Reading between the lines

If you listened to the social housing maintenance firm Connaught, you could be forgiven for thinking George Osborne had taken a cleaver to the sector in his recent emergency Budget.

A profit warning saw Connaught lower its estimates for this year and next - and all because of cuts unveiled by the chancellor. The group said local authorities had ‘deferred’ capital expenditure programmes and, as a result, it was having to reduce its profits forecast for the year to the end of August by 20 per cent.

The City’s reaction was instant and brutal, wiping off two-thirds of the company’s value.

And not just Connaught - social housing rival Mears also suffered as analysts marked the sector down. But Mears’ reaction was interesting. Alan Long, its development director, said: ‘It’s very much Connaught’s performance, not the market’s.’

Bob Holt, chair of Mears, said: ‘This is not a sector-wide problem.’

The Mears men have a point. For a start, Connaught trimmed its profits by 20 per cent but the share price fall was much greater than that. Sometimes, investors overreact but on other occasions, they judge the situation well. Here, there was definitely an element of shareholders suspecting that 20 per cent was just the beginning and that more bad news lay ahead.

When Mouchel, the consulting and engineering group, also cautioned of a public spending squeeze, its shares dropped 10 per cent - Connaught’s on the other hand dropped more than 65 per cent.

Making excuses

This was the market saying to Connaught: ‘We don’t believe you. We think you’re using the Budget as cover for an underlying problem.’

First, what exactly was in that Budget that would cause Connaught to behave in the way it did? Answer: not a lot. Most of Mr Osborne’s address was concerned with tax rises - he said government departments, but not health and international aid, should brace themselves for a 25 per cent reduction in costs but the detail will not be revealed until late October.

Local authorities had their central government cash frozen. Regional housing targets have been scrapped which may lead to fewer planning permissions being granted and that, in turn, may drive up the price of new builds. But there was no all-out assault on social housing and besides, if there had been, other companies in the sector would also have issued dire predictions and they didn’t - Connaught was virtually alone.

Dark clouds looming

The truth is that City knives have been out for Connaught for a while - and with reason.

The first sign of trouble looming was the sudden departure of chief executive Mark Davies in January. Mark Tincknell, who took over from Mr Davies but stepped down last week on health grounds, did his best to head off concerns when he presented the results in April. ‘There are no big surprises out there,’ he told analysts.

But they were not so easily placated and several were asking how Connaught treated its contracts in the company accounts. Investec analyst Guy Hewett issued a note claiming Connaught was ‘more aggressive’ than its competitors in recognising profit. According to Mr Hewett, the company’s peers usually write off ‘mobilisation costs’ - expenses incurred at the start of a contract - immediately. But he said that Connaught likes to do it over the lifetime of the contract.

Kevin Cammack analyst at Cenkos Securities, said: ‘I’m pretty sure Connaught’s issues are 90 per cent company specific.’ And Andy Brown, analyst at Panmure, expressed the doubts about Connaught another way when he said: ‘The question is whether Connaught is seeing things early or whether there are more ingrained issues at the company.’

But Mr Cammack went on to say that he would ‘not expect investors to be clamouring to support Mears or Kier until [the public sector’s] position is clear.’

This makes sense. While Connaught has troubles of its own, huge uncertainty hangs over the sector. In a trading update, house builder Taylor Wimpey reported a strong order book but expressed fears about the impact of grant reductions. ‘Although the recent UK Budget did not contain new measures that we would expect to have a detrimental impact on the housing market, we remain concerned regarding the future spending review that could impact on housing initiatives, particularly the level of social housing grant,’ the update said.

Despite admitting to a ‘growing sense the worst is over’ in the property market, boss of residential developer Berkeley Tony Pidgley said he remained cautious about the arrival of a new government committed to probing Whitehall for savings. He said: ‘Such reviews and changes in policy are inevitable and necessary. Most important is that hard work and innovation are rewarded and growth is encouraged. In our own industry, this means a continued and concerted commitment from the private and public sector to work together to address the shortage in supply of quality housing.’

Bad, but not that bad

It wasn’t so much what Mr Osborne said in the Budget as to what he did not say. Michael Levack, chief executive of the Scottish Building Federation, said it was the absence of stimulation for the supposed enterprise-led recovery that was so disappointing. Ministers want commerce to pull the country out of recession but are not providing the tools to help. Mr Levack said that the latest survey of his members had found confidence was ‘slipping into reverse, with many firms blaming a lack of bank lending for our industry’s sluggish performance.’

Mr Levack added: ‘Sadly, I can find nothing in the Budget that would help ease the availability of affordable credit to building firms, to businesses that wish to expand or to home-buyers. However politically popular it may be, I fear the proposed new bank levy may actually encourage banks to restrict their lending further.’

He also made the point that the increase in VAT to 20 per cent, due in January, ‘is a retrograde step which plays into the hands of cash-in-hand cowboys by increasing their advantage over legitimate firms.’

It was a bad Budget for the industry - but not as bad as Connaught claimed.

Chris Blackhurst is city editor of the London Evening Standard