The Performance of Construction Index (PCI) fell to 43.3 in October 2022 – the fifth consecutive month below 50, indicating that the industry remains in contraction. On the positive side, supply side constraints are easing, with higher supplier deliveries and capacity utilisation stabilising.
According to the Ai Group PCI Report for October 2022, new orders declined particularly in housing, commercial and engineering, attributed to the fears of an economic slowdown, rising interest rates and builders becoming increasingly selective on the projects they take on. Supply side conditions are improving, with input price growth in October 2022 slowing to its lowest result since February 2021, and supplier deliveries recording its first month of growth since May 2021 (seasonally adjusted). The report disclosed that capacity utilisation stabilised in October 2022 with fewer hours lost to illness, a positive sign that the recent labour pressures are easing.
As supply side pressures ease and costs of finance increase, management teams are increasingly looking at their cash and working capital management to build resilience. Our recent Working Capital Survey of over 300 Managing Directors, CEOs, and CFOs found that 48% of industry respondents were concerned about liquidity pressure in the next twelve months.
The recently published McGrathNicol Advisory Working Capital Report for 2022 of ASX-listed construction and engineering companies, found that 58% of operators exhibited a structural funding gap in their working capital cycle where they paid suppliers more quickly than they received payment from customers. Overall, average Days Working Capital (DWC) in the sector increased by 6.3 days to 47.9 days in 2022, tying up an additional $649 million in cash within the sampled companies.
The increase was attributable to an increase in that structural funding gap. On average customers took longer to pay, with Average Days Sales Outstanding (DSO) increasing from 63.1 to 71.4 days. Our survey found that 46% of respondents had recently agreed to longer customer terms. In contrast, operators were only able to stretch their own supplier payments (DPO) terms by 1.9 days.
There are active discussions between industry and government on the structural funding gap and the resulting pressure on liquidity within the sector. Construction industry insolvencies have increased both in aggregate and as a proportion of total insolvencies, with 26% of business failures in FY22 being construction businesses. Options currently being discussed include increasing payment frequency, simplifying claims processes, requiring head contractors to hold funds on trust for subcontractors and increasing bid cost reimbursements.
These discussions are a positive step towards a more stable industry, although any substantive change will likely take time. In the meantime, we would recommend management teams focus on ensuring strong cash and working capital management to build resilience and competitive advantage.