Balfour Beatty: ‘Not short of stellar’

One year ago Balfour Beatty chief executive Leo Quinn was in no doubt as to the financial performance of the company he’d just taken over. Speaking in March after publication of the firm’s 2014 results, he branded the numbers – a £304m pre-tax loss on revenue of £8.7bn – “awful” and “horrible”. He said they exposed “underlying weaknesses” and “poor control” in the group in terms of its lack of cost and cash management, and went on to set out a two-year “self-help” strategy designed to turn the business around. Along the way he berated a “failure of leadership” at the firm before he arrived.

One year on from that tongue-lashing, the UK’s largest builder last month announced results for Quinn’s first year in charge and – understandably – his rhetoric was much changed. Announcing plans to reinstate the shareholder dividend he cancelled in 2015, Quinn said the firm now had a “clear direction” and “upgraded leadership team”, and that its performance on bringing cash in had been “not short of stellar”.

But while the rhetoric was much different, to some observers the actual results, which included falling revenue and another huge (£199m) pre-tax loss, didn’t look much better. In fact, by some key metrics, such as the “underlying” pre-tax profit/loss – which excludes one-off or exceptional costs and credits – the situation actually worsened significantly, with losses widening by over 50%. However, for objective observers the labyrinthine complexity of the global business’s group accounts make it all but impossible to work out whether Quinn’s backers or detractors are right. Here, Building uses an exclusive interview with Balfour’s chief executive to examine whether Quinn’s turnaround programme is really on track, and if he’s on course to hit his two talismanic self-imposed targets – to bring £200m of cash into the business and drive out £100m of cost.

Comeback kid

Certainly the generally accepted interpretation is that Quinn has made positive moves to stem the business’s problems. He says these problems stemmed from “forced growth” during the last decade, in which Balfour bought 45 businesses and grew revenue fivefold. This left the business a sprawling and uncontrollable giant, with responsibility devolved to unintegrated business units taking too many contract risks – and few would disagree. Following a string of profit warnings Quinn joined in January 2015 shortly after the firm had threatened to break its banking covenants if the sale of its consulting business Parsons Brinckerhoff hadn’t gone ahead. The crisis was confirmed by a KPMG review showing the business had 89 significant problem contracts.

We’ve stabilised the outlook and people can get back on with their jobs, rather than thinking about what’s the next crisis that’s going to be announced from head office

Leo Quinn, Balfour Beatty

Quinn’s two-year turnaround plan put the promises to bring cash in and drive costs out alongside a wider culture change programme, entitled Build to Last, itself with four separate elements. The recent results mark the halfway point in this programme, and the assessment of analyst Howard Seymour, from Balfour’s corporate broker, investment bank Numis, is typical. He says the continuing losses simply reflect the “acceleration of management actions to eliminate legacy issues” and that Quinn is right in moving to cut out back office duplication, put in central controls over contract risk, and target larger, more profitable contracts. Seymour concludes his actions “[…] will progressively provide Balfour with the strongest profit recovery profile in the sector”.

Numis is by no means alone in its supportive take. Former Whitman Howard analyst Stephen Rawlinson, who is not known to shrink from critical assessments, says: “Quinn looks to be doing the right things, dealing with some of the poor operating disciplines. His approach has bought himself some time to deal with the really big problems.”

Unsurprisingly, that is also Quinn’s assessment. Speaking to Building, he says: “I’m quite pleased with where we are to date […] I do think that in a very short period of time we’ve stabilised the outlook, and people can now get back on with their jobs looking after customers, rather than thinking about what’s the next crisis that’s going to be announced from head office.”

Quinn has certainly been able to demonstrate progress on his cost reduction target – 60% of the £100m of overhead costs he promised to take out of the business have already been stripped away in the first year. Building Value analyst Tony Williams says the indication that the firm will reinstate its dividend shows that progress is being made, and points to Quinn’s track record in turning around previously struggling listed firms Qinetiq and De La Rue. “Leo Quinn is a breaker, not a maker – but that’s probably what Balfour Beatty needed. Reinstating the dividend is a lead indicator. It’s more than a PR exercise – I really don’t believe he’d do it if he didn’t think things were on the mend,” he says.

Shaky numbers

Nevertheless there are a number who hold serious doubts as to progress at the firm. The case against is essentially that the recent results don’t show enough signs of progress to be clear Quinn’s prescription is working. The fact that underlying losses have grown sharply from £80m to £123m is key to this view. In the firm’s “horrid” 2014 results, three-quarters of its losses didn’t come from the firm’s core business, and were instead due to one-off events or legacy contracts in parts of the business it was exiting. However, this year a large majority (62%) of its £199m pre-tax loss came from its core business, most particularly its Construction Services UK business, which made a £187m operating loss. Added to that its US construction business, which at £3.1bn turnover is now 50% bigger than the UK one, moved in to loss-making territory for the first time, recording a £22m deficit. This worsening picture comes despite the fact that – as Quinn himself has said – Balfour is operating in an improving market where there should be opportunity to make higher margins.

At this stage you’d think the management changes would settle down a bit. You’d expect change when he came in but it’s now looking like a negative rather than a positive

Kevin Cammack, Cenkos

Quinn’s answer to this is to point to the fact these underlying losses, caused by poorly performing contracts mainly in the UK, were taken in the first half of last year, and therefore that from six-month period to six-month period progress is being made. “In the second half of the year, we actually make £7m profit underlying.” Kevin Cammack, analyst at Cenkos, is one for whom the jury is still out on Quinn’s turnaround. He says Quinn’s “comfortably ahead” of where he wanted to be on bringing in cash, but has concerns over the trading position. “It feels like he’s behind the curve in the recovery of the overall business,” he says.

For example, in January last year Quinn told Building that he expected the business to be “comfortable, fully operational and performing well” within 24 months. While he is not specifically contradicting this, he is saying it will be another 24 months from here before the firm will reach the 2-3% “industry standard” margins he is aiming for. He has also declined to promise that the business will not report another loss in 2016. But Quinn says the most important thing is that the business is heading in the right direction. “We are certainly where we would want to be – we’re a little bit ahead; on some areas, you could argue we’re a little bit behind […] You could be plus or minus £10m either way. On an £8bn turnover its neither here or there, it’s a rounding error on a calculator.”

However, some of the specific numbers held up by Quinn to exemplify the firm’s progress look less solid when examined. For example, the firm has identified 89 “legacy contracts” which are the source of much of its pain, and which the business is currently working through. Quinn told Building 60% of those are now “complete”, and 90% will be by the end of the year. But in fact these figures include jobs that have only reached practical completion – only a third (29) of problem jobs have actually reached financial close. Practical completion, when the majority of the building work is done, does not mean further losses won’t be incurred, and Quinn will give no timeframe for when those remaining 60 accounts will be finally settled.

Quinn says: “The reason we talk about practical completion is that we’ve effectively handed over the facility – the fact of the matter is we’re off the job, so at least you’re not burning any more cost. In terms of financial close, some of those can close quite quickly, others will be a lot more arduous, some will actually be quite litigious, because unfortunately that’s the nature of some contracting.”

Cash conversion

Quinn’s progress on cash also demands scrutiny. Any investors that assumed his “£200m cash in” pledge might see Balfour Beatty’s net cash actually increase, will be disappointed. Quinn says the metric he will actually be judged on is that of comparing Balfour’s cashflow since he joined with that in 2014. In 2014 an enormous £438m of cash flowed out of the firm’s coffers (excluding the impact of the sale of Parsons Brinckerhoff). Under Quinn’s leadership cash has continued to flow out of the business – but at a much-reduced rate, with £81m out in 2015.

The difference between the two figures means Quinn can correctly claim to have smashed his target one year early with a £357m improvement in cashflow – despite the fact cash in the business is still decreasing.

Quinn has introduced a “Cash is our Compass” programme in the firm, and says this progress is “primarily” down to a resulting “better management of working capital” through ensuring it gets paid and turns its inventory more quickly. But the 2015 figure was actually made much healthier by the £96m decision to cancel the dividend, and the fact Balfour hasn’t actually paid out the cash on most of its problem jobs, because their final accounts haven’t been settled. Hence – Quinn confirmed – there will be £100m-150m more flowing out of the business this year than in 2015. But he adds: “When we get rid of our legacy issues and we’re generating cash-backed profit from our projects, then you’ll see that the cashflow will turn positive for the company on an annual basis.”

Downsizing

At the same time as these group-level challenges, on an operational level there has been a continuing steady drip-drip of senior departures in the UK construction business. Cost cutting means numerous UK offices have closed, with the results stating the regional construction business is “rationalising its management structure and offices” and that the £300m fall in UK construction revenue to £2bn was “predominantly” due to its contraction. Quinn said in 2015 that the “front office” would be “ring-fenced” and “actively protected” from cuts. Nevertheless, those who have left the business recently include former Multiplex, Mowlem and Lendlease director Paul Gandy, one of a six-strong senior team sitting beneath UK MD Dean Banks, who is joining Kier. Gandy’s regional director of operations for London, Jeremy James, is also leaving. Building understands Tim McCarthy, group commercial VP in the US and recruited last year, has now retired, while north-east MD Eddie Tribe left the business after the merging of the north-central and north-east delivery units at the end of 2015. Cenkos’ Cammack says: “Quinn’s been doing sensible things, but at this stage you’d think the management changes would settle down a bit. You’d expect change when he came in but it’s now looking like a negative rather than a positive.”

In response, Quinn says he has made Balfour’s expertise one of the four planks of his Build to Last strategy and is confident he’s holding on to the right people. He said: “First and foremost, if the competition weren’t recruiting some of my leaders and my front line capability, then I think I’m doing something wrong. My job is to make sure we’ve got the best people because I’m investing in them, training them and developing them.”

The fact is it’s impossible to say definitively one way or another from the numbers whether Quinn’s recovery is on track – it’s simply too early to tell. Faith in the process comes down, primarily, to whether you have faith in the man himself. But it is clear that these are at best mixed results. “He’s had his last chance, he’s used up his time period for making massive provisions,” says Cammack. He looks likely to have to demonstrate more tangible progress at the half-year results in August in order that the City doesn’t lose faith.