Balfour Beatty has today announced that profits in its UK construction business will be reduced by a further £70 million following the findings from the review of the business by KPMG.

The infrastructure group also published a trading update in advance of the Group’s full year results in March alongside the KPMG findings, together with an updated valuation of the Investments Portfolio - the Directors’ Valuation of the existing Investments Portfolio has increased to £1,300 million.

However, Balfour Beaaty said that against the backdrop of current earnings and in order to maintain balance sheet strength during the Group’s transformation, the proposed share buyback of up to £200 million is being cancelled, and the dividend policy will be reviewed at the time of the full year results in March. At the same time the Group will re‐engage with the Pension Trustees on the pending pension deficit payment.

The summary KPMG findings were presented to, and considered by, the Board last night.

Excluding the impact of the KPMG findings in Construction Services UK, there has been no net material change in underlying trading across the Group as a whole, since the last trading update on  November 2014.

As a result of the KPMG review and recommendations the Board expects to reduce 2014 UK construction profits by a further £70 million, comprising:

• £20 million relating to the difference between the reported contract positions, as at August 2014, and KPMG’s assessment as at the same date; and  
• £50 million relating to an assessment of contract forecasts and subsequent deterioration in project performance up to the end of December 2014  

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.   

Issues in the construction business are principally restricted to the previously highlighted delivery units of Engineering Services, and London (including major projects buildings) and the South West regions of the regional business.  The contracts account for less than 10% of CSUK’s August 2014 year to date revenue.  

Outside of UK Construction, there has been no net material change in underlying trading since the Q3 trading update.

Leo Quinn, Group Chief Executive commented:

“The summary report on UK Construction is an important step in drawing a line under a period of uncertainty for our customers, and enabling us to focus fully on delivering value."   

“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."  

“The updated valuation of the Investments Portfolio, together with its income stream, clearly demonstrates its ongoing ability to deliver significant value. Within Balfour Beatty’s business model, it also provides a strategic anchor both with key customers and to the Group’s growth prospects, earnings and balance sheet.”

“Working changes into the culture of the Group will take time and discipline, but everything I have seen so far reinforces my first impressions about the depth of engineering capability in Balfour Beatty, and the expertise, commitment and passion of our people. Our goal now is to ensure that the value delivered to our customers by what is an exceptional workforce, translates into best‐in‐class performance and returns.”

Balfour Beatty announced on 29 September 2014 that KPMG would undertake an independent review of the contract portfolio within Construction Services UK (CSUK), given the continued inconsistent operational delivery across some parts of that business.  

The review focused on bidding and tendering disciplines, commercial controls, 'cost to complete', contract value forecasting, reporting at project level, and project reporting and reviewing.  

KPMG reviewed a sample of 127 projects across CSUK as at August 2014. The selection criteria were:

• A sample consisting of the majority of the projects that comprised the profit shortfalls announced in September and July 2014; and
• A risk based sample of other projects from across CSUK which did not form part of the profit shortfalls.  

The sample, measured by August 2014 year to date revenue, covered approximately 74% of Engineering Services and 58% of Major Projects. Across the four Regional business units it covered 33% of August 2014 year to date revenue in London and the South East, 19% of the South West, 12% of the North and Midlands and 14% of Scotland. Overall the sample comprised 36% of CSUK’s August 2014 year to date revenue.

Key findings - tendering at very low margins with optimistic assumptions and poor contract administration

KPMG has identified the following root causes of poor operational performance:

1. Bidding – Tendering at very low margins with optimistic assumptions around cost, programme and procurement savings, and inadequate provisions for risk.  

2. Commercial and contract management – Insufficient local management challenge and review of contract performance, failure to recover genuine contract entitlement due to poor contract administration and optimistic assumptions on contract penalties.

3. Accuracy of cost and programme forecasting – Insufficient visibility, control and understanding on actual versus reported contract performance.  

Balfour Beatty said it also 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.” 

Recommendations include more rigour and improved accountability

The Board is acting on the recommendations of the KPMG review to strengthen performance over the project lifecycle through:

1. More rigour in tender assessments – Improve tender review processes through improved guidance, improved operational inputs, earlier and ongoing risk management assessment, additional independent oversight and appropriate allocation of resource. A review of a sample of recently bid contracts shows a tightening up of tender processes but also demonstrates that further standardisation of the bidding process is required.  

2. Improve accountability for project performance ‐ Ensure project managers have greater financial and commercial accountability for project performance with an appropriate set of project performance KPIs. More robust challenge and review of contract performance by local management.

3. Accuracy and timeliness of forecasting – Increased focus on identifying, understanding and reporting risks inherent in projects and the implications on financial performance on a timely basis, and enhanced project reporting supported by consistent application of strong commercial management and contract administration processes.

4. Group policies – Improve and reinforce Group policies to commercial and local financial management ensuring rigorous application across all projects.

The Board will also 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. The recommendations on the UK Construction business will be implemented within the delivery units with immediate priority.

As a first step, the UK structure will be simplified and de‐layered with the Major Projects construction business reporting to the Group Chief Executive with immediate effect. Balfour Beatty said “similar rigour” will be applied in assessing the Group’s processes and project performance across all of its major markets.

The brief Trading Update said:

"The mechanical and engineering joint venture in the Middle East continues to operate in challenging markets, whilst the highways maintenance business in Support Services has performed strongly."

"It is expected that the year‐end order book will be slightly lower than the third quarter which stood at £11.7 billion. The Group ended 2014 with a net cash balance of approximately £180m.”