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Investors have 4-month wait for 'new-look' Fletcher Building that may shed B+I

Wednesday 14th February 2018

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Fletcher Building's shares tumbled to a two-year low $6.69 today after the company unveiled further provisions at Building + Interiors (B+I) that bring two-year losses at the unit to $952 million.

They've since recovered to $6.85, a two-month low but well off the heady highs of September 2016, when the stock reached $11.40.

It's been a high-profile fall from grace that's claimed the scalps of the chairman and chief executive in a company whose building products are in the majority of Kiwi homes and which wins its share of infrastructure projects including in the consortiums winning roading contracts. It employs 10,000 people in New Zealand and 20,000 worldwide. 

Mistakes and misjudgements by an inexperienced team at Building + Interiors have ended up generating losses over two years of $952 million including the $660 million ebit loss it is projecting for the unit for 2018  - a huge amount of red ink for a business that's contributed an average $16 million ebit between 2005 and 2016. Most of its contracts are fixed price or "guaranteed maximum price" - a strategic decision that looks like madness in a construction market of hyper-inflation.

Chair Ralph Norris is stepping down to take responsibility, leaving the company he joined as a director in 2014. He already apologised in October on behalf of the directors although in departing he doesn't accept that his own performance was found wanting. He led the board that sacked former CEO Mark Adamson last July because of the ongoing problems in B+I. 

"It's a hard decision. You've got to sit down and put your own personal considerations aside and ask what's in the best interests of the company," he told BusinessDesk. "The market, in general, is going to say, okay who carried the can for this - whether it's right or wrong."

"A lot of this was well in train before I joined the board," Norris said, adding that he is confident his own performance has been acceptable while chair. Much of blame he sheets home to management.

"There has been management failing - that's the situation. The board became aware just over a year ago and the market has been moving in such a way when you've got this boom in construction. Supply and demand rules start to apply. Costs have gone up. That's what's happened here."

Adamson had been CEO since October 2012, having previously worked for Formica, a Fletcher-owned business that analysts say lacks pricing power in the laminates market.

His replacement on deck since last November, Ross Taylor, helped precipitate the increased provisions announced today, making a review of B+I the first of his tasks in what he called a two-phase review of the company. By June he expects to have unveiled a revamped business strategy for Fletcher which he hopes will restore the company's name. Taylor's last job was at UGL, an engineering firm owned by Cimic Group and formerly known as Leighton Holdings.

"This obviously causes some damage to the brand," Taylor told BusinessDesk. "I'm quite convinced we've got these provisions right. Once we've confirmed that and got that monkey off our back ... we'll look at where we want to take Fletcher Building. What bits, if any, we want to trim."

B+I is already likely for the chopper. Taylor said today that the B+I was now focused "on project delivery only" and was "ceasing all bidding on vertical construction projects in New Zealand," Taylor said. "While our broader construction businesses continue to benefit from favourable market conditions and strong growth, the B+I sector remains characterised by high contract risk and low margins. Unless these dynamics change we will no longer work in this sector."

It would mark the end of an era at Fletcher Construction, whose buildings have spanned the Chateau Tongariro in 1930 to Wellington's Michael Fowler Centre and Auckland's Sky Tower.

A $20 million restructuring provision to exit B+I has also been recognised, with key resources to be redeployed to other construction division businesses as B+I projects are completed. B+I had a contract backlog of $926 million, the biggest for any unit in Fletcher's construction division, which includes the profitable roading firm Higgins.

Taylor says B+I contracts including the Convention Centre in Auckland and the Justice Precinct in Christchurch needed a level of complexity and sophistication that Fletcher lacked. "Fletcher is predominately a builder and it has gone into design-and-build contracts. If you don't control that you can get significant cost blowouts."

He said a couple of themes had emerged in his review of B+I. One was contract terms that were "very difficult and gave clients lots of rights in terms of price and schedule." Fletcher didn't start with the right team in place and "in an Auckland market that has got very busy."

Taylor said since he came on board Fletcher has participated in tenders for what he called major projects but the company didn't progress its bids "because we couldn't work with those margins. The margin expectations just didn't make sense" to Fletcher.

There were companies that managed to successfully compete in that sector "but they have to be very, very disciplined and work the variations and contractual angles," he said. That was "different to what I work in or where I see Fletcher working."

Fletcher has been a dud share to hold in the past five years - a 24 percent decline in a time the NZX 50 climbed 90 percent. Returns in some businesses have been below cost of capital. In his farewell note, Norris said he was confident Fletcher would "weather this storm and once again deliver our shareholders the value they expect and deserve."

Taylor said he was confident the company could reposition B+I to target smaller contracts of $200-$300 million in vertical construction "but for Fletcher, it would be madness to have that revenue with that risk. There's plenty of other construction work that makes sense, better margins."

Today's statement said Norris would step down from the board by the time of this year's annual meeting, in the face of a further $486 million provision for project losses at its Building + Interiors unit where 14 of the unit's 73 projects, worth $2.3 billion, are regarded by the company as loss-making or 'on watch'.

The projected 2018 loss for B+I has been widened to $660 million on an earnings before interest and tax basis from a previous estimate of $160 million, while guidance for group ebit excluding B+I was reiterated at $680 million to $720 million. There are still risks in the numbers, investors say. The poorest-performing contract, the Convention Centre, with a margin impact for 2018 of -$254 million is only 22 percent complete.

"We would think that the size of it might lead to more confidence they're putting a final cap on losses from that division," said Nick Dravitzki, an equity analyst at Devon Funds Management. "It's sensible for this new CEO to be looking to put this to bed as soon as they can."

On the Convention Centre, he said, "you would be a brave individual to say there's not a chance for further downside," Dravitzki said.

Fletcher said it has obtained a waiver from its commercial banking syndicate after breaching the terms of its loans. Taylor said the strength of Fletcher's remaining business and the phasing of the cash impact of the B+I provisions "meant the company remains well capitalised and solvent."

An agreement hadn't been reached with holders of its debt issued in the private placement market. Norris said the number of people involved meant it couldn't be done in time and that it was a priority to get the banks onboard because that reassured the private placement investors. The cash-flow impact of the losses from B+I are being spread over four years.

As at Jan. 31, the company had borrowing headroom of $1 billion and said net debt is forecast to increase by about $250 million this calendar year. Net debt stood at $2.1 billion with $173 million of cash on hand.

The B+I losses breached four lending covenants relating to ebitda against debt and interest payments. The waiver from the banking syndicate requires Fletcher to agree new covenant terms by March 31. Fletcher said it is in talks with holders of its debt issued in the US private placement market and expected new covenant terms to be agreed by the end of March, meaning all of its funding lines would be re-negotiated by the end of next month.


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