONSTRUCTION TPI LONDON BUILDING CONSTRUCTION TPI NATIONAL INFRASTRUCTURE CONSTRUCTION TPI % (2%) 2% (2%) 3% (3%) % (3%) 2% (3%) 4% (5%) % (4%) 3% (4%) 4% (5%) % (4%) 3% (4%) 4% (5%) % (4%) 3% (4%) 4% (5%) ( ) Last quarter s forecast Percentage movements are in the year to Q4 4

6 MARKET VIEW AUTUMN 2018 PREPARING FOR BREXIT - 5 POINT PLAN With less than six months to go, progress at the negotiating table has been slow. Preparing for an event with such significant political, economic and administrative consequence is challenging the complexity of, and interrelationships between, the factors at play make it difficult to model the detail of Brexit scenarios with any certainty. Building a comprehensive picture of potential exposure to the challenges Brexit could present will help to build the foundations to support an agile response to whatever post- Brexit challenges are encountered. Our 5 Point Plan provides a framework through which project exposure can be explored and mitigation can be planned. HEADLINE ACTIVITY CONTEXT KEY READINESS ACTIONS 1. Engage with the supply chain Availability of EU labour may change. Prices may change as a result of EU and non-eu tariffs. Schedules may be affected by customs barriers. Value of sterling may fluctuate. Quantify the proportion of EU labour working on individual sites. Quantify direct exposure to euro and dollar exchange risks. Identify the extent of supply chain preparations and work with supply chain to develop understanding and build resilience and agility. Understand sources of components and materials. 2.Review procurement strategy Tender pricing decisions influenced by sentiment. Additional customs checks may cause near-term delays to materials/component deliveries. Key events can trigger forex fluctuation. Excessive risk transfer may attract a commercial premium. Understand how the critical path may be at risk from unexpected customs delays. Achieve clarity on where commercial risks sit. Develop mitigations addressing threats to schedule. Review the balance of risk transfer to ensure appropriateness in relation to Brexit risks. Understand key points in the Brexit process that could impact buying decisions. 5

7 PREPARING FOR BREXIT HEADLINE ACTIVITY CONTEXT KEY READINESS ACTIONS 3. Review contracts for clauses Contractual tension may increase as a result of Brexitimpacts, raising the potential for disputes. Brexit clauses are being introduced into some contracts seeking to manage Brexit-related risks. Increased potential for extreme contract remedies e.g. Force Majeure or Frustration. Make sure contracts are signed. Ensure contract administration practice is being conducted in accordance with contract terms. Review contract terms and amendments for risk and opportunity areas. Liaise with legal team to identify potentially vulnerable or contestable contract clauses. Identify contractual exit points. 4.Undertake due diligence High levels of financial fragility remain in the supply chain. Supply chain is exposed to Brexit-related financial risks. Insolvencies are rising. Commission comprehensive review of current financial and deliverability status. Review of contingent liabilities. Contingency plans for supply chain failure. 5.Make contingency plans Costs may escalate significantly. Labour supply will be reduced if free movement ends. Imports of EU materials will be more costly. Disruption to logistics and programme. Organise contingency funds against identified risk areas. Review schedule and deliverability to develop contingency plans. 6

8 MARKET VIEW AUTUMN 2018 LIFTING THE CAP AN AFFORDABLE HOUSING REVIVAL? The decision to scrap the cap on local authority borrowing which constrained the amount of funds local authorities could raise to invest in social housing is a positive development. Back in the 1970s, it was not uncommon for councils to deliver in excess of 100,000 new homes annually. Now, numbers have dwindled to a meagre annual total of less than 2,000. With nearly 14,000 people estimated to be homeless, 80,000 households in temporary accommodation, and almost two-thirds of councils describing their need for affordable housing as severe, the severity of the situation is clear. But is this policy change sufficient to make significant inroads towards addressing the shortfall? Rebuilding the capacity and internal capability to ramp up development programmes is the first hurdle that needs to be overcome. Government estimates suggest this policy change can deliver up to 10,000 new affordable homes each year. A policy that removes the shackles allowing the potential afforded by valuable asset bases to be fully exploited for the good of affordable housing provision is a positive step forward. An additional 10,000 units per year is significant relative to recent levels but pales into insignificance on longer-term comparisons. If the nation is to truly address the housing crisis, a significant uplift in central government funding is needed. The Prime Minister brought the Tory Party Conference to a close with a pledge to end austerity and lift investment in public services to rapturous applause. With general government gross debt equating to 86% of GDP, and our public finances ranking second to last in a recent health check by the IMF on the wealth of 31 nations, this may be a classic case of easier said than done. 7

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10 CONTACT WILL WALLER DIRECTOR - MARKET INTELLIGENCE WILL.WALLER@ARCADIS.COM SIMON RAWLINSON HEAD OF STRATEGIC RESEARCH & INSIGHT SIMON.RAWLINSON@ARCADIS.COM Arcadis Our world is under threat - from climate change and rising sea levels to rapid urbanisation and pressure on natural resource. We re here to answer these challenges at Arcadis, whether it s clean water in Sao Paolo or flood defences in New York; rail systems in Doha or community homes in Nepal. We re a team of 27,000 and each of us is playing a part. Arcadis. Improving quality of life. Disclaimer This report is based on market perceptions and research carried out by Arcadis, as a design and consultancy firm for natural and built assets. It is for information and illustrative purposes only and nothing in this report should be relied upon or construed as investment or financial advice (whether regulated by the Financial Conduct Authority or otherwise) or information upon which key commercial or corporate decisions should be taken. While every effort has been made to ensure the accuracy of the material in this document, neither the Centre for Economics and Business Research Ltd nor Arcadis will be liable for any loss or damages incurred through the use of this report. Arcadis United Kingdom 2017 Arcadis