The COVID-19 pandemic and its attendant effect on markets and commercial activity is presenting a range of challenges to the engineering and construction (E&C) industry — challenges that could deepen depending on the severity and length of the crisis in the US and globally. Uncertainty surrounding the duration and severity of this crisis make it hard to anticipate how a recovery could unfold for the industry.
Some construction projects have been delayed, and some canceled, as a result of the impacts of COVID-19 on the companies and governments that commissioned them. Further, possible supply chain bottlenecks of equipment and materials — including structural steel and glass from Asia — could cause project delays in currently funded projects, or reduced spending on future ones.
The most immediate impacts are being felt at the subcontractor middle market of the industry, as the specter of potential widespread construction site shutdowns loom in the wake of recent decisions to do so in Massachusetts. Subcontractors may be especially vulnerable to bankruptcy, which could occur after a site shutdown of only weeks.
Government stimulus actions could throw a lifeline to this segment — via a package of tax benefits or direct cash disbursals — potentially making situations more tenable for subcontractors. But the timing is critical. A stimulus package could also prevent an upward ripple effect on the major E&C players’ ability to secure construction labor in the short term. Equally important, preventing a possible meltdown in the middle-market segment could avert a drain of skilled laborers and help prevent delays ramping back up once the crisis is over.
Clearly, the E&C industry is not alone. The COVID-19 outbreak is causing widespread concern and economic hardship for consumers, businesses and communities across the globe. The situation is changing quickly, with widespread impacts. We’ve prepared some general guidance on COVID-19: What US business leaders should know: crisis management and response, workforce, operations and supply chain, financial reporting, and tax and trade.
As if COVID-19 weren’t challenging enough, many E&C companies are also wrestling with the compounding effect of plummeting oil prices. This is creating a chain reaction, with industries such as energy likely to postpone capital expenditures for construction projects linked to refining, exploration or production. While most core energy companies (such as oil-field services firms) will likely see the reduction in oil prices hit their revenue almost immediately, E&C firms that serve the energy and chemical markets are likely to see a much longer-term reduction in revenue.
Some firms will be more insulated than others. For example, E&C companies with state and local government contracts may be less exposed to suspended projects, and those with federal contracts may have the least exposure to canceled or postponed projects due to COVID-19 issues. We anticipate a sharp rise in the number of organizations invoking “termination for convenience” clauses for projects in the US and even abroad, as well as force majeure claims by suppliers — especially those in hard-hit parts of Asia.
Here is our take on some issues that companies in your industry may face:
The industry should continue to prepare for potential struggles in the subcontractor middle market of the industry, especially as construction site shutdowns begin to occur on a large scale and remain in place for a prolonged period. If this segment does not receive government support and sites begin to close extensively, many firms may become insolvent in the next two months, which could cascade throughout the industry in the form of a major worker shortage and an abrupt cessation of projects. Such a scenario would likely also open the door to a potential rise in acquisitions of distressed firms.
If US interest rates continue at their low levels, the industry should assume that the Fed may not have a lever to stimulate further, as was done in the 2009-2010 period. However, the federal stimulus package may well help ease the pressure many companies are facing.
E&C companies may face continued downward pressure on demand, along with supply chain issues, as the COVID-19 pandemic intensifies. That may cause privately commissioned projects — and even some state and local government projects — to be delayed, and future spending to be curtailed. Such a scenario could trigger cash-flow liquidity challenges and difficulties in managing debt obligations.
The industry’s workforce may be vulnerable given that most of the work must take place on-site and cannot be done remotely. Additionally, companies may need to find ways to impose social distancing through smaller crews and longer, staggered shifts.
If they haven’t done so already, E&C companies should put in place immediate and contingent safety measures for their employees and decide which functions can be carried out remotely should an outbreak occur within their ranks.
The industry should also plan for a prolonged reduction in capacity and cost structure, which may translate into potential staff reductions and related measures.
In the event of widening outbreaks of COVID-19 that may affect workers, companies should consider the need to outsource some corporate functions (e.g., moving IT to the cloud, or shifting internal non-core operating functions to contractors). Such changes can help lower operating costs and eliminate maintenance capital expenses.
E&C companies should prepare for continued weakening links in their supply chain — both nationally and internationally — as some vendors and suppliers may likely face operational or financial struggles. The industry may experience continued supply issues surrounding construction equipment and materials from Asia (e.g., structural steel and floating glass) and, to a lesser degree, from the EU.
The deeper into the supply chain the outbreak goes, the greater likelihood the impact may be. Companies with global supply chains may see tier 2 and especially tier 3 suppliers most affected by disruptions related to the pandemic.
As with previous downturns, the industry may move quickly to cut discretionary and capital spending to support operations. A key question for all companies will be: Do you have the financial reserves to weather the storm — or even to capitalize on the tumult in the industry?
Disruption in the sector may lead to numerous financial disclosure implications. Stakeholders are making it clear they expect transparency from companies, as well as disclosures about actual and anticipated impacts and, most important, the risks and vulnerabilities to their business.
E&C companies should plan for potential changes to supply chains and workforce global mobility due to COVID-19. This will require careful consideration of potential tax implications.
The E&C industry should prepare to be affected by the government stimulus plan. For example, some E&C companies may be contenders for government-provided financial assistance. Extending lines of credit, reducing infrastructure costs, short-term funding, lowering the tax burden and supply chain assistance are measures the government is likely to explore.
Multinational companies should expect potential cash-flow constraints from overseas operations — including cash repatriation complications and irregularities. Cash could also be bottlenecked when goods are paid for but not supplied (or delayed and stranded). Such cash bottlenecks will likely occur in geographies most affected by COVID-19.
As the COVID-19 crisis unfolds, E&C companies are being hit on numerous fronts. Yet, how your company will be impacted depends on what segments you serve and where you sit in the industry’s value chain. For instance, large E&C firms with federal contracts will likely experience some protection, and that protection could extend to a lesser degree to companies holding state and local contracts. Projects commissioned by private enterprises, though, may be more precarious — especially if the contracts are with companies who may be hardest hit by the volatility of the markets and the severity of COVID-19 (such as energy companies in survival mode during a low oil-price environment).
How the subcontractor middle market fares amid this crisis in the short term could dictate how the industry in general may fare in the long term. Keeping construction workers safe and subcontractor firms’ balance sheets healthy are critical for the overall recovery of the industry. This will also help prevent a possible buying spree of distressed middle-market firms by foreign investors.
Large multinational E&C players will also need to look beyond their own economic viability. They may need to coordinate closely with the public sector to help forge plans central to public safety and the solvency of their workforce, while keeping the lights on in their operations. This should be especially relevant for firms designing and building projects connected to critical infrastructure, such as energy and power, transport, communications, food and agriculture and others.
Many E&C companies will be compelled to make cuts during this volatile period. Some will be austere. So, be surgical with cuts while balancing short- and long-term needs.
Keep in mind that austerity measures should be tempered to preserve long-term objectives. Although moving quickly can certainly create an advantage, knowing where you’re headed will help you ensure the changes you make are more impactful.