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Executives

Steve Marshall – Executive Chairman

Duncan Magrath – CFO

Nick Pollard – CEO, UK Construction

Analysts

Will Morgan – Goldman Sachs

Howard Seymour – Numis Securities

Olivia Peters – Royal Bank of Canada

Mark Howson – Canaccord

Kevin Cammack – Cenkos

Andrew Gibb – Investec

Alastair Stewart – Westhouse Securities

Stephen Rawlinson – Whitman Howard

Balfour Beatty (OTC:BAFBF) Q2 2014 Earnings Conference Call August 11, 2014 4:00 AM ET

Steve Marshall

Good morning everybody and thanks for attending this morning’s call at short notice. I’m going to start with the decision to reject Carillion's merger proposal, the sale process for Parsons Brinckerhoff and then move on to group priorities. Duncan is then going to cover the interims and then about progress in Construction Services UK

We will aim to be as crisp as possible so that we can provide you with the full opportunity for questions and we also be available later on. We have brought forward our interim results announcement schedule for this Wednesday to coincide with this morning statement on the rejection of Carillion merger proposal.

We judged this appropriate in the circumstances so apologies that we’re not able to actually present that to you in person today. I’m required to make some regulatory health warnings. We are still in an offer period until the 21st of August and until then the code restricts our ability to provide forward-looking information unless it has been reported on by accountants or approved by the panel.

There are other restrictions such as a confidentiality agreement that prevent us going into details of the merger discussions. That said as always we will do our very best to provide as much information to you as possible.

A case in point is our revised Investments Director’s valuation which as you know we had intended to provide to alongside today’s interim results. The information is ready to announce but we’re not now permitted to do so without the benefit of an independent valuation. This wasn’t practicable at such short notice. So we intend to publish this information as soon as we can.

More generally the group’s executive team is now working hard on a limited number of very clearly set out priorities, as Nick Pollard will illustrate shortly, we believe we are taking an optimal approach to restoring value in our UK construction business and as we will explain for the group as a whole.

And today we have published a fairly detailed summary of events to assist the market in understanding why the Board has taken this decision in the interest of the company and of its shareholders. I will now turn to the Carillion discussions. These were entered into for the right reasons, because we perceived an opportunity to enhance shareholder value.

The proposal has also been rejected for the right reasons because in the Board’s judgment the risks involved are significant. We have announced the original terms we negotiated with the Carillion over some weeks prior to our agreement to engage. Also the revised proposal received from them more recently which does not materially address the fundamental concerns that we have.

As you will appreciate the timing of the original approach was less than ideal. We had a large M&A transaction in flight and of course an interim executive structure. To mitigate these risks we negotiated upfront terms that we regarded as beneficial to Balfour Beatty shareholders and the explicit support for the PB sale that we relied upon.

Aborting the sale of the PB business at this late stage would create a number of significant risks. No strategic logic has been advanced for its retention and it cannot make sense to so obviously warehouse a major people business simply to enhance profitability without a strategy for it and whilst the global professional services sector rapidly consolidates around it.

The value risk to Balfour Beatty shareholders from a failed auction or from the merger subsequently failing to proceed has been largely unaddressed in this revised proposal. The Board also judges that there are very substantial, financial and operational risks. We’re not at liberty to comment in detail on the combined business plan that was proposed and so I will talk in general terms. To achieve bankable synergies while substantially downsizing a very large UK construction business is very challenging. As you run out the project base and reduce revenues the underlying level of cost you’ve to remove is very significant and that is before you even get to bankable synergies. In addition there would be increased restructuring cost and cash and working capital outflows.

Balfour Beatty believes that such an approach would create unacceptable operational and financial risks. Our own more measured alternative approach is well underway and Nick will cover it. And in a progressively recovering market we believe it will be value maximizing with a manageable cash flow and risk profile as we implement it.

Furthermore the cost savings achieved will be a 100% for the benefit of Balfour Beatty shareholders and will support a progressive return to peer group margins in a larger UK construction business.

And finally if discussions had continued there was a detailed mutual due diligence process still to be undertaken. Firstly you did not likely expose your entire business to a competitor and then potentially to any other legitimate bidder you might present themselves if you’ve serious reservations about the transaction and it's deliverability.

Secondly although Carillion were keen to accelerate the announcement date to the 28th of August, the Balfour Beatty judged that there was a risk this might not be achieved. Not leased given our own due diligence requirements of Carillion. Accordingly there was a significant risk that the PB sale process would have failed ahead of any transaction outcome.

I’m turning to the Parsons Brinckerhoff sale process, notwithstanding the unhelpful publicity the process is moving ahead well and in-line with the Board’s expectations. Strong competitive interest is being maintained. Indeed round 3 bids are expected very shortly. As you know M&A transactions aren’t bankable until they are signed but the process is now well advanced.

At the point of announcing a transaction and not lease the sale price itself the Board will set out it's thinking on the application of proceeds. This will result in a beneficial outcome for all key stakeholders and that’s to say shareholders, funders and the UK pension plan.

However it's anticipated that we will return up to £200 million to our shareholders. As a Board we will also consider the implications of the disposal on the dividend. This is likely to be reassessed at year end and as we have consistently said our prudent approach to the group balance sheet will be retained. We will also assess what is a sustainable and appropriate level of ongoing dividend cover given that the characteristics of the new Balfour Beatty once Parsons Brinckerhoff is sold.

Overall we believe that concluding a successful PB sale transaction at full value will result in a beneficial outcome for all key stakeholders. Now to the key group priorities for the balance of the current year.

As I’ve said many times the Board is committed to restoring shareholder value. For any business, broad success in your chosen markets in Paramount. If you lack the managerial all financial resources to credibly achieve your strategic ambitions in other words if you’re spread too thin something normally has to give. To address the group is being refocused and simplified.

We intend to conclude the PB sale process, our otherwise tightening the geographic footprint and improving the risk profile of the group and group wide our bidding disciplines have been strengthened where necessary.

As this simplification process proceeds over the coming months there will be new opportunities for further indirect overhead and shared service efficiencies to be achieved.

A few comments on our UK construction turn around. We see a managed rather than dramatic overall downsizing and we do see a place for a profitable regional business within the portfolio.

As you know only too well the CSUK business has recently been subject to reorganization. The healing process is underway but certainly not complete. It has a full systems migration this autumn to get all parts of that UK business on to a common ERP platform. The investment has largely been made; the benefits are to come in future years.

Our targeted approach will limit operational risk and reduce working capital and restructuring cash outflows as a result. There is no reason why we cannot return to peer group margins. All of that said it is very important to be consistent and to not overreach. It remains the case that the legacy contract portfolio is being worked through and so some short term risks still remain.

Nick Pollard will shortly provide you with the more detailed update on the CSUK business.

The search is well underway to recruit a Top Flight Group Chief Executive to drive the group’s recovery and that is clearly a Board priority. He or she will also develop a longer term strategy around the core of a post-PB Balfour Beatty group. The core is our strong Anglo-American construction and specialist services presence with significant U.S. market opportunity and UK market margin recovery potential. And in investments business that is value creating and synergistic.

The Group will retain it's Far East and Middle East joint venture investments to the extent that it judges they continue to be value accretive. So our intention is to provide an incoming Chief Executive with a more focused, simplified and substantially derisked Balfour Beatty Group and with some financial flexibility to take things forward.

The Board is firmly of the view that this approach is in our shareholder’s interest and that it merits their support. Finally back once more to value, the Group will remain open to future value creation opportunities. In considering these it will take into account the executional and transactional risks involved and the significant recovery potential that we see within Balfour Beatty’s businesses.

Now over to Duncan.

Duncan Magrath

Thank you Steve. Good morning everybody. I will keep my comments relatively brief partly because there is little in here that we have not already told you about but also due to the different forum we’re presenting in today. As we highlighted in our recent trading statement, our results for the first six months of the year have again been dominated by the poor performance from our UK construction business which has again massed some good performance elsewhere across the group and in the continuing strengths of our investments business.

For instance over the last 30 months we have generated £309 million of UK proceeds for an average increase over the Director’s valuation of 52%. First let’s look at the headline numbers; at constant currency we have seen a broadly stable picture for both revenue and order book for the first six months of the year. Overall total profits after corporate activities are £37 million down on the £54 million from last year due to the issues within our UK construction business.

Average borrowings for the period and period end both increased over the last year principally due to the reduction in negative working capital. There are three reasons for the working capital movement, firstly, a seasonal unwind that we always get in the first half. Secondly, that underlying reduction in UK construction as expected at the start of the year. Thirdly, high levels of positive working capital in professional services and support services. Finally we have kept the interim dividend in-line with last year at 5.6 pence.

The professional services order book was down 4% at constant currency with stable order book in the U.S. and rest of the world and reductions in the UK. Revenue performance was up 1% at constant currency with a broadly stable performance across all geographies.

Turning now to construction services, here again the overall order book was broadly stable; however reductions in the UK construction order book were offset by increases in the rest of the world principally due to the continuing strength of the Hong Kong market.

The U.S. order book increased slightly at constant currency despite the very strong revenue growth in the period. Revenue grew by 6% at constant currency in the period with a 7% reduction in the UK being offset by a very strong growth of 14% in the U.S. and 25% growth in the rest of the world, in Dubai, Hong Kong and Singapore.

Now let’s give you just a little more color on the U.S. construction business with an update to the slide I showed you back in March. You can see on the left hand side, continuing strength in the order intake with the building business booking more orders in the period than at any time in the last five years. On the right hand side you can see that there has been a slight fall back in the ABI readings and also our book to bill ratio as the revenue ramps up but we remain confident of the continuing growth of our business in this market.

In our civils and rail business the market is less buoyant than the building market although it continues to move towards larger scale projects which should favor our business model.

Turning now to support services, overall the order book was down 4% in the period despite a big jump in the water sector as the AMP6 order cycle comes through into the book. As anticipated the order book in power has been reducing as we work through the large contracts with National Grid.

The transport order book has also come down slightly as we work through to the end of our rail renewal contracts. Revenue was down 5% in the period, declines in power as highlighted back in March and in water coming to the end of their five year cycle outweigh the growth in transport with increase in the local authority work one last year.

Now infrastructure investments, you can see from the slide that we have achieved financial close on six projects since the year-end, five of them at the other side of the Atlantic. We’re also very pleased to win the Aberdeen peripheral road where we were appointed preferred bidder in the period. This demonstrates our ability to continue to feed new projects into the funnel to ensure that whilst we have active disposal program we continue to replenish with new projects.

It's probably worth reminding you of our recent track record on asset disposals. I’m not going to go into detail in this slide and all of this information has been previously published. But just to say that over the last 30 months we have generated 309 million of UK proceeds for an average increase over the Director’s valuation of 52%.

Turning now to our Director’s valuation. As I noted on the previous slide the proceeds we receive for the two assets that’s sold in the first half significantly exceeded our expectations and were 82% of our Director’s valuation. This combined with challenges from investors, analysts and not least the Chairman triggered a much more detailed overview of the investments portfolio in the first half. We have looked at each of our UK concessions and considered the specific discount rates recognized in the maturity and individual risks of the projects.

We have only looked at our UK portfolio as there is more active liquid market against which to benchmark these rates. We have also looked at the underlying cash flows to reflect expected cost savings. Finally we also looked at inflation assumptions although this has the smallest impact of the three elements. Unfortunately as we’re in an offer period in order to publish the valuation we need and independent valuation report but this was not possible to commission and prepare in the time available. We will publish our valuation as soon as we’re able to.

Turning now to the profits by segment, working across the slide from left to right we start with professional services. Performance was in-line with our expectations and with last year we saw reduced losses in Australia and a sequentially better Q2.

We also saw improved profitability in the UK. There have been some delays in both U.S. transportation and U.S. power, although we anticipate both of these recovering by the full year. In construction services as we have previously announced operational issues in the engineering services business has resulted in a very poor performance for the first half and is outweighed a good performance in U.S. construction. In the Middle-East we’re see growth in our Dubai based construction business offset by poorer performance from our M&E business which is consolidating back into Dubai.

As we see strong growth in the order book and revenue in Hong Kong and Singapore profit performance continues to lag as the growth is largely coming from large complex civils projects where our profit-take policy means this will only feed into profit in future years.

Now support services which had a very good performance in the period with good operational delivery across the business of particularly in highways and local authorities’ roads business. We also benefit from the network rail contract which were scheduled at the end of Q1 being extended through to the end of July.

In infrastructure investments performance in terms of both P&L and gains on disposal continues to be very strong. Overall for the group total profits after corporate activities are 37 million which was down on the £54 million from last year.

Turning now to cash flow, the key item on this schedule is working capital outflow of a £191 million, there are a number of different movements within this and therefore it is easiest if I take you through each of those segments in term which I will do on the next slide.

Starting at the top left hand corner you can see the graph of professional services, this has increased in the period partly due to delayed receipts in both the Middle-East and to a lesser extent in the U.S. business but also it's probably a reflection of management stretch whilst they have been managing through the sale process. Clearly a successful sale process will crystalize this working capital into cash which maybe before the year-end.

Turning now to support services where working capital has also increased due to the large contract with National Grid which I’ve previously mentioned. We continue to work with the clients to try and bring this back down to a more normal level. I would anticipate the year-end position for support services being closer to a neutral working capital position.

Looking now at the U.S. construction business you can see that we have been in a reasonably stable pattern now for the last two years with the negative working capital being seasonally lower at the half year and increasing again in the full year. This combined with a continuing growth in revenue well I believe generate a working capital inflow in U.S. construction business in the second half of this year.

Finally turning to construction services UK. In March I told you I anticipate a 60 million outflow in 2014 on an underlying basis. The 60 million represents a reduction in just over 2 percentage points in the negative working capital as a percentage of revenue figure. So you can see about half of this has occurred in the first half. On top of this we’re also seeing a working capital outflow as a result of the revenue decline. We’re likely to see this continue in the second half.

We remain mindful that working capital in the UK could be impacted by a broader utilization or project bank accounts or government legislation but for the time being we see the impact of this on our business as being reasonably limited.

Now to summarize, it has been a difficult first half with poor performance in UK construction but our order book has remained stable and we have seen good performances from a number parts of our business. We have experienced working capital outflow in the first half that are expecting inflows in the second half. We have maintained the dividend at the same level.

Our first half trading and financial performance is in-line with our most recent trading update. The performance of our UK construction business which we believe is recovering remains a work in progress. To give you further details on this I will now hand over to Nick Pollard, CEO of UK Construction. Over to you Nick.

Nick Pollard

Thank you Duncan. Good morning ladies and gentlemen. I would like to run you briefly through some of the journey that Balfour Beatty Construction Services have been on in the UK over the course of the last 12 months or so. The slide you’ve got up in front of you overview indicates the timing and nature of the different stages of work that we have been engaged in to turn around the performance of our regional major projects and engineering services business units. In each case this turnarounds followed a structured phasing and process progressing initially through diagnostics and stabilization then strengthening and monitoring and finally the realigning and improvement of performance, profits, competitiveness, customer relationships, capability and there how.

All of this to drive the business up the competitive curve essentially working to restore our company to the consistent performance and top reputation that we have previously enjoyed. In the regional and major projects business unit the turnaround has pretty well progressed and whilst without any doubt there is much more work to do, there are some clear signs of improvement to share with you.

However as you know from earlier in this year the progress to turnaround the engineering services business is less well advanced. We started work to turnaround that third and last business unit in the last 4 or 5 months after engineering services began showing signs of distress during Q1, 2014.

With the engineering services business we’re now through diagnosis just completing strengthening and have in place monitoring. We’re being stabilizing performance and have begun realignment to the business. But as yet we do not have the unwavering application of process nor the depth of bench strength in the operational team to which we aspire and which together we will remove the volatility of performance.

Turning to the second slide and taking the businesses in turn then, in regional last year the work was mostly diagnosing what was wrong, observing, listening, testing, measuring and then beginning to stabilize that business.

We have put a lot of effort into crafting a plan of action known to our staffers the road ahead. We talked through to secure their buying face to face with our leaders, our managers and employees to a whole series of road shows and workshops. We made sure we communicated and focused on the plan through business reviews, personal incentives and team targets. So we carried our people with us, lifted spirits, secured transparency, escalated problems and began fixing the issues that had damaged business performance in the preceding couple of years.

Bidding disciplines were tightened last year as part of this process including the setting of minimum margin hurdles which we have kept progressively under review as the market moves whilst making sure that the rigor of bidding reviews is significantly improved.

Operational improvements have also been at the heart of gripping the business performance in particular improving the quality of project controls, risk management and governance.

By no means are these all perfect everywhere yet. Some places are blindingly good, whilst others are much slower in implementation and capability. The processes of reviewing and controlling projects inevitably depends upon the experience and skill of the manager conducting the review. So we have been putting a lot of emphasis into training and developing our people, equipping them with the right tools and techniques and making sure that when we appoint someone new whether that’s organically from within the business from external companies it's into the right role in a way that aligns their capabilities, experience and skills to their accountabilities and responsibilities.

To build a single team in Q4, 2013 we realigned our brand to be singularly Balfour Beatty for regional construction and major project works alike. We have appointed a new Managing Director in Q1, 2014 and you may have seen recent announcements to better align and strengthen the regional leadership team towards our future pipeline of work and opportunities.

We have also put in place lead and lag measures and metrics, not only around business performance but around the implementation of our change program. Importantly, those measures and metrics have included a significant amount of work to make sure that we’re thorough in securing customer feedback that we listen to our customers and that we follow through on what we have learned.

We have drawn heavily on the experience of our U.S. colleagues as well as the best of British industry expertise in developing collaborative behaviors. Building trusted relationships with customers and suppliers to secure the best outcomes for each other. We have used their feedback to continually improve our bidding quality as well as our delivery in the field and this brings me to the third point on this slide.

Central to improving and realigning the business has been the strengthening of the governance of bidding. We’re now continually selecting and preferring larger scale contracts particularly those comprising repeat business for customers with whom we have been able to build collaborative relationships and gain a deep understanding of their needs.

By being selective in our bidding we’re reducing exposure to the places sectors and customers with poor quality pipelines. The recent move to trade more selectively in the South-West reflects just this. In future we will direct our time and effort to the areas where we believe there is better quality of profitability to be had. Of course there is no use just winning good quality bids if one doesn’t execute and deliver well. So we have been simultaneously improving operational control introducing tools, techniques and measures that bring visibility and granularity of project performance right in the way through our management structure.

This is important in enabling us to intervene and to place support behind our teams wherever necessary to improve profits. We are connecting a strengthened front line on site with the work that we have been doing to centralize procurements and through that combination leverage relationships with both our global supply chain and local SMEs who are able to bring additional value to regional projects in modest scale.

In construction, though procurement can be global execution of work is always local. On key projects the introduction of visual planning, lean tools and techniques have been providing better control than before and have helped secure some significant project turnarounds and improve margins.

The regional business requires a National Footprint with a local focus. It's founded on strong collaborative relationships with customers and embedded supply chain knowledge bringing the ability to work locally. Its purpose is to profitably deliver infrastructure and buildings of modest scale but in reasonably large volume. In a slowly improving market we have already begun to see an increase in both the scale and quality of profitable opportunities handled by our experienced construction teams.

In a warming market we have limited resource pool, the quality of work and the opportunities are important so as in retaining and developing the very best people in our industry. So turning to the next slide, we’re seeing improvements in our performance and the lead indicator suggest our strategy is starting to work. As we have been more selective in our bidding disciplines the regional business has been moving up in project scale. From June 2013 through to June this year we have already seen a reduction in revenue from live jobs at the smaller end of the market described here as less than £5 million.

My expectation is that that proportion will be around 15% by year-end bringing with it economies in terms of the overhead and supervisory structures as well as in the enabling functions that support all the different sites. As a result of stabilizing and strengthening the business we have also seen a number of unprofitable delivery units reduce.

In June last year, a third of them were in profitable. At the moment it's three units, one-sixth, and the purpose behind the announcements of restructuring in the South-Western London is that by the end of the year our target is that we will be operating 17 local business units rather than 20 and that all of them will be trading profitably.

On the bottom part of this same slide we show our regional bid margin on new orders which you can see is encouragingly being moving upwards as we see the opportunities in the market begin to come through in better quality much more suited to our offering.

So turning to the next slide on the major projects business, the key issue when we reviewed major projects in Q3, 2013 was that the team hadn’t been winning work in the volumes and quality that historically have been the case. This was partly because the market conditions with less major infrastructure schemes coming through in the UK but it was also because our bidding quality had not been successful.

We strengthened the leadership team and our work winning team changed our attitude and behaviors and consequently begun changing our fortunes. We've been more thoughtful, engaging early with and listening to our customers working hard on collaborative behaviors and consequently we’re being more successful.

Our bid focus remains tight. Transport renewable energy, nuclear decommissioning and new build together with special complex projects. Though the turn of the year we also moved a selection of the smaller building projects within major construction across into the regional business where they would be better aligned with the skill sets and capabilities that those types of building works require and where they would provide better continuity of employment for our people.

In winning work we made sure that we’re correctly presenting our considerable credentials in areas which are of rapidly increasingly importance to our customers. The environment truly sustainable business propositions, engagement with local communities, creation of apprenticeships; opportunities for people from disadvantaged backgrounds and by collaborating closely we have been cutting out risk and waste for our customers, ourselves and our supply chain partners.

Although the major infrastructure market maybe set to improve in future years depending of course on government policies and UK economies, we have already seen our order book pick-up by 6% since June 2013 and if we include our ABNC contracts, those awarded but not contracted, then the total has risen by 26% over the same period, albeit from a low base. This is really encouraging. However, we must bear in mind that most of these projects effectively don’t come to book until 2016 at the earliest because of the significant lead time in project procurements and development typically associated with these sectors.

So then this is a business that is in great shape and has the capabilities to compete and win against the best in the world. Designing and constructing the increasingly complex and changing infrastructure necessary for UK Society and our economy to flourish.

Turning to the next slide on the third and smallest business, engineering services, a Tier 2 M&E building services contracting business. Engineering services for the last few months has required intense work reviewing the business top to bottom, diagnosing and then starting to stabilize its performance. We have an intensive management focus to extricate us from those projects which of course there is losses. Through a twin process of performance turnaround and commercial renegotiation.

We’re making steady progress towards a more detailed level of control but we’re certainly not fully out of the woods yet. We have taken a number of steps to strengthen our leadership changing almost the entire executive team, Commercial Director to Regional Director, Finance Director; and introduction of a Chief Operating Officer, the last appointment is the final one which was the announcements of Mark Hoyland, who joins us later this week on the 14th of August as the Managing Director for this business.

We have commenced our withdrawal from geographies and customers that have only a poor quality pipeline and I confirm that we have stopped bidding work for other Tier 1 contracts in London, in the South-East where all of our bidding is now in association with other Balfour Beatty Group companies providing an integrated approach where we can control the design and deploy our skills and facilities in BIM technology and offsite manufacture to add value for customers and ourselves alike.

We have also stopped bidding for M&E work in the South-West, although of course we’re still working there concluding current contractual obligations. Finally and just for the avoidance of any doubt whatsoever, we’re continuing vigorously to pursue engineering services contractual entitlements in relation to a number of the legacy contracts and to recover monies that we believe are fairly due.

Turning to the next slide on the cross divisional masses that support and affect the performance of each of those three business units we have been describing. Overhead in the cost improvement plans are well-established and they have cut some £40 million off CSUK’s overhead over the course of the last couple of years. Nonetheless, although our overhead has fallen in-line with revenue reduction we should be more efficient. Some of the changes has already taken, will help us make that step alongside measures to provide more efficient back office through the Balfour Beatty shared service center.

The implementation of a single ERP platform for CSUK starts live in parts of the business in Q4 this year concluding in Q1, 2015. When that’s completed we will have an enhanced analytical capability in turn providing many more navigational aids, tighter operational controls and helping us to consolidate procurement further.

From my personal perspective we simply need to keep the foot on the gas with all of the measures implemented really make the bite, deliver profits, and at the same time identify and accelerate our work on procurement by engaging more collaboratively with our suppliers to identify and eradicate wasted effort all to the mutual benefit at the bottom line.

We must do more to simplify our business processes, enhance governance and at the same time reduce our business risks. Underpinning all of this is the fundamental fact that the construction industry is still highly dependent upon individual intellect, skills, know-how and perhaps most of all ethics, behavior and belief and thank god engineering is still about people.

There is much to be very proud of in Balfour Beatty’s history. It's what has driven the company’s brand and we need to take care to carry our people with us as we accelerate the pace of the turnaround in the coming 12 months. It's a good sign to be doing all of this for commentators, such as the CPA, note that the market is showing signs of recovery which means that on top of any enhanced profitability from being better there is opportunity gently to move our bid margins up as demand increases. Good people always command a premium.

Now turning to my final conclusion slide, in a nut shell, the road ahead, our performance turnaround plan has being in place since Q3, 2013. Our people understand it, they have bought into it and they have been executing on it. The key points then, developing collaborative customer and supply chain relationships, increasingly more selective and thoughtful bidding, driving operational excellence in delivery, encouraging, developing and retaining the best people. Securing permanent cost base improvement, all of this through a progressive phased approach to reduce business risks and generate profit.

The lead indicators show the plan is working. Our people are committed and engaged. Delivering on these forges the means of navigating safely through the short term risks that remain whilst also bringing the opportunity and potential for our company. Thank you. Steve?

Steve Marshall

Thanks Nick. In conscious of time we’re now going to go straight to questions. Please be kind enough to identify yourself from the firm you represent and as I said recognizing the constraints on us we will do our very best to be open and helpful. If we could go straight in please.

Question-and-Answer Session

Operator

(Operator Instructions). The first question is from the line of Will Morgan from Goldman Sachs in London. Please go ahead, Will.

Will Morgan – Goldman Sachs

I've got four questions if that's okay; some of them are very brief though. First one is you talk about in the event of a sale of PB a £200 million return of capital. Could you just maybe walk us through slightly how you did that math? I just wondered why you were being very specific about £200 million.

Second question is you talk with regards to the Carillion rejection about the risks of achieving synergies, while you were managing down the size of the UK construction business. I just wondered that this is something that presumably you were going to have to do anyway and therefore that is a significant challenge to the Balfour Beatty business standalone. I mean were there plans for an even more aggressive reduction in the event of a merger? I just wondered if you could elaborate a little bit on your point there.

The third question just relates to the UK turnaround. There's obviously a lot of talk about good things here. Just one question I had is, in terms of the monitoring of projects, could you just maybe be specific in terms of what actual reports you got to Board level from the ground level of the projects? And whether you could just give something specific in terms of what kind of reporting change is there in terms of what you see on your desk regularly to monitor the projects that are going on?

And the third question is a very bitty numbers' question. But on I think slide 23 you had some little pie charts at the bottom, which showed the split between the major projects and the regional business, et cetera. It looked like regional was 65% – 70% and maybe 20% major projects. I just wondered if we look back a few years ago when the business was maybe a bit more mid-cycle, I just wondered if that split would have been materially different and if so what it might have looked like vaguely? Thanks very much.

Steve Marshall

All right we will do a combination response to your various questions and Duncan is going to pick up the first one.

Duncan Magrath

Essentially we basically are not going to go into the details of the calculation and clearly what we actually end up doing will be dependent when we got a completed sale transaction but essentially we did look across particularly the individual stakeholders looked at effectively what the strength of balance sheet we needed to retain which is obviously important to our customers and debt providers and surety providers what we needed to pay to the pension fund and what we needed to look to see we could distribute to the shareholders and I guess that’s the methodology we went through.

We obviously looked at forward projections for the company and I think it was important today to give some indicator of the likely or the potential level of return that shareholders could get and so essentially that was why we were giving an indication today although it clearly dependent on an eventual sales transaction.

Steve Marshall

We come on to the second one which was about the correlation between downsizing the business and the level of synergies that are achievable in those circumstances. We will break the response into two parts, because we can obviously talk most fulsomely and eloquently on Balfour Beatty’s plan and I’m going to ask Nick to give you a flavor of that in a second. We can’t comment in detail on the combined business plan of which we were given site of but we have given an example in our comments that the implications of dramatically downsizing a large construction business are significant, that you’ve to first of all outrun the loss of margin if you radically downsize the contract base and only then once you’ve done that with cost reductions would you be in a position to then actually create genuine cost savings that could flow through to value some of which might be true synergies from a combination, others of which Balfour Beatty can achieve for itself a 100% for the account to its shareholders and as also I covered in my remarks clearly if you dramatically downsize the business you end up with a much smaller business that is capable of earning peer group margins.

So that alongside the working capital outflows and one-off restructuring costs implications, the shape of such a plan would for us be pretty high risk but that’s the broad thing. I think Nick it's worth making a few comments about our own plans.

Nick Pollard

Certainly Steve. Thank you. Well morning, the point is there is little point just exploding the whole business. There is a rising market out there and our plan is about a phased staged approach that refocuses our business on the parts of that market where we can make good money and there is no reason to turn our back on the parts of that market where we can make good money. The other point is that to make good money you need to take three communities with you. You need to certainly take your employees with you because that’s where the talent and the skill lies. You must also take your customers and your supply chain with you, because actually the only way to deliver construction is to have that kind of integrated approach.

So from our point of view it's a question of making sure that we make sensible changes that people understand them in those three communities and that we take people with us on that journey but we make the journey as quickly as possible but without causing a necessary collateral damage on the way. So that’s the approach we have taken with us and that’s why we have put so much hard work into communicating the plan and to making sure that we have routine updates for our people on where they are, how they are doing and kind of what’s happening next that kind of culture of no surprises, but moving forwards as quickly as possible. So that's the focus, that’s where we’re headed.

I think you also asked about reporting changes. So whilst I’m kind of on my care if I can just deal with that, the kind of reporting changes for instance we have now got a dashboard that reports at a granular level every single project, every single month. We can see the shift visibly myself, my executive colleagues on the leadership team, CSUK, we can see performance diced and cut by delivery units or by business stream, the nature of contracts, size of contracts and so forth and that capability will be reinforced by the ERP platform that Steve was banging on and I was banging on about earlier on the call, on the former presentations.

So that’s kind of where we’re at. We’re about getting reports in granularity that allow us to analytically understand what’s going on and to be better able to intervene when we start to see anything sliding away at any scale of size.

Steve Marshall

And just to add to what Nick said, the question sort of also talked about visibility at Board level and I do come back to the focus and simplification of the Balfour Beatty. We get to see because Nick is coming along with the Board in some detail, discussing it with us and surfacing data to us, a great deal of information on the journey that those businesses are taking and a much more focused group, less hopping on airplanes and more focusing on those two major businesses that we have is the right way to take Balfour Beatty forward and that way you can be focused on the metrics, the key drivers and on your customers and really understanding your marketplace in conjunction with the guys who are actually running these businesses every day.

And then the pie chart question at the end, Duncan, in terms of how has the mix changed, was the final question I think.

Duncan Magrath

Yes. I think the M&E business will probably hasn’t changed very much. I suspect there has been probably a 10 percentage point shift between the regional business and the major projects business that will be off the top of my head, I don’t actually have the figures in front of me but something of that order.

Operator

The next question is from the line of Howard Seymour from Numis Securities. Please go ahead, Howard.

Howard Seymour – Numis Securities

A couple from me if I may, just starting on one that you mentioned Steve, you mentioned on the key group priorities retaining a profitable regional business on UK construction turnaround, just really the thought process on two aspects. One, major projects within that, because obviously Nick outlined on that a more confident outlook. So why you've specifically said a profitable regional business as opposed to large business; i.e., is major projects potentially non-core? And secondly, I suppose, the same question on rest of world. It was actually a bit better than I thought it would be, I noticed the margins slipped good. What do you need to think about in terms of your rest of the world businesses to decide if they're core or not?

Steve Marshall

Right, let’s start with the first one for the avoidance of any conceivable doubt, major projects is absolutely a core business with Balfour Beatty and Nick has covered the progress that we’re already making in that business but I mentioned that we had site of the combined business plan. I’m not in a position to comment on its contents but clearly our largest business is our regional business, what is it Nick? 1.7 billion turnover something of that nature. So the lion share as the pie chart say and any downsizing proposal would clearly significantly take the size of that business into account. It is a business that in terms of where we play and which markets and which segments within the UK, Nick is actively reviewing and he has already made changes as he set out. But underneath it all there is a viable profitable business that is capable of making return progress to peer group margins and that is in Balfour Beatty shareholders interest to retain that, we shape it and trade forward with it.

I was just going to address the second part, I mean if you make an assumption of a post-Parsons Brinckerhoff/Balfour Beatty, in practice, outside UK and North America our principal whilst the rest of the world operations are our two joint ventures, neither of which we manage although in different ways we contribute to them, i.e., Gammon in the Far East, and our Middle East JVs and the purpose of the comment I made up front was merely to signal that they are not a strategically core as our Anglo-American construction presence and the investment business that overarches it but we’re perfectly comfortable holders of those investments providing as in all other areas of the business, we see the ability for them to be value accretive overtime. So that remains our position.

Howard Seymour – Numis Securities

Can I just ask you a quick question on the infrastructure as well? As you allude to in the interim statement, there was a fair value gain of £15 million on policies you've mentioned it before. Just really asking, Duncan, if it's possible to clarify whether you'd see a similar amount of benefit on fair value gain, in the second half in the infrastructure investments?

Duncan Magrath

It's difficult for me to make any forward-looking statements in terms of the -- if I can just perhaps say that the fair value gain came off the revision of the cash flows that we did in the first half that’s something that we would be doing every year but not necessarily twice a year.

Operator

We now have a question from the line of Olivia Peters from Royal Bank of Canada. Please go ahead.

Olivia Peters – Royal Bank of Canada

Just three questions, please. I just wanted to try and get a sense of what the underlying UK construction margin was, excluding the issues that you had in the engineering business or to put it differently maybe, where do you see peer margins at, at the moment? I'm just trying to get a sense of where you're going to.

Secondly, on your average net debt guidance of £375 million, I mean given the working capital outflow in the first half and the fact that you're expecting a second half inflow, are you still comfortable with that guidance? And then just lastly, Nick, you said that you could improve the cost base in the UK construction business. I was just wondering if you could quantify what those future cost savings may potentially be. Thank you.

Duncan Magrath

Olivia, perhaps I will deal with all three of those. Unfortunately two of them have forward-looking questions in them, I’m not going to be able to deal with particularly around the margins and the cost base one in terms of the average net debt I think I’m probably on the safer ground in terms of the expectation there.

If you look at the average net debt we were up 424 for the first half, the average net debt for Q2 was just over 500 and I would expect that to remain around about that level for Q3 and Q4. We will see a working capital inflow in the second half. We do have two dividend payments that go out in the second half. The other thing that I probably should have highlighted is that 55 million of our disposal proceeds wasn’t received until the day after the half year cut off so that fell into the second half cash flow.

So if you put all that together then the average net debt will be higher than the 375 which was where we were towards the beginning of the year. It will be closer to around about 450 for the year as a whole.

Steve Marshall

Olivia we can’t give you any numbers on it but if you look on page 8 of the presentation it talked about areas I mean like procurements and shared service efficiencies, and ERP platforms that I think can give you some idea of where some of those savings come from and on the earlier slides we have indicated we’re moving away from the smaller jobs, it's just above 5 million and obviously that affects as I said in my talk, that affects supervisory and enabling function overheads behind that. I think you got to draw your own conclusions from that I’m afraid.

Operator

And I’ve a question from the line of Mark Howson from Canaccord in London. Please go ahead, Mark.

Mark Howson – Canaccord

Can I start on support services? Obviously, the working capital became a bit of an issue; larger than expected in the first half. Can you just talk about what's going on there, particularly with National Grid? None of your peers have been working with National Grid, so some of the terms are getting paid. It's one thing recognizing profits, but actually, it's another thing getting the cash in against that, are quite onerous. Can you just say -- you mentioned earlier I think in the slide pack, what you would do -- you're doing things to try and improve things with the client. Can you just say what that's involving please?

Duncan Magrath

Yes, so this is a contract that we signed in the middle of last year, Mark. We highlighted at the time that there was going to be a significant level of positive working capital associated with the projects which was priced into our bid so there is -- it was contractual. We agreed to those terms and so it's agreed on both sides. What actually happened was that actually a lot more work came through in bigger packages last year and the way the mechanism worked is we ended up having more working capital than we anticipated. National Grid understood that and helped us which is why towards the end of the year the negative working capital came down again because effectively it wasn’t operating as both sides intended.

Where we’re at the start of this year is we’re sort of back in the same process again and I’m sure we can continue to have a constructive dialogue to make sure that we get back into a good space by the end of the year.

Operator

Next question is from the line of Kevin Cammack from Cenkos in London. Please go ahead, Kevin.

Kevin Cammack – Cenkos

I've got three, but I suspect two of them probably fall foul of what you're allowed to say. But I'd be pleased to know if, even in the round, there was anything stopping you maintaining the forecast that you made for the full year, in terms of the range of profitability, firstly.

Secondly, again I guess this is probably difficult. But given the underlying movement that you've seen in the cash, the net debt, in a post-Parsons Brinckerhoff and assuming the ballpark proceeds are the right amount, give or take even £100 million, going forward and with the repayment of some of that cash to the banks, is there any sense that the banks are seeking a further reduction in the ongoing level of debt, that a post-Parsons/Balfour Beatty, would be -- they would be tolerant of in that structure?

My last question in way is, if I was a shareholder in Balfour, is one of the things going forward that might perhaps disturb me is the commitment, in a sense of the Executive, given the arrangements that were agreed and detailed in your merger discussions that effectively, Chairman, CEO, and FD would all be nominated by Carillion. I just would feel -- what can you comfort people by saying in terms of an independent Balfour going forward. Obviously, I understand the CEO role, that speaks for itself. But what, generally, can you -- how can you comfort shareholders that there is an absolute commitment by the Board to see through a successful recovery of the Group?

Steve Marshall

I will pick up the first two of your questions, you’re absolutely right I’m going to struggle to answer your first question I will just point you to the statement which basically says that trading in the first half was in-line with our recently trading update. In terms of the second point about underlying cash, I think the question from my perspective is how we wish to run the group’s balance sheet and what is a sensible arrangement for that and effectively what we have talked about earlier was very much looking at how we would see the world. I have not had any conversations with banks that are for them seeking to put any question mark or pressure on us at all. So it's very much what I’m talking about today is how I think we should be running the group’s balance sheet going forward. I will hand the question over to Steve in terms of the third one.

Steve Marshall

Yes I think it's very sensible and reasonable question and I think in responding to it, the first thing to do is to go back to the approach to the Board during the month and more that we had discussions with Carillion before actually agreeing to engage and as you’ve seen we have published the general terms that we have agreed with it between the two Boards before we agreed to engage and if you look at the key elements of that the view that the Board took and I come back to the commitment to restoring value that it talked about in my remarks, the view the board took was that this was somewhat of an approach with take over characteristics attached to it but frankly without a check book to match. So the view that the Board took was that the negotiating very firmly indeed in terms of the share of a combined that our shareholders would own was an absolutely key priority.

Negotiating a clear understanding on the disposal of the Parsons Brinckerhoff and, at Carillion’s request the retention of those proceeds in the combined group was something we have spent a lot of time on it was clear as we engage in those discussions that there was a very strong priority within Carillion to occupy those top Board slots and in the round given as you have mentioned we don’t have continuing Chief Executive at this point. We took as a Board a very pragmatic decision that if we focus the discussion around value and all of the other things that be needed to do to preserve value, such as the PB disposal, then, as a balanced package it could well be in shareholders’ interest.

The issue however clearly is that a merger combination you’ve to be very mindful of an obligation to be able to recommend the entire package deal shareholders and we have talked about that piece elsewhere but the reason I go through that is the agreement to those top three slots in Carillion’s favor was part of that package of discussions, it does not in any way reflect a lack of ongoing commitment from the current Balfour Beatty team or the Board to take this group forward. Quite the reverse, having got to where we have got to, there is a vigorous sense that we want to now take the group forward, clearly recruiting a top flight group of Chief Executive is important but the although the likes of Duncan and myself are principally visible to investors.

What you don’t see but Nick is with us today, is a very strong top-team of divisional heads in the executive committee that currently reports to me who are totally committed, totally running their businesses and each with plans to take those businesses so forward. So it's actually a strong bench that is committed and we need to get our Chief Executive recruited which we’re very focused on and there are plenty of top-flight people who want to come along and talk to Balfour Beatty. That is clear. So that’s the context if that helps.

Operator

We now have a question from the line of Andrew Gibb from Investec in London. Please go ahead, Andrew.

Andrew Gibb – Investec

Just a couple from me, just wanted to check on, clearly with the Italy rail business putting -- discontinued, because you think you'll get it sold within the next 12 months and clearly where you are in the process on Parsons Brinckerhoff, could you just talk to me about thinking about not putting Parsons through the discontinued line at this stage, please?

Duncan Magrath

I mean it is a judgment call, I think the fundamental difference between the two is that the PB disposal is subject to shareholder consent and the Italy disposal isn't and fundamentally that was what changed -- made our view that it would keep it in continuing. Clearly we would like to carry on so hopefully very quickly it will be in discontinued.

Andrew Gibb – Investec

And just on the point, really going back to Kevin's point around the balance sheet, you mentioned in terms of the update on sales of Parsons about the satisfying the interest of shareholders, pension fund and debt providers. On the debt-provider point is it very much that's just the Board's view on how the balance sheet needs to look, rather than banks or surety providers putting some pressure on how the balance sheet needs to look.

Duncan Magrath

I will repeat what I said last time it's absolutely the Board’s view of how we should run a sensible balance sheet.

Andrew Gibb – Investec

Okay. And just finally maybe one for Nick, just looking at the mix in terms of the construction business UK as it stands, I appreciate it's got to go forwards comments where you're at, at the moment. But in terms of the split, is that how you see the mix going forwards? Or do you think there will be some sort of variances around that?

Nick Pollard

Andrew I think it depends entirely as the market shapes up, If a new government after an election came forwards with a huge package of infrastructure investments, our major products business would leap forwards into the breach, because that's where they're predominantly focused. If nuclear power suddenly advanced quickly equally they would be straight in there. On the other hand if it turns out that the UK invest in local infrastructure through local authorities and schools and small roads and things of that nature. It will be the regional business that addresses it. So it's a question of playing to our strengthens and we value that although we talk about them on calls like this as if they are two separate businesses and they are not. They sit underneath my command and that’s why we change the branding so that everyone is smelt, felt, and looked like Balfour Beatty. So we'll move our resources as we said in the presentation to where customers people and supply chains align, those have always been all my career the three tenets of good profitable, stable construction. And that’s the method we will adopt, so it will depend on the market is the answer.

Operator

I have a question now from Alastair Stewart from Westhouse Securities in London.

Alastair Stewart – Westhouse Securities

Two questions, one on the PPP disposals and then the second on average net debt. On slide 16, you've got a progressively better overshoot in terms of the Directors' valuation, 25% for the 2012 disposals, 54% for last year and 82% for this year. Apart from the roads ones in 2013, they all seem to be similar to the UK schools and hospitals. Is that progression the result of an improvement in the underlying market and discount rates dropping? Or is it the latest ones have been better, in terms of maturity or quality of assets? That's the first question.

Duncan Magrath

Yes, I think inevitably it will be a combination of things. I don’t think there is a significant difference in the quality of assets. I think there are it remains a strong market and I think people as the market has matured people have a better sense of what things are worth and what they are prepared to pay for things as it's gone forward. So I think it's more of a function of that than it is anything else.

Alastair Stewart – Westhouse Securities

Fine. The second question -- well, one question and a couple of clarifications on the average net debt; does the £424 million average net debt in the first half include the cash from the discontinuing, I presume it's rail businesses, as is the case on the front page of the actual release? And looking at note 9, I think it's the cash is net of debt -- net of borrowing is £23 million. Is £23 million equate with the average net debt for those businesses? Basically, does that -- will the average net debt position be worse once the rail businesses go? And then it's just a couple of clarifications, I've got a crackly line, but if you could do that first.

Duncan Magrath

I don’t think it's going to make a huge difference because obviously when they go we will receive cash for them, so I think it's broadly a neutral answer.

Alastair Stewart – Westhouse Securities

So, basically, the disposal price will be, basically the cash in the business?

Duncan Magrath

Broadly, I mean without going into the details on the individual ones but I don’t think it's going to make a dramatic difference to our net debt position.

Alastair Stewart – Westhouse Securities

Sure. And finally just the clarifications, I've got a bit of a crackly line. I didn't hear how much disposal proceeds had been picked up just after the half-year end. And then did you say that the average net debt for Q3 and Q4 or was it Q2 and Q3 would be just over 500 million?

Duncan Magrath

So it's £55 million is the proceeds that was received one day after the half year and in terms of the average net debt it was just over 500 million in Q2 and I’m expecting a similar level for Q3, Q4, i.e., basically staying roughly at the same level as it was in Q2.

Operator

The next question is coming from Stephen Rawlinson from Whitman Howard.

Stephen Rawlinson – Whitman Howard

Firstly have you consulted the debt providers regarding the use of proceeds from the sale? Secondly how much is the payment to the pension funds expected to be if 200 million is to be given back to shareholders? And thirdly, Nick mentioned on one of his slides that designing major projects is an activity, why is this mentioned if Parsons Brinckerhoff is being sold?

Duncan Magrath

I will deal with the first two. I mean in terms of -- we have had no formal discussions with banks but clearly we have conversations with banks all the time in terms of how we might utilize proceeds and in terms of the pension fund there is an automatic mechanism which essentially works out that they would broadly get about 42% of any return of capital to shareholders would and 42% would be the automatic payment into the pension fund.

Steve Marshall

Yes and in relation to the designing, construction of major projects, I know it's typically how customers buy it, they buy it as a package. It's not one or the other. Sometimes the customers appoint their own designer and we pick them up in the course of taking on the work at bid and at other times we team with the most relevant designer and that’s not necessarily PB. We have got JVs running in this country with Mott MacDonald, with Atkins and with others and we select the most appropriate partner that'll make us most competitive at bid. So it as simple as that, it's just a factual statement and we’re quite agnostic as to whom we use as long as they are the best.

Operator

(Operator Instructions).

Steve Marshall

Okay, well if there are no further questions, can I just thank everybody for participating and just to underline the fact we will be available and very happy to interact later on and during the course of the week. Thank you very much.

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