How did Fletchers get it so wrong?
By Sam Dickie, Portfolio Manager, New Zealand
07 April, 2017
You may have heard about how one of New Zealand's largest listed companies, Fletcher Building, issued a profit warning in March, just a month after its first half result, surprising the market and leading to a share price fall of 10%. We don't own Fletcher Building but are nevertheless interested to understand how they could have got it so wrong.
To put it in context, Fletcher Building has grown rapidly and now has more than 20 separate divisions. What was once a quality NZ focused building materials and construction company is now a global building materials and construction conglomerate. Maybe it's the scale and magnitude of growth that has led the company astray?
Fletcher's construction backlog (which is the crux of the company's problems) is three times the size it was at the previous cycle peak. This scale must add complexity and be significantly more difficult to manage than the business of old.
The rationale for Fletcher having a construction division at all has been to exert control over a key channel so it can market its significantly more profitable building materials. It is concerning that this division has grown so rapidly and is now causing unexpected losses.
The company completed a review of around 55% of the backlog in its construction division. The result was a 15% downgrade to earnings guidance for the 2017 financial year. What might be discovered when the other 45% of its construction division is reviewed?
In stark contrast to Fletcher's woes, the privately-owned NZ civil construction firm, Fulton Hogan lifted first-half pre-tax profit 13% as its NZ (and Fijian) operations tracked ahead of expectations. Fulton Hogan achieved this in a period that MD Nick Millar described as a "challenging environment" where multinational firms were competing more aggressively for large projects in New Zealand and Australia.
As anyone who drives around Auckland will attest, there are plenty of civil and commercial construction projects underway. However, with increasing competition, the challenges of pricing long dated construction projects with volatile commodity input costs, and already thin construction margins, you need everything else in your business to be absolutely nailed.