**2nd UPDATE: Balfour Beatty Reveals Extent Of Turnaround That’s Needed **
LONDON (Alliance News) – Balfour Beatty PLC’s new chief executive Thursday admitted he has a lot of work to do to turn around the business after it cut expected 2014 profits from its UK construction business by a further GBP70 million following a review of the business, whilst raising its own valuation of its public-private partnership portfolio to GBP1.30 billion in the wake of a recent acquisition approach.
Balfour’s shares fell by a third in 2014, after it issued a string of profit warnings and in September initiated a review of its UK construction services business which has come under pressure after getting locked into unprofitable contracts. The review was undertaken by KPMG.
Its struggles prompted a takeover attempt by rival Carillion PLC last year, but that fell apart when Balfour refused to halt the sale of its Parsons Brinckerhoff US asset management arm, which it sold for GBP820 million in cash to WSP Global inc in October.
In December, Balfour then rejected a bid from John Laing Infrastructure Fund Ltd for its PPP portfolio, saying the GBP1 billion offer undervalued the assets. Balfour said at that time that its director’s valuation of the PPP portfolio was GBP1.05 billion at June 28, but said it believed the realisable value of the portfolio to be “substantially in excess” of this valuation.
However, a deal to sell the PPP assets would give new Chief Executive Leo Quinn the firepower to turn around the rest of Balfour’s business, analysts said at the time.
In its statement Thursday, the company said the director’s valuation of the PPP portfolio stood at GBP1.30 billion as of December 31, 2014. It said the figure tallies with an independent valuation undertaken by KPMG.
“The principal drivers of the increase in valuation are lower discount rates and revised cash flow assumptions on the UK portfolio and improved cash flow assumptions on the North American portfolio,” Balfour said.
KPMG’s review of the UK construction business, meanwhile, found that Balfour had been tendering for contracts with very low margins whilst at the same time under-estimating the costs and risks involved. The company had then failed to sufficiently review and manage the contracts, and didn’t have any visibility, control or understanding on actual contract performance compared with the reported 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 said.
It said the GBP70 million further reduction in UK construction profits for 2014 is made up of GBP20 million relating to the difference between reported contract positions last August and KPMG’s assessment of the actual position at that time, and GBP50 million for the deterioration in project performance up to the end of 2014.
“In addition, as recommended, the board will assess the overall level of contract risk provisions in the UK construction business in light of the operational issues identified and will announce the outcome at the full year results in March,” Balfour said
Balfour had already cut its 2014 UK construction arm profit forecast by GBP75 million at the end of September, by GBP35 million in July, and GBP30 million in May.
The company said it will continue to simplify the UK construction business, stripping out layers of management. It said Quinn would also oversee a programme to strengthen its bid approval and project delivery review processes, change the culture of the business, boost its leadership and align all staff grade incentives with programme targets, and establish a standard reporting system to increase transparency.
In order to shore up its balance sheet, Balfour Beatty said it will cancel its proposed share buyback of up to GBP200 million and will also review its dividend policy in March when it puts out its full-year results.
The company’s struggles have been exacerbated by a big change in management and its board. Earlier this week it poached Phil Harrison from corporate services company Hogg Robinson Group PLC to become its new finance director, but it is still seeking a new chairman. Former Chief Executive Andrew McNaughton stepped down last May and Duncan Magrath, who Harrison replaces, said in November that he would step down after a replacement was found.
Non-executive directors Belinda Richards and Bill Thomas also both resigned from their positions on Balfour’s board last November.
“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,” Quinn said Thursday.
Balfour also said Thursday that trading in the rest of its business hasn’t changed since its last gave a trading update in November. It said its mechanical and engineering joint venture in the Middle East continues to operate in challenging markets, whilst the highways maintenance business in its support services unit has performed strongly.
It expects its year-end order book to be slightly lower than the third quarter when it stood at GBP11.7 billion. It said it ended 2014 with a net cash balance of approximately GBP180 million.
Balfour Beatty shares were up 0.6% at 206.90 pence Thursday morning, having dropped sharply at the open.
Liberum said it expects Balfour to cut its dividend in March, and it noted that investors are going to have to wait until then to hear about the additional contract risk provisions “which could be significant”.
However, the broker, which has a Buy rating on the stock, still thinks it’s a recovery play for investors.
“Carillion are free to return in a month and JLIF have already made a GBP1.0 billion approach for Balfour Beatty’s PFI portfolio which helps to underpin the valuation. This may not be the cleansing statement investors had hoped for but there is as much recovery potential as ever and buyers will be watching closely,” Liberum wrote in a note to clients.
By Steve McGrath; firstname.lastname@example.org; @stevemcgrath1
Copyright 2015 Alliance News Limited. All Rights Reserved.