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The bandwagon of good news rolls on through the construction industry, the stream of positive announcements tempered only by some niggling indications that the sector鈥檚 recovery may have paused for breath in the past few months.

For example, the total value of commercial and retail construction contracts awarded in August 2014 almost doubled compared to the same month in 2013, according to data gathered by Barbour ABI. And this was within an overall rise of 17% for all types of construction.

According to the Office for National Statistics, construction output in July 2014 was 2.6% higher year-on-year, although static against the previous month. The buoyant residential sector saw housing starts grow by 18% year-on-year in Q2 2014, but again they were static by comparison with the previous quarter.

Sector Comparisons

Encouragingly, tender prices seem to be rising, with 58% of contractors reporting higher values in Q2 2014 according to the latest 91黑料网 Trade Survey. The bad news is that costs are also rising and almost certainly much faster than tender prices. In the same survey, 95% of contractors said their material costs were rising and 75% experienced increased labour costs. Rising labour costs will come as no surprise to anyone, as there has been widespread concern about severe labour shortages. Also widely anticipated was the 6% yearon- year rise for Q2 2014 in overall costs revealed by the Output Price Index published last month by the Department of Business Innovation & Skills. Rates for sub-contractors in August rose to a seven-year high, indicating that profit margins are increasing to the detriment of larger contractors, a fact which may soon translate into even thinner margins for the bigger players.

But how are these conflicting factors affecting the UK M&E market? The Company Watch data on the financial profile of UK鈥檚 largest M&E contractors reveal a financial profile which has seen a sharp deterioration in many key measures in the past year.

The research covers those companies with annual turnover greater than 拢50m that describe their business activity at Companies House as being in the 鈥渆lectrical, plumbing and other construction installation鈥� field 鈥� which effectively equates to all mechanical and electrical contracting. The sample comprises 45 companies in all. Profit margins have halved from last year鈥檚 paltry 2% to an unacceptably threadbare 1%. This is the worst performance of any individual sub-sector we have looked at over the past twelve months. It means that the average contractor in our sample is making a profit of only 拢2.7m on turnover of 拢266m. These companies may have combined profits of 拢120m between them but they are utilising total resources of just under 拢6bn and borrowing 拢370m to achieve that outcome. The return on capital is just 6.7%, which is not exactly a risk/reward ratio appropriate for a key part of one of the most important industries in the UK economy. Nevertheless, with leverage still a hot topic in many other industries, such as retail and care homes, nobody could accuse M&E contractors of being debt junkies. On average, they borrow just 7% of their net worth, compared to gearing ratios of 78% for plant hirers, 51% for scaffolders and 39% for demolition contractors.

Sixty percent of them have no debt at all in their latest balance sheets, although in some cases these are subsidiaries within groups where debt is held elsewhere in the corporate structure. Even so, this is conservative by modern commercial standards.

As with other construction businesses, this low level of borrowing is probably driven by the banking industry鈥檚 own much-reduced appetite to lend to such a low-margin sector. It may also mean that activity levels are still generally too low to require outside finance for working capital.

Turning to the overall financial health of our major M&E contractors, they are a picture of relative positivity, although slightly less so than a year ago. The average H-score (see left) of the 45 M&E contractors in our sample is 52 (down two points from 54 this time last year) which beats the norm of 49 for all UK companies of similar size. This ranks them fifth equal among the eight construction sub-sectors we have analysed, along with commercial building contractors.

Mechanical & Electrical Contractors

Road builders, utility & water contractors, plant hirers and scaffolders score better; demolition contractors and house builders do less well on this measure (but this reflects the historic nature of the published data and will undoubtedly improve as the Help to Buy housing bonanza feeds through into annual accounts published this year). The even better news is that only four (9%) of the M&E contractors in our sample are in the Company Watch warning area, an improvement from six (12.5%) last year. Across the economy as a whole, the expectation would be that around 25% of any sample would be in this financial twilight zone.

In fact, 53% of the sample have H-Scores of 51 and above, compared to around 50% for all UK companies. Last year there were 60% in these two upper quartiles. Drilling down in more detail to potentially adverse financial characteristics, there are only four (2013: two) contractors with negative net worth and 11 (2013: 5) are loss-making. Inevitably, all but four of these companies are in the bottom ten of our health score league table.

The results of our research show a mixed picture of sharply declining profitability and margins close to crisis levels; but the overall financial health remains acceptable, even if it is declining. However, it is worth emphasising, as we have consistently for the past year, that our figures cover only the big boys of a hugely diverse M&E world, populated by thousands of smaller, undercapitalized players.

The bulk of these smaller businesses are inherently less strong financially and too often the victims of the supply chain squeeze and late payment culture, which remain the curses of the industry. For them, the position will be far more precarious. There is much talk among construction commentators about a growing resistance to absurd pricing models driven by excessive competition and aimed at winning work for its own sake, no matter what the bottomline consequences might be. We must all hope that this welcome trend is reinforced in the year ahead and that in another year鈥檚 time we are reporting a far more robust profit picture in this and every other part of the construction world.

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