Construction contract woes wrong-foots investors

Article – BusinessDesk

March 20 (BusinessDesk) – Fletcher Building was quizzed by analysts and investors over why industry rumours were circulating about losses from a major construction contract before they were disclosed by the company today in a surprise move that …Monday 20 March 2017 03:45 PM

Fletcher’s disclosure of $110M of construction contract woes wrong-foots investors

By Jonathan Underhill

March 20 (BusinessDesk) – Fletcher Building was quizzed by analysts and investors over why industry rumours were circulating about losses from a major construction contract before they were disclosed by the company today in a surprise move that wiped more than $650 million off its market value.

On a conference call today, chief executive Mark Adamson said he “took full responsibility for the current situation”. He was unable to comment on industry rumours and had to rely on his own chain of command. “The reality is we were already aware of those issues last year.”

Questioned by analysts he said the review of the construction division began in the second week of November, which was about the time chief financial officer Bevan McKenzie started in his role. It was also just weeks after the company’s annual meeting, where Adamson told shareholders that in New Zealand “every indicator points to another good year in the construction sector”.

Instead, on Feb. 22, the company’s first-half results showed New Zealand construction generated operating earnings of just $1 million even as gross revenue surged 54 percent to $1.15 billion. But the first-half results were also light on details of the problems in the construction division, referring to “losses incurred on a major construction project” among a list of issues that had held back the division in the first half. At the same time, the company affirmed its full-year earnings forecast.

Today, four weeks later, Fletcher has cut its full-year operating earnings forecast by $110 million to a range of $610 million to $650 million, saying the revised guidance “is due to the identification of additional estimated losses and downside risk in the buildings and interiors (B&I) business unit of the construction division.”

Fletcher Construction’s major projects include the $300 million Justice and Emergency Services precinct in Christchurch, which was due to be handed over at the end of this month, but according to a Ministry of Justice spokesman quoted by The Press is now not expected to open until the third quarter of 2017 after the company put the hand-over date back to June 30. The spokesman described the precinct as “the largest multi-agency government co-location project in New Zealand’s history.”

While Fletcher won’t disclose the contract on which it has incurred losses, citing client confidentiality, it has also characterised the project as complex – starting with “certain engineering issues that had not been resolved” and that “caused the initial delay” and that was “exacerbated” by changes to the design brief for the “unique” building.

Adamson said the critical thing with a major project was to stay on programme and if there was slippage in the timetable it was hard to get back and could have “almost an exponential multiplier effect”. He confirmed that for the loss-making development and a second one where the company had issues, Fletcher had been given the design rather than developing it in-house.

In the wake of the review, new managers have been or will be appointed for the construction business and the company has reviewed its bidding processes. “It’s clear there will be buildings to be built (but) we will pick and choose,” Adamson said. “There’s enough work out there.” It is now applying “a far more stringent filter” on the nature of contracts and clients.

Asked about the makeup of the company’s $2.7 billion backlog of building work and whether it had a concentration of risk, Adamson said roughly $1.5 billion was work within B&I.

McKenzie added that within B&I, the 20 biggest projects accounted for $1.4 billion. Those had largely been from bids won in 2016 or before but have subsequently been reviewed with the new team in place, he said.

McKenzie said the information presented to the market at the first-half was accurate at the time and today’s announcement was prompted by new information.

The stock fell 94 cents to $8.28 and earlier touched a six-month low of $8.035 when it resumed trading after being halted on Friday pending the announcement.

“It’s not a great look,” said Paul Richardson, chief investment officer at Mint Asset Management. “The company has now been reasonably upfront but there are still more questions and wider questions about the construction division.”

While the problems related to complicated projects, “aren’t these the people who handle complicated contracts,” he said. The problems at Fletcher Construction may also point to industry-wide issues, given the recent performance of Metro Performance Glass and Opus International.

“We may be seeing cracks in the whole New Zealand construction story,” Richardson said.

Fletcher said today that the major unidentified project represented about half of the earnings downgrade while another major project has attracted provisions for losses due to significantly higher costs needed to complete it, and a number of smaller jobs also faced lower earnings.

One of the projects was expected to be completed within the next few months and the other has a target date for the 2019 financial year. Fletcher said the main problems were in the complexity of design, subcontractor management and building programme delivery, which delayed the projects and led to higher costs.

As a result, Fletcher has appointed a chief operating officer and a new head of risk and governance for the construction division, while a new general manager of the B&I unit will start soon.

Asked whether there was scope for a claim against other parties involved in the loss-making project, Adamson said there was “no doubt the board and I are preparing for (those) conversations. We’re not taking this lightly.”

As one of the country’s biggest building firms, Fletcher participates in many major development projects.

All but one of its major projects underway in B&I were either a “fixed price lump sum” or “guaranteed maximum price” contract, which was standard practice in the commercial construction industry, it said today.

The company said growth in the B&I business wasn’t driven by a deliberate strategy to boost volume growth for its building products division, which traded with the construction division on an arm’s length basis.

Other major construction projects include Auckland’s convention centre and Hobson Street hotel, a $700 million contract, the $425 million Commercial Bay development in Auckland for Precinct Properties, and roading work including the Waterview Connection, and Puhoi to Warkworth.

(BusinessDesk)

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