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Balfour Beatty issues new £70M profit warning following KPMG review - updated

Balfour Beatty has issued a fresh £70M profit warning as it published results from a review of its UK construction business by KPMG. This brings the firm's total write down to £260M since a drip feed of announcements began in May 2013 .

Leo Quinn Balfour Beatty

The contractor has now cancelled the proposed £200M share buy back, which would have used some of the profits from the sale of Parsons Brinckerhoff in October for £820M to return value to shareholders. Dividend policy, it said, will be reviewed in March at the time of the full year results and at the same time the group will “re-engage with the Pension Trustees on the pending pension deficit payment”. This was due to be £85M.

The announcement is the first major public task for new chief executive Leo Quinn who started this month and came days after the company named Philip Harrison as its new chief financial officer who joins in a few months from Hogg Robinson.

"The business is a monster and we need to get it down to manageable size and scope. How we rationalise the portfolio is too early to say." Leo Quinn

KPMG was called in by the contractor in September when Balfour Beatty's own internal investigations had flushed out a £75M profit black hole. The consultant was asked to undertake a detailed review of the UK Construction Services’ divisions’s contract portfolio including new wins, looking in detail at Balfour Beatty’s performance in its core skill area of contracting, focusing on commercial controls, cost to complete, contract value forecasting and reporting on a series of troubled projects mostly in the London building market.

The KPMG report uncovered another £70M of profits at risk. Of that, £20M relates to the difference between Balfour Beatty's reported contract positions in August and KPMG’s assessement at that date and £50M relates to new contract problems and a “deterioration in project performance up to the end of December".

According to Balfour Beatty: “Issues are principally restricted to previously highlighted delivery units: Engineering Services, and London (including major projects buildings) and the South West regions of the Regional business”. The contracts account for less than 10% of CSUK’s August 2014 year to date revenue.

“The summary report on UK Construction is an important step in drawing a line under a period of uncertainty for our customers, and enabling us to focus fully on delivering value,” Quinn said.

"Poor tendering, poor control, lack of contingency and what I call a consipracy of optimism in terms of cost to complete. The fixes are not compicated. They will take time to put right but we know the solutions." Leo Quinn

“I was never in doubt that there was a great deal of work to be done to restore the group to strength. Balfour Beatty is a large organisation which had become too complex and too devolved for adequate line of sight and financial control. The key is that these issues can be put right and we now have clear action plans in hand. Significant opportunity exists across the group to drive reduced costs, improved profits and strong cash generation to the full benefit of our shareholders.”

He said that he was not surprised by the root causes of the problems - they were common to many companies.

These are: "Poor tendering, poor control, lack of contingency and what I call a consipracy of optimism in terms of cost to complete. The fixes are not compicated. They will take time to put right but we know the solutions."

Balfour Beatty has become "too large and overly complex with a lack of transparency and loss of control". There is too much cost and too little cash generation, he said. But he also, after his first 14 days in the job, called it a stunning business with construction and infrastructure seen as strong bedfellows.

Quinn said he would be able to say more in March when the final results are announced as to how the business would be reshaped but he suggested it would be made smaller.

"The business is a monster and we need to get it down to manageable size and scope. How we rationalise the portfolio is too early to say." 

"Major Projects is an important part of the business and it does perform well. I am taking away that distraction and focusing management (in UKCS) on the areas that need care and attention." Leo Quinn.

In terms of taking cost out Quinn is launching a drive to cut overhead costs and improve cash flow generation but promised that process, engineering, project management and customer-facing resource “will be actively preserved”. He said that the £175M of savings that Carillion believed possible when it bid to buy the group last year was reasonable. "I can't imagine anything less than that number would be on the table in terms of benefit to shareholders," he said.

One early action in terms of managing the business has been the decision to "simplify and de-layer" the UK Construction Services structure. 

The Balfour Beatty statement said the review “has helped distinguish those units requiring strong corrective action from the remainder which are performing more effectively. This in turn highlights the need to drive greater transparency and accountability.”

As a direct result Steve Tarr’s Major Projects construction business which reported through UK Construction Services, led by Nick Pollard, will now report direct to Quinn.  

"Major Projects is an important part of the business and it does perform well. I am taking away that distraction and focusing management (in UKCS) on the areas that need care and attention," Quinn said.

The statement also announced that value of the investments portfolio had increased to £1300M from £1,051M. 

Issues being addressed in the review, as highlighted by KPMG include:

Bidding – tendering at very low margins with optimistic assumptions around cost, programme and procurement savings, and inadequate provisions for risk.

Commercial and contract management – insufficient local management challenge and review of contract performance, failure to recover genuine contract entitlement due to poor contract administration and optimistic assumptions on contract penalties.

Accuracy of cost and programme forecasting - insufficient visibility, control and understanding on actual versus reported contract performance.

“The Group considers insufficient visibility on project deterioration was compounded by an overly complex reorganisation programme that led to high levels of employee turnover at a time of extremely challenging market conditions,” Balfour Beatty said.

Remedies, to be implemented immediately, are:

More rigour in tender assessments – Improve tender review processes through improved guidance, improved operational inputs, earlier and ongoing risk management assessment, additional independent oversight and appropriate allocation of resource. A review of a sample of recently bid contracts shows a tightening up of tender processes but also demonstrates that further standardisation of the bidding process is required.

Improve accountability for project performance ‐ Ensure project managers have greater financial and commercial accountability for project performance with an appropriate set of project performance KPIs. More robust challenge and review of contract performance by local management.

Accuracy and timeliness of forecasting – Increased focus on identifying, understanding and reporting risks inherent in projects and the implications on financial performance on a timely basis, and enhanced project reporting supported by consistent application of strong commercial management and contract administration processes.

Group policies – Improve and reinforce Group policies to commercial and local financial management ensuring rigorous application across all projects.

If you would like to contact Jackie Whitelaw about this, or any other story, please email jackie.whitelaw@infrastructure-intelligence.com.

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