This article originally appeared in the NZ Herald.
Fletcher Building’s second profit downgrade this year is a huge disappointment and indicates that the company has serious governance issues.
It also shows that directors and management have limited visibility of the company’s profit outlook, as indicated by the following figures:
At its June 2016 year profit announcement, on August 17 last year, the company’s guidance for operating earnings (Ebit) was in the range of $720 million to $760m for the June 2017 year, compared with $682m for the June 2016 year.
The $720m-$760m profit guidance was reconfirmed at the October 18 annual meeting and at the 2017 interim profit announcement earlier this year.
On March 20, less than four weeks after the interim profit announcement, Fletcher Building announced it was anticipating operating earnings in the range of $610m to $650m for the June 2017 year, compared with its previous guidance of $720m to $760m.
On Thursday, chairman Sir Ralph Norris announced that the company expected operating earnings to be approximately $525m for the June 2017 year, with a further $220m impairment charge on two Australian businesses. He also revealed that chief executive Mark Adamson is leaving the company immediately. How can Fletcher Building, which has a high-powered board of directors, have such poor visibility of its profit outlook?
Why is its construction division reporting large losses while New Zealand’s construction sector is experiencing boom conditions?
There are three main answers to these questions: the company has effectively been controlled by a small executive team with an autocratic approach towards directors; the group’s structure is far too complex; and directors and management have a poor record of predicting industry trends.
Many books have been written about the Fletcher group of companies, including those by Selwyn Parker, Bruce Wallace and current Government Minister Paul Goldsmith. Wallace’s book, called Battle of the Titans, described the brutal alpha male battle between Sir Ron Trotter and Hugh Fletcher which eventually led to the breakup of the Fletcher Challenge group.
This strongman culture has continued at Fletcher Building, particularly with the appointment of Adamson in October 2012.
Adamson told the Australian in December 2013 that he, rather than the board, was determining the group’s overall strategy and his senior management team was seriously underpaid.
In a story given front page business sector prominence, Adamson was quoted as saying he had a “pretty bloody good” relationship with chairman Ralph Waters and after board meetings Waters would say “I don’t necessarily agree with what you are doing but I didn’t give you the job to interfere”.
Adamson also told the Australian: “I come to New Zealand, the land of the tall poppy. I come to the biggest public company that is under daily scrutiny and the board are well connected with society and value their role on that board. It is a real clash of cultures. It is the one issue that I have outstanding to resolve”.
The clear impression from these comments was that Adamson believed that board members were more interested in status than making hard decisions and this created a clash of cultures between his hard-nosed management team and a soft board.
Shareholders were hoping that the appointment of Sir Ralph Norris as a director in 2014 would strengthen the board, but the new chairman remained strongly supportive of Adamson, even after the first profit downgrade earlier this year.
Fletcher Building has been Adamson’s company for the past five years, as was clearly demonstrated by the 2013 Australian interview, along with his remuneration increases.
Adamson’s annual remuneration has risen from $3.3m in his first year to $3.7m in 2013/14, $4.0m in 2014/15 and $4.7m last year, while the total number of Fletcher Building employees with annual remuneration of $500,000-plus has soared from 33 to 61 over the same period.
Meanwhile, under Adamson’s tenure, Fletcher Building has gone from a clear number one in terms of NZX sharemarket value to number five behind Auckland International Airport, Meridian Energy, Spark and Fisher & Paykel Healthcare.
Mark Binns, the Meridian Energy chief executive and a former chief executive of Fletcher Building’s infrastructure division, would probably have been a far better CEO than Adamson but the Fletcher Building board didn’t appoint Binns, who has a more consensus-based approach to business.
The second issue is the complex nature of the group, with 189 separate companies listed in the 2016 annual report.
These 189 companies have legal requirements, with one Fletcher Building executive sitting on 76 boards and another on 56 boards. How can executives do their day job while sitting on over 50 boards and meeting the legal requirements of these companies?
Michele Kernahan, who replaced Graham Darlow as chief executive of the construction division, has also succeeded Darlow on the Fletcher Construction board, the company at the centre of Fletcher Building’s current problems. Fletcher Construction has three executive directors – Kernahan, CFO Bevan McKenzie and company secretary Charles Bolt – but no independent director with in-depth construction experience.
Fletcher Building is in a time warp and badly needs to simplify its business. This includes the rationalisation of its 189 separate companies, the sale of subsidiaries and the possible breakup of the group into different listed entities. The old Fletcher Challenge group was successfully broken into four listed entities in the 1990s, until each of these entities grew far faster than their governance and management capabilities.
Finally, Fletcher Building is a cyclical business but has major problems forecasting business cycles as neither the board nor senior management team have demonstrated strong economic and industry forecasting abilities.
The construction division’s problems are believed to be focused on two projects, the $300m Christchurch Justice and Emergency Services Precinct and the $477m SkyCity International Convention Centre in Auckland.
The company aggressively bid on these fixed-priced tenders without anticipating future cost pressures, mainly due to a shortage of sub-contractors and the huge costs associated with design modifications.
If a fixed-priced contract is completed below the tender price then Fletcher Building records a profit; if it costs more to complete than the tender price the company reports a loss.
Meanwhile, the NBR reported that Adamson sent an email to senior staff last year saying that the company’s construction division was “full of pompous old farts”. This characteristic, if it is true, is not confined to Fletcher Building’s construction division.
The big concern with Fletcher Building is that the construction writeoffs may not be finished and there will be more problems, particularly with SkyCity’s Convention Centre. There are also concerns that the company will misread the residential property cycle and be caught with a large amount of expensive land when the market softens.
The accompanying table shows the operating earnings (Ebit) of Fletcher Building’s divisions over the past five six-month periods. The construction division has achieved solid earnings of $24m to $46m for these six-month periods, although the division is relatively high risk because of its low profit margins.
The construction division is expected to record a loss of between $140m and $150m for the six months ended June 2017, resulting in total operating earnings, before significant items, of only $215m for the six-month period compared with $404m for the corresponding period in the June 2016 year.
The big question now is whether the Fletcher Building board has the capabilities and leadership skills to simplify the business and appoint a new chief executive who can bring employees together, rather than alienate them.
The last person Fletcher Building needs is another big alpha male, with limited industry experience, at the helm.