Like the rest of the Australian economy, the construction industry was getting back on its feet after the worst of the pandemic. But the sector has now been hit by a perfect storm of supply chain disruptions, cost blowouts and staff shortages as inflation and interest rates rise.

Many of these forces, particularly cost increases, are beyond the control of construction companies. But construction also has major industry-specific challenges. Construction has the worst late payment record of any industry. About 12 per cent of construction businesses are more than 60 days in arrears on their payment to suppliers. Fixed-term contracts are also placing cost pressure on contractors.

The risk is that construction collapses cascade down, creating a chain reaction of failed businesses. That could have a serious impact on Australia’s economic recovery.

In this episode of Business Insights, Patrick Coghlan, CreditorWatch CEO; Anneke Thompson, CreditorWatch Chief Economist; James O’Donnell, CreditorWatch Data Analyst and Ginette Muller Director of GM Advisory discuss the findings from our ‘Cracks in the Foundation’ construction white paper and the outlook for the industry for the remainder of 2022.

Download the whitepaper here.

PODCAST TRANSCRIPT:

Patrick Coghlan

Hi everyone, welcome to the latest episode of the CreditorWatch Business Insights podcast. I’m Patrick Coghlan, the CEO at CreditorWatch. Today we are looking at the construction industry. CreditorWatch recently released a white paper titled ‘Cracks in the Foundation’, which is a comprehensive overview of the construction industry and what we’re expecting to see in the next 12 months; some of the challenges that they’re facing and the potential increase in insolvencies.

Today, I am joined by CreditorWatch Chief Economist, Anneke Thompson. Anneke, great to have you along again with the CreditorWatch Business Insights podcast.

Anneke Thompson

Thanks for having me Patrick, great to be here.

Patrick Coghlan

And we’ve also got Ginette Muller, who is the Director of GM Advisory, talking all things insolvency, liquidation and safe harbour. Not just in the construction industry; she’s across all industries. But today, of course, just construction. Ginette, great to have you along as well.

Ginette Muller

Thank you for having me Patrick, great to be here.

Patrick Coghlan

Now, for anyone that wants to download, and you should all be doing this, please download the white paper. There’s a link in the description of the podcast platform that you’re listening through. And then if you click on company blog, you’ll be able to scroll through and find the ability to download the whitepaper. It’s a great one; some great contributors. And we will talk a little bit about it today.

Patrick Coghlan

Ultimately, what we found is that construction industry key metrics are starting to trend the wrong way. So late payment times are lengthening, are worsening. Insolvencies are increasing and there’s an expectation that they will continue to increase over the next twelve months.

On top of that, the industry as a whole is garnering more media attention than probably any other industry at the moment, thanks to the demise of several large companies including Probuild, which is one of Australia’s largest builders with a national pipeline of $5 billion. And that has been somewhat followed or preceded by varying other collapses like Privium, Condev and most recently Next Constructions.

The industry as a whole has really been hit by a number of challenges from various angles. There are labour shortages; there’s significant supply chain disruptions; there’s been cost blowouts as inflation bites. And the ability to actually get your hands on material, even if it has increased 20, 30, 40 per cent just in the last few months, is extremely challenging as well. We’ve also seen the gradual removal of COVID-19 government stimulus, so it feels, at the moment, Ginette and Anneke, that every week there’s another collapse or the potential for another collapse of a significant construction company. There are rumours galore, which are just putting even more pressure unfortunately on a struggling industry.

In a nutshell, what are the factors that are causing so many to fail? Is it COVID, is it non-COVID related? Anneke, given your Chief Economist hat that you wear for CreditorWatch, let’s start with you and get your take on the industry.

Anneke Thompson

Yeah, absolutely thanks Patrick. So, I think for non-COVID related factors, there’s been strong demand in the construction industry for a very long time now. So, a lot of players have come into the market. And, by a long time, I mean the last 10 years.

There has been lots happening in the residential construction sector, lots happening in the commercial construction sector and as well as government projects. So, there’s been a lot of activity, a lot of players entering the market, a lot of competition for some of these big construction contracts, and that has caused margins to compress over time.

So, I think by the time we got up to COVID, there were a lot of these contracts in place that were pretty low margin contracts, but we were in a world of low inflation, so it was okay for quite some time. We went through COVID, and as you mentioned, there was a lot of government stimulus.

The businesses or this whole sector got really another boost, especially the home renovation sector, which was at its highest level it’s ever been at by the end of last year. Lots of Australians choosing to spend their money renovating their property because they couldn’t travel and had cash in the bank. But what happened then is that we’re at this tight margin scenario and then inflation hit.

And that was something new for the industry to comprehend. A lot of these contractors are price takers – so they’ve already set their price; they set their price a couple of years ago when they entered into the contract, and now they’re starting to take all these new prices in, and it doesn’t really work when you work on a low margin scenario.

So, there’s a lot of factors. Some of them are structural, related to the industry itself. Some of them are COVID-related. And then you’ve got all these other economic factors, inflation and, on top of that, we’re now entering a new monetary policy cycle as well. So, there’s probably three different factors there that are really negatively impacting some construction companies.

Patrick Coghlan

Yeah, thank you for that.

Patrick Coghlan

So, Ginette with your experience obviously as a registered liquidator, years of experience in insolvencies, what is it that you’re seeing in the construction industry at the moment and what’s your take for the future?

Ginette Muller

Sure, well thanks Pat. Look I think you’ve hit the nail on the head when you talk about the high profile of a number of those collapses that we’ve seen recently. They certainly hit the headlines and, to me, I feel like the media’s acutely attuned to watching for insolvencies. But it’s interesting to note that last year was one of the lowest years we’ve had in about 16 years for insolvency appointments.

So, even today, I just quickly checked what ASIC’s website was showing and we’ve only had a 10 per cent increase of last year. So, we’re still working off a pretty low base of appointments. And I guess based on what Anneke’s said as well, and what we sort of feel with the supply chains and all the rest of it. The question for me is why aren’t there more insolvencies? You start thinking about the major Australian creditors such as the tax office, state government, revenue departments, banks etc. Have they turned the screws? I don’t really think they have at the moment.

Patrick Coghlan

I don’t think they put the screw in yet, have they?

Ginette Muller

Yeah exactly! I mean there’s so many options at their fingertips aren’t there. And yet all people are telling me they’ve seen is really sternly worded letters. I don’t know, are you seeing more? Are there more to come? Or perhaps we got to wait for that election, I don’t know.

Patrick Coghlan

Yeah, that’s right, that’s right. Look, I agree with you. We know that the ATO’s made a lot of noise, but it’s been bark so far. But I think being the largest creditor in Australia and being a government agency, they have to sort of really pre-warn when they’re going to get going, but I think we’ve started to see that.

So, we’ve seen talk about the fact that they’ve started calling and collecting, which was early this year. They then sent out 5,000-odd director notices for overdue or late company tax. And then they started registering ATO tax defaults with CreditorWatch as well a few weeks ago.

I think naturally the next step is we will start to see those windups that we’re so used to and combined that with, as you said, like the SDRO and the big banks. We’re still 30 to 40 per cent below pre-COVID numbers as a whole on insolvencies and that includes the construction industry. So yes, they definitely do have to go up. You’ve made a very good point there – it sounds like companies are collapsing all the time yet we’re still way down on where we should be.

Staying on the payments, but this time more looking up and down the supply chain. There are some really unique payment structures in the industry and ultimately that imposes a lot of risk on subcontractors and smaller businesses. You’ve got your developer and then your head contractor and ultimately everything rolls down often quite slowly. It’s never good to be generic, but we’ll be generic for the sake of this podcast, you know rolls down quite slowly to those smaller organisations, usually the small subbies who are who are onsite. And, for them, they can put in a claim for $100 and then the contractor also will pay you, you know, “We believe that’s only worth eighty.” And then they also hold part of that for defects and whatnot for a period of time as well. So, it is really challenging.

Ginette, what do you expect to see? Do you expect to see those smaller people, smaller organisations, come to insolvency first before we start seeing the larger contractors?

Ginette Muller

Yeah, look, it’s a really difficult business model, in fact. Anneke highlighted the fact that we’ve got lower margins, they’re really tight, and then you combine that with the fact that out of every progress payment, a certain amount is being withheld… and it starts to get quite difficult. And certainly, by the end of a project, a subcontractor can be missing between five and ten per cent of their of their work not paid. They’re at risk; they potentially don’t get their profit right to the end.

Then they’ve got to wait for a longer period of time to get that – that could be six months, usually twelve months, by the time they’ve gone back and fixed up the defects etc. So that places a lot of risk onto them. When in a lot of cases, particularly the smaller subcontractors, is they’re a little bit more than an employee or they’re not actually highly sophisticated outfits.

They’ve had to purchase some, like, if it’s paint or some other stock etc. They’ve got all that risk on them and they’re still waiting six months after the contract’s finished to get paid. I think that that is a difficult area and hopefully if we get time at the end, I might talk about some of the issues that some of the grassroots subcontractor groups are talking about, you know, trying to change that structure and that process.

Patrick Coghlan

Yeah, that would be good. And Anneke, you’re well positioned to probably link that pain that those subcontractors are feeling to the inflation and interest rate rises that are coming right? These subcontractors are typically smaller businesses and therefore likely to be borrowing against their family home, right?

Anneke Thompson

Yeah, and that’s real trouble if you’re getting delayed payments – that the economy and prices are running away from you before you even get the money in your bank account. I think what we’re going to see in the next year is very different to anything the industry has felt for a number of years, because we’ve been in such a low inflation environment, hasn’t been such a big issue. But you’re right, the cash rate, as we know, went up last week.

It will very likely, in fact, it’s certainty that it will go up again. Their interest rates, the repayments either to pay banks or whoever they owe money to, are going up before they’re even getting their payments in their bank account. So somewhere along the line, they’re going to have to make up that payment shortfall to come out of their business accounts or their personal account. And such a big sector. And I think that’s something we highlighted in the white paper – that all this friction and all these payment problems, they eventually flow through to the rest of the economy. And I think that’s something that we probably as an industry should highlight – that it’s not just affecting the construction sector. They’re such a big sector, it has ramifications for the whole economy and that’s one of the key risks that I think we should be highlighting.

Patrick Coghlan

Yeah, definitely. And the human toll that takes place is really heavy, really heavy. So, jumping onto, just conscious of time, jumping onto probably one more question. What needs to change for all participants in the construction industry to be able to look forward to a more sustainable future?

Now we know that construction companies operate at thin margins, I think it was one of the large private ones which was talking about sort of two and a half, three per cent profit margins, and they’re doing billions of dollars. It’s not hard to have one project blow out and wipe out a year’s worth of profit and then some. You also have the challenges with progress payments where, with all the delays due to labour shortages and material shortages, all of a sudden where you expected to get paid after three months, the project takes six months, and there’s an extra three months where you’ve got to essentially fund your own cash flow there. Ginette, have you got a view on this?

Ginette Muller

Yes. Look, I think you’re right with those razor thin margins. The groups I talk to say that they’re between one and three per cent. And that something’s got to give, in that the subcontractors can’t keep funding these projects essentially.

And they also are sort of saying that they feel like they’re being held to ransom in many cases with these defective works holding the retentions back. It then leads us into that whole minefield of preferential payments. You’re there. You’re trying to get that last little bit of your work paid for, and you’re just at the beck and call of the builder and that’s what you just have to do.

You just have to keep on doing whatever it is to try to get that last little piece of money to get the profit on your job. So there’s going to be calls, I’m told, very shortly to see if they can start removing these retentions from construction matters. I’m told, it’s not mandatory, and yet it’s done on most contracts at the moment, in particular in Queensland. So, that’s something that I think would make a lot of subcontractors feel a lot more comfortable if that could be removed.

Patrick Coghlan

Yeah, definitely. And Anneke, maybe as a final sort of discussion point, looking into your crystal ball, when do all these supply chain issues come to an end?

Anneke Thompson

I wish I had a definitive answer for you.

Patrick Coghlan

Multibillion dollar question!

Anneke Thompson

Yeah, yeah. And look, unfortunately, as everyone in the industry knows, a lot of it is out of the hands of even people high up in government. It’s global issues. Australia is not the only country that’s been impacted by this. But I think long term we’ve got to learn lessons from what’s going on, and we do have to produce more key building inputs domestically. We already talked about that the very start of COVID, about producing things for healthcare needs domestically. I think as a country we agree to that very quickly.

But as I said, construction is such a big employer and such a huge contributor to GDP in this country. We need to de-risk it from a supply chain perspective. And it’ll take time and will take investment by government. But I think the sector really will rely on that going forward because we can’t just assume that goods are going to continue to come in from overseas at a competitive price. And I guess from the payment structure level, I think customers now have to be realistic when it comes to negotiating fixed past contracts with their builder and that goes all the way from Mum and Dad who are doing a renovation, all the way through to governments who are doing major infrastructure projects.

A lot of that compression of margins has been led by the customers, so there has to be some realism if we want to have a sector that operates or that functions appropriately. That happens in every other sector – people sort of meet the market and pay what they need to pay, and that probably needs to start happening more and more in the construction industry too.

Patrick Coghlan

Yeah, yep, I agree, I agree. And we might wrap it up there unless anyone wanted to add any sort of final comments or predictions for the future? Anyone? No pressure.

Anneke Thompson

Oh look, I think from an economic perspective, we’re only just at the start of the inflation cycle. So, all the pain being felt by the construction sector. Look, unfortunately, it’s just starting and as you’ve both pointed out, it’s quite interesting that we haven’t seen more insolvencies already. And yeah, I think the problem’s here to stay for at least 2022.

Ginette Muller

Yeah, look I’d just add, is it good management or good luck? With respect to the number of insolvencies. We know they’re out there. We know what the tax debt is that’s sitting on everyone’s balance sheets. So it’s just a matter of time and depending on which government is in power, and in the next month or so, they’ll have to tackle what could potentially be a tsunami. We’ll see.

Patrick Coghlan

Yep, very good points. Thank you very much for that. So great to have you both on the show and looking forward to having you on the show again in the future. So thank you very much for your time. This doesn’t just happen – we don’t just call up one another and start discussing… plenty of work has gone into this so I appreciate that. And for everyone listening at home or at the office or in the car, thanks for joining the CreditorWatch Business Insights podcast.

As I mentioned at the beginning of the show, we recently released our white paper called ‘Cracks in the Foundation’ – comprehensive review and current state of play of Australia’s construction industry. You can access that within the description where you’re listening to your podcast or you can jump on to creditorwatch.com.au and access it there. Thank you everyone for your time and we will see you on the next episode.