Annual Financial Report

RNS Number : 6046A

Morgan Sindall Group PLC

27 March 2017

 

Morgan Sindall Group plc ('the Company')

Annual Financial Report

27 March 2017

Further to the release of the Company's Preliminary Results announcement on 23 February 2017, the Company announces that it has today posted the following documents on its website at www.corporate.morgansindall.comwww.morgansindall.com:

·     2016 Annual Report

·     Circular containing the notice of the 2017 annual general meeting

The Company will hold its annual general meeting at 10.00am on Thursday 4 May 2017 at the offices of Jefferies International Limited, Vintners Place, 68 Upper Thames Street, London EC4V 3BJ.

A copy of each of the documents listed above has been submitted to the Financial Conduct Authority's national storage mechanism ('NSM') and can be accessed via the NSM website at www.hemscott.com/nsm.do.

In accordance with the requirements of Rules 4.1 and 6.3.5 of the Disclosure Guidance and Transparency Rules, a description of the principal risks and uncertainties affecting the Group is set out in Appendix 1 to this announcement. The Company's Preliminary Results announcement released on 23 February 2017 contained all other information required by DTR 6.3.5.

ENQUIRIES:    

Morgan Sindall Group plc                                Tel: [phone]

Clare Sheridan, Company Secretary

Appendix 1

Overall the Group's risk profile has improved with focused contract selectivity, a strong balance sheet and no noticeable impact following the EU referendum.

Our approach to risk management

Risk is inherent in our business and cannot be completely eliminated if we are to achieve growth. However we view risk management as a fundamental part of our business planning process. Each year objectives and strategies are set that align with the risk appetite defined by the Board.

The Board is responsible for risk management and assesses the principal risks to the Group that threaten our business model and performance. 

In accordance with our decentralised philosophy, each division identifies the risks facing its business and takes measures to mitigate the impacts.  Twice a year every division carries out a detailed risk review, recording significant matters in its risk register. Senior managers take ownership of specific risks and ensure that tolerance levels are not exceeded. Each risk is evaluated, both before and after the effect of mitigation, on its likelihood of occurrence and severity of impact on strategy. The risk registers record the activities needed to manage each risk, with mitigating activities embedded in day-to-day operations for which every employee has some responsibility.

It is critical that we have rigorous reporting procedures in place to ensure that significant risks throughout the divisions are effectively managed at Group level. The divisional risk registers are reviewed and collated by the Group's head of audit and assurance, who refers to them when preparing the Group risk register. The Group register also contains matters identified by the heads of key Group functions, including legal, regulatory, finance, tax, treasury and sustainability. Both the divisional and Group registers are reviewed by the risk committee before being presented to the Board and audit committee. This approach ensures that principal risks and controls throughout the Group are under regular review at all levels.

With regard to decision-making, the Group's finance director and head of audit and assurance have produced a formal document which delegates approval for material decisions to appropriate levels of management. The document applies particularly to project selection, the pricing and submitting of tenders, and capital requirements. Board approval is required before undertaking the largest and most complex projects. This approval system is implemented throughout the Group and regularly reviewed.

Overview of the Group's risk profile

Overall the Group's risk profile has improved due to a continued focus on contract selectivity, bolstered by a strong balance sheet. The result of the EU referendum introduced some uncertainty into our markets with a corresponding rise in risk at the half year point of 2016. However, we have not witnessed any noticeable impacts to the business since then and do not foresee any in the short term. Based on current trading patterns, our high-quality secured order book and a visible pipeline of opportunities, the outlook for 2017 looks positive. It is still too early to predict the medium- to long-term effects of the UK's decision to withdraw from the EU, and we will continue to monitor Government and commercial reactions in light of the uncertainty still affecting our markets.

Our diversity of offering through our construction and regeneration activities protects the business from cyclical changes in individual markets. All businesses are focusing on long-term partnerships and procurement routes remain favourable. Our regeneration activities are underpinned by a pipeline which is long term and development portfolios that are mostly non-speculative.  Residential schemes have shown no short-term impacts since the result of the EU referendum, with sales, reservations and building targets continuing to be met. With low interest rates and Government support for housing, we remain confident that our products will continue to be both in demand and affordable. Should this not be the case the schemes are subject to economic viability measures and robust risk and capital controls which will help mitigate any negative fluctuations that might arise. In Construction & Infrastructure, improvements made in project selectivity have resulted in a strong order book deriving significantly from committed public sector schemes and frameworks. Projects have sensible risk profiles, entry margins and contract terms. Fit Out, while more susceptible to GDP fluctuations, has a particularly strong secured order book for 2017 and beyond, providing higher visibility of future workload than in previous years.

In terms of resourcing our medium and long-term plans, we have committed banking facilities until 2018, a significantly improved cash profile and robust cash and capital controls in place. Our People Promise, initiated to attract and retain talented people, is gathering momentum. Voluntary staff turnover is falling at various rates across the business and new people are being recruited who will help us achieve our strategic objectives.

Principal risks

The principal risks to the business are set out below. It is not an exhaustive list of all the risks the Group faces, but those currently considered most significant in terms of potential impact.

The risks are set out as they relate to the Group's strategic priorities, indicating any change in severity and likelihood of impacts compared to 2015 and describing mitigating actions being taken.

Viability statement

As required by provision C.2.2 of the UK Corporate Governance Code, the directors have assessed the prospects and financial viability of the Group and have concluded that they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the period of the assessment. This assessment took account of the Group's current position and principal risks and has been made using a period of three years commencing on 1 January 2017, which is consistent with the Group's budgeting cycle.

The Group is subject to a number of principal risks, and the directors have considered the Group's solvency and liquidity using cash flow projections.  These are compiled on a bottom up basis incorporating each division's detailed business plans. At Group level, the base case financial projections assume modest revenue growth and an improvement in gross margin.

Operating cash flows are assumed to broadly follow forecast profitability in the Group's construction activities, but are much more independently variable in regeneration, driven by the timing of construction spend and programmed completions on schemes.

The Group's main committed bank facility matures in September 2018. The directors draw attention to the key assumption that there is a reasonable expectation that this will be renewed at the appropriate time or the term extended for sufficient facilities to meet the Group's funding requirements over the period of assessment.

The impact of a number of downside scenarios on the Group's headroom against its committed facilities and the financial covenants thereon has been modelled based on the Group's principal risks. The scenarios are focused on the risks that are scored as most likely to occur or that would have the greatest potential severity should they occur and include lower revenue growth, failure to improve gross margin from current levels, a decline in gross margin and deterioration in working capital, specifically client receivables.

The Board has also considered a range of potential mitigating actions that may be available if one or more of the scenarios arose.

Win in targeted markets

The markets we operate in are affected to varying degrees by global and UK economic conditions which could potentially impact our longer-term strategy.

Risk and potential impact	Risk change in reporting period1	Mitigating activities
Changes in the economy The number of opportunities in our chosen markets could be reduced or become less profitable. Allocation of resources and capital to the pursuit of declining markets or less attractive opportunities would reduce the Group's profitability and cash generation.	No change · While the EU referendum result has not to date had a significant impact, worldwide economic influences (including the triggering of Article 50, outcomes from the elections in the US and Europe and the impact of exchange rate fluctuations) remain difficult to predict and could affect investor confidence. · Government indicators are encouraging in terms of housing policy and infrastructure spending, as highlighted in the autumn statement. · Our business model is designed to provide a mix of earnings across different market cycles and is now benefiting from historic investment in regeneration. · Opportunities have continued to flow in all our markets and there is high demand for our development schemes. This is partly tempered by competition levels in construction and expected exchange-rate-driven inflation although procurement routes, margins and contract terms remain favourable. · Infrastructure has been reshaped and resized to handle any short-term delays owing to political uncertainty while taking into account expected growth in regulatory work for the rail, road and airport sectors which constitutes around half of Infrastructure's workload.	· Targeting sectors identified for Government investment, such as infrastructure, housing and urban regeneration. · Monitoring changes in the global economy, which helps us detect shifts in spending and adapt our strategy if necessary. · Strategic focus on market spread, geographical capability and diversification to protect against the cyclical effect of individual markets. · Business planning that focuses on markets and opportunities consistent with our risk appetite. · Committing only to viable development schemes, allowing us to maximise our residential portfolio while responding quickly to any market changes. · Selecting opportunities that will provide sustainable margins and repeat business. · Scale of operations that enables us to compete in areas with higher barriers to entry. · Divisions working together, which adds value for clients. · Regular monitoring and reporting of financial performance, work won, prospects and pipeline of opportunities.
Exposure to UK housing market The UK housing sector is strongly influenced by Government stimulus and consumer confidence. If mortgage availability and affordability are reduced this could make existing schemes difficult to sell and future developments unviable, reducing profitability and tying up capital.	No change · There have been encouraging signals from the Government in terms of housing policy and stimulus, which supports our business model. · Sales volumes, pace and inflation have held up since the EU referendum in both the investor and private markets. · Dialogue is increasing with housing associations and local authorities, which is not yet reflected in our pipeline. · Demand remains high across our property portfolio given the pressures on housing.	· Monitoring key UK statistics, including unemployment, lending and affordability. · A residential portfolio that supports the Government's demand for affordable housing. · Rigorous three-stage approval process before committing to development schemes. · Development vehicles structured to be largely non-speculative, minimising any negative impacts from market fluctuations. · Where possible, subjecting forward purchase of land to economic viability test before committing. · When feasible, forward selling sections of large scale residential schemes to institutional investors. · Regular reporting on work won and pipeline and regular development forecasting.

Risk and potential impact	Risk change in reporting period1	Mitigating activities
Poor contract selection In a volatile market where competition is high, a division might accept a contract outside its core competencies or for which it has insufficient resources. Failure to understand the project risks may lead to poor delivery and ultimately result in reputational damage and loss of opportunities.	Decrease · The majority of our larger projects continue to be secured with longer- term repeat clients with whom we have good relationships. · The quality and volume of our order book continues to improve. It includes a high proportion of public sector clients, resulting in a healthier risk profile. · A strong order book allows the divisions to be more selective when bidding for contracts. · Improved pipeline and software tools for selecting the right work have de-risked Construction & Infrastructure and provided greater visibility of projects likely to be more successful. · A greater understanding of medium-term pipeline quality and early indication of longer-term changes enables us to predict trends more accurately and adjust our strategy in response. Market stability has meant continued attractive procurement routes and contract terms.	· Business planning to target optimal markets, sectors and clients. · Divisions select projects according to pre-agreed types of work, contract size and risk profile. · A documented approval process of bid selection, including tender review boards. · Staff planning to ensure appropriate levels of qualified resource. · Initiatives to select supply chain partners who match our expectations in terms of quality, sustainability and availability. · Regular reporting on sales, pipeline and order book, using customer relationship management software. · Communication of feedback from supply chain.
Safety or environmental incident Health, safety and environmental (HSE) impacts will always feature significantly in the risk profile of a construction business. We carry out a significant portion of our work in public areas and complex environments, requiring strict observation of Health and Safety Executive standards. Incidents that cause harm to an individual or the community could result in legal action, fines, costs and insurance claims as well as project delays and damage to reputation. Poor HSE performance could also affect our ability to secure future work and achieve targets.	Increase · New sentencing guidelines for health and safety have come into force which can impose significant fines. We have no historical material issues that might attract a fine and we continue to focus on managing HSE issues to the standards required to protect individuals, the community and the environment. · Construction & Infrastructure has embedded its cultural development programme and introduced a new initiative, Human Factors.  Human Factors is also being introduced into joint venture projects. · Partnership Housing set up its PAVES system. · We held health and safety leadership team meetings during the year to discuss safety matters and trends impacting the business. The meetings were attended by divisional managing directors and health and safety directors.	· Individuals in each division and on the Board with specific responsibility for HSE matters. · Communication of each division's HSE policy to all staff and senior managers appointed to ensure they are implemented. · A Group health and safety forum with representatives from all divisions that continues to share best practice and exchange information on emerging risks. · Established safety systems, site visits, monitoring and reporting procedures including near-miss and potential hazard reporting. · Investigations and root cause analysis of accidents or incidents and near misses. · Regular HSE training that includes behavioural change. · Major incident management plans and business continuity plans that are periodically reviewed and tested. · HSE report to the Board each month, HSE audits on projects and training schedules and incident investigation reports if necessary.

Develop and retain talented people

We undertake high profile projects and operate in sectors that are technically complex and require innovative solutions. We recognise that talented, motivated people improve our performance    and reputation, and that attracting and retaining them is key to our planned growth.

Risk and potential impact	Risk change in reporting period1	Mitigating activities
Failure to attract and retain talented people Talented people are needed to provide excellence in project delivery and customer service. Skills shortages in the construction industry remain an issue for the foreseeable future.	Decrease · In divisions where voluntary staff turnover was higher than it should have been, efforts have been made to improve the working environment, for example by developing technology and providing leadership training. Staff turnover rates have fallen as a result, although there is room for further improvement. · Our investment in graduate, trainee and apprenticeship schemes is gaining momentum with a number of participants now progressing to more senior positions. · The relatively new leadership development programme launched in 2015 is progressing well in its target to train 400 leaders by 2018. · We are building our reputation as an attractive employer, with Partnership Housing achieving an 'Investors in People' gold award.	· Continued implementation of the People Promise to help employees fulfill their potential. · Annual appraisals providing two-way feedback on performance. · Training and development plans to build skills and experience. · Remuneration packages benchmarked where possible. · Monitoring future skills requirements. · Succession plans in all businesses. · Debriefs with leavers and joiners to understand the reasons for their decision. · Divisional 'people boards' that meet twice a year to review talent in the business. · Monthly HR reports to the Board including a report on leavers and joiners. · Monitoring recruitment.

Disciplined use of capital

The long-term success of the business depends not only on disciplined use of capital within the Group, but also on the liquidity of clients, partners and suppliers, which could be affected by overtrading in an increasingly uncertain market.

Risk and potential impact	Risk change in reporting period1	Mitigating activities
Insolvency of key client, subcontractor or supplier A client's insolvency could result in bad debt and significant financial loss. Insolvency of a supplier could disrupt project works, cause delay and incur the costs of finding a replacement. There is a risk that credit checks undertaken in the past may no longer be valid.	No change · Disciplined project selectivity has included focusing on sectors and clients with a secure financial outlook. · A high proportion of our current order book is public sector focused. · Construction & Infrastructure continues to develop long-term relationships with financially sound subcontractors.	· A business strategy focused on the public sector and commercial clients in sound market sectors. · Rigorous due diligence and credit checks. · Obtaining financial security where necessary, such as specific preferential payment terms or escrow accounts. · Formal approval process before entering contracts, supported by tender review boards. · Working with preferred or approved suppliers wherever possible, which ensures visibility of both financial and workload commitments. · Regular meetings with key supply chain members to exchange feedback and maintain dialogue, resulting in meaningful relationships and a greater certainty of project outcomes. · Monitoring pipeline and order book. · Monitoring work in progress (uninvoiced income), debts and retentions.

Risk and potential impact	Risk change in reporting period1	Mitigating activities
Inadequate funding A lack of liquidity could impact our ability to continue to trade or restrict our ability to achieve market growth or invest in regeneration schemes.	Decrease · Debt availability and terms continue to be favourable for the Group, our clients and our supply chain. · There has been a significant improvement in average cash in the period, increasing confidence in future investment opportunities. · We have significant headroom due to our bank facilities and strong cash performance. · A strengthened balance sheet gives us the opportunity to explore further investment in new regeneration schemes.	· Securing medium-term committed banking facilities. · A three-stage process for approving development and investment-related schemes, which gives an early indication of potential long-term balance sheet commitments. · A disciplined allocation process for significant project-related capital which considers all future requirements and return on investment. · Daily monitoring of cash levels and regular forecasting of future cash balances and facility headroom. · Regular stress-testing of long-term cash forecasts.
Mismanagement of working capital Poor management of working capital leads to inadequate liquidity and funding problems.	Decrease · Working capital continues to improve as a result of working through the low-margin legacy projects, better contract terms and timing of completions in regeneration schemes together with the continued benefits from cash optimisation and controls. · There has been improved cash management with average net debt significantly down for the period and changed to average net cash.	· Monitoring and management of working capital with acute focus on any overdue work in progress, debtors or retentions. · Ongoing cash management. · Cash profiling of key opportunities at an early stage to ensure they meet the Group's expectations. · Daily monitoring of cash levels and weekly cash forecast reports.

Maximise efficiency of resources

Contract terms need to reflect risks arising from the nature and duration of the works. Projects must be properly resourced to ensure successful delivery for clients

Risk and potential impact	Risk change in reporting period1	Mitigating activities
Mispricing a contract If a contract is incorrectly costed this could lead to loss of profitability that reduces overall gross margin. It might also damage the relationship with the client and supply chain.	Decrease · Improved contract procurement routes and terms are reflected in our forward order book and pipeline. · We have maintained our drive to select projects that are right for the business and match our risk appetite. · We are anticipating an increase in some of our supply chain costs due to exchange rate inflation which will need to be carefully managed to avoid surprises. · Good progress made on legacy contracts with lower margin projects largely worked through by year end.	· A well-established bidding process with experienced estimating teams. · Robust review of pipeline at key stages, with rigorous due diligence and risk assessment. · Tender reviews at three key stages of pre-qualification, pre-tender and final tender submission, with each stage approved by senior management via tender review boards. · Using the tender review process to mitigate any impacts of rising supply chain costs.

Risk and potential impact	Risk change in reporting period1	Mitigating activities
Changes to contracts and contract disputes Changes to contracts and contract disputes could lead to costs being incurred that are not recovered, loss of profitability and delayed receipt of cash. Ultimately we may need to resort to legal action to resolve disputes which can prove costly with uncertain outcomes, as well as damaging relationships.	Decrease · The high proportion of two-stage and negotiated work in our current order book has reduced the likelihood of unforeseen changes and disputes. · Improved early warning tools and metrics are flagging potential issues in Construction earlier than before. · Development is continuing on electronic project management and commercial controls to improve trend analysis and early warning intervention.	· Carrying out work under standard terms wherever possible. · Reviewing contract terms at tender stage and ensuring variations are approved by the appropriate level of management. · Well-established systems of measuring and reporting project progress and estimated outturns that include contract variations. · Continued use and development of early warning tools. · Building Information Modelling (BIM) to identify any design issues before costs are incurred. · Regular project reviews including feedback from peers, to learn from experience and put procedures in place to prevent or mitigate issues on future projects. · Where legal action is necessary, taking appropriate advice and making suitable provision for costs. · Monthly monitoring of financial and operational performance on projects. · Electronic dashboards for project management and commercial metrics.
Poor project delivery Failure to meet client expectations could incur costs that erode profit margins and lead to the withholding of interim cash payments which impacts working capital. It may also result in reduction of repeat business and client referrals.	Decrease · New early warning tools are flagging problems in project delivery, enabling earlier intervention. · Improved project selectivity has de-risked the order book and reduced the probability of poor performance. · Various initiatives in Construction are underway that focus on improvements in product quality, predictability and customer experience. · Fit Out is using a sophisticated initiative to drive customer service and experience. · We have used electronic snagging technology to improve the way we manage project close outs. · Urban Regeneration has established a team specifically engaged to enrich customer experience both pre- and post-occupation.	· Incentivising project teams on Perfect Delivery outcomes to achieve high levels of client satisfaction. · Strategic supply chain trading arrangements to help ensure consistent quality. · Electronic project management tools which help improve quality and efficiency. · Continued application of early warning tools to highlight delivery issues. · An escalation process to ensure senior management intervention at an early stage if necessary. · Formal internal peer reviews that highlight areas of improvement and share best practice and lessons learned exercises. · Collection and analysis of client feedback. · Monthly monitoring of project performance and electronic dashboards for project management and commercial metrics.

Pursue innovation

Innovation drives quality, efficiency and competitive advantage. Continued developments in technology give us opportunities to improve our delivery and service. Business continuity depends on secure and resilient IT systems and the persistent threat of cyber-risks continues to present a challenge.

Risk and potential impact	Risk change in reporting period1	Mitigating activities
Failure to innovate A failure to produce or embrace new products and techniques could diminish our delivery to clients and reduce our competitive advantage. It could also make us less attractive to existing or prospective employees.	Decrease · The divisions have continued to develop solutions to improve efficiency, customer service and employee satisfaction. Examples range from engineering solutions such as Construction & Infrastructure's uphill excavator to the social enterprise initiative set up in Basildon.	· One of our core values is to challenge the status quo and innovation is strongly encouraged. New ideas are welcomed from every employee, partner and supplier. · Business improvement and IT forums review, sponsor and promote new innovations across the business.
Failure to invest in information technology Investment in IT is necessary to meet the future needs of the business in terms of expected growth, security and innovation, and enables its long-term success.	No change · We have continued to invest in IT as part of a Group-wide strategy, with a centralised team working to ensure a stable and resilient IT environment. This has allowed us to focus with confidence on delivering new and improved technology into the business. · New software was introduced to parts of the business where it was needed, including customer relationship management, data analytics, workflow management, business intelligence and project-specific commercial and operational tools. More new technology is in the pipeline. · We upgraded our Group-wide financial software with the option to add additional construction-specific features as required. · Security levels and data resilience were improved as a result of Group- wide initiatives that included a new dedicated and accredited information security and compliance team, the rollout of endpoint encryption, initiation of formal threat analysis including active monitoring  of external web-based threats, and data protection and information security training.	· A centralised IT service that improves efficiency, oversight, reporting, security and performance, with localised divisional resource providing business-specific product support. · Group-wide and divisional IT forums that discuss and report IT strategy and operations. · Continuing investment to improve infrastructure, application service and new technology. · A dedicated information security team certified and accredited with key industry bodies in data protection and information security. · Group-wide risk and security strategies that address creating awareness, threat alert, risk and vulnerability prioritisation and response. · Government-accredited security installations and certification to hold protectively marked information, including under the Government's Cyber Essentials Scheme.

¹   Risk change in reporting period signifies the Board's opinion of pre-mitigation risk movement.

 

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