You can forgive Murray & Roberts shareholders for wanting to throw in the towel. Two weeks ago, the group astounded the market with an abrupt profit warning, having posted relatively decent year-end numbers two months earlier.
Shareholders were warned to expect an “at least 100%” slide in profit for the six months ended December, largely due to its Traveler petrochemicals project in the US and the Waitsia onshore gas project in Australia. Unsurprisingly, its shares crashed 32% on the day, taking this year’s decline to almost 65%.
It’s not just a 2022 horror show: Murray & Roberts shares have been on a one-way hiding for five years. Yet this is hardly a South Africa-focused company any more. In 2016, it sold its local building division to a consortium for R314m.
The FM asks CEO Henry Laas what happened.
FM: Why did you ditch the local construction sector?
HL: That business didn’t ever really make any money other than the period leading up to the 2010 World Cup, when there was a lot of investment in infrastructure, and even then we had only a marginal profit. The future was also very dependent on government investment in infrastructure and our view was that companies that were black-owned would be favoured for those contracts. So we thought it best to divest and sell to a black owner to give the company a better chance to be successful in South Africa. So we expanded our business in Australia, and that’s separate from the mining business, which was always international.
FM: Clearly, it’s no less difficult overseas?
HL: In the ERI [energy, resources and infrastructure] sector where we undertake work on a lump-sum, fixed-price basis, you take risk as the contractor for many things. And Covid really had a huge impact on our activities from 2020. Initially it was because projects were being stopped and the most difficult problem was all the legislation prohibiting cross-border travel, so to mobilise people onto project sites was almost impossible. And now the aftermath is all the supply chain disruptions.
The two projects we refer to in the update — Project Traveler and Project Waitsia — are nearing completion in June and we now, for the first time, have a better understanding of what all the impacts were of the supply chain disruption. These two projects are going to cost more to complete than we anticipated.
FM: Why did you only get a better appreciation of the implications so late?
HL: We recently found out that the settlements that we could expect from our clients [do not] meet our expectations — there’s quite a big gap between where they’re prepared to settle and where our expectation has been.
FM: It seems these lump-sum, fixed-price contracts are flawed — they’ve blown up many construction companies. Do they not have to be changed?
HL: It really depends on how the market goes. Today, as we speak, in the Australian market you do get clients offering alternative commercial models like reimbursable-type contracts which are a lot less risky, but three or four years ago, there was no other type of work available. So if you had to keep your business going, that was the type of contract that was on offer. If you didn’t do it, you didn’t get the job.
The pendulum is now returning, we’ve got only two [problem] projects out of a large portfolio. As far as the balance of the portfolio is concerned, many of them also on a lump-sum, fixed-price basis, and they’re doing perfectly well.
FM: In the relationship between client and contractor, construction companies don’t seem to have any power.
HL: In most instances that’s probably true, but it doesn’t really apply to all the market sectors. In mining there, you get quite a different approach. It’s really when you look at larger infrastructure projects — such as a power or a chemical plant. These contracts always provide clauses where, if there’s variation on a project, you’d get compensation. But where it becomes very difficult is when you’re disrupted, because you need to be able to prove cause and effect.
We don’t think [Traveler and Waitsia] are going to be loss-making but it’s just that we have recognised profits on them in the past and may have to reverse it, and there’s also cash that goes along with it.
FM: But why book revenue or profits from these projects already? Some analysts say you recognised revenue when you shouldn’t have done — is that fair?
HL: No, not at all. When you look at construction projects there’s a high element of judgment in accounting, right to the end when the project is built. And areas of judgment are: first of all, what is the percentage of completion on a project? The way which we express that is your cost incurred to date as a percentage of your forecast cost at completion. So if I say it’s going to cost 100 units to build this project and I’ve already spent 60, then you’ve got to say your project is 60% complete — and then what you should do is take 60% of your forecast profit at completion …
There are many variables and many areas of judgment in project accounting — and [auditors] have to assess the judgment all the time and conclude whether it is reasonable.
FM: But this is a nightmare for shareholders, who may think on the basis of the numbers that business is all going to plan, until they get a nasty surprise.
HL: It’s difficult. And I can tell you, I always say to people: I’m the largest executive team’s shareholder in Murray & Roberts so it affects me as much as it affects the other shareholders.
Just some context: I was supposed to retire at the end of July and my contract was extended for another two years. If I didn’t think at the time that Murray & Roberts had a bright future, I wouldn’t have extended my contract. But the point really is that it is a higher-risk investment than other businesses.
FM: Do you think there’s an upside to being a shareholder in a construction firm?
HL: If you look at all the investors who are buying Murray & Roberts shares at current levels, surely there is going to be a reward for them. It is about trying to establish what the true value of a company is ... but in our type of business, I think there is bigger downside risk than upside opportunity. That is because things can go wrong on a project.
FM: Is there another funding avenue, if not from shareholders who think they’re going to get burnt or risk-averse banks?
HL: Ultimately when you build a project, who at the end of the day is the beneficiary? It is the client. We should build with clients’ money, not with banks’ money. And that is where we have our issues. When you build a project, it’s only really on day one that what you intend to build is still the same.
Even if the design is 100% complete, as you build it, there’s design optimisation which happens, and changes, and this is what contract management is all about. You must manage that change, and make sure that you get full entitlement on that change.
FM: So that there is the skill?
HL: Yes, but it’s common for all construction companies. That’s why we have clients which are blacklisted within our group, that we’ll never do any work for. For us, client risk is a big thing. But you shouldn’t really find yourself in a position where you have a challenge like the one we’ve got now …
I still think Murray & Roberts is a very good company. But we’ve got an issue and we have to deal with this.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.