Practical steps for responding to the coronavirus crisis
The COVID-19 pandemic and its attendant effect on markets and commercial activity will likely present 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 may be delayed, or perhaps 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 likely to be 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.
Considerations for engineering and construction companies
Here is our take on some issues that companies in your industry may face:
Crisis management and response
The industry should prepare for potential struggles in the subcontractor middle market of the industry, especially if 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.
Steps to consider
- Work closely with subcontractors (and governments) and consider emergency measures to assist them in the case of widespread construction site shutdowns.
- Assess how profitability, loans, revolving credit and cash flow reserves can support ongoing operations in a low-revenue environment — in light of current (and forecasted) cash operating expenses, taxes and other cash expense items.
- Review capital and corporate cost budgets to help identify not only marginal investments, but also discretionary items that can be cut.
- Consider divesting non-core or possibly underperforming assets or assessing mergers and acquisitions (M&A) prospects as potential sources of cash.
- Consider refinancing debt — although access to capital may be constrained.
- Work closely with municipal, state and federal governments to coordinate plans for worker and consumer safety, while keeping mission-critical projects running.
- To help assess labor costs, consider workforce contingency planning scenarios, including during a period of diminished demand and activity.
E&C companies should prepare to 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.
Steps to consider
- Confirm that your employees are safe and know how to protect themselves. Consider instituting sanitation rules in the workplace and assess mobility policies to encourage remote working, when necessary and possible. Ask employees who are sick to stay home until they are better. Stagger shifts, increase distance between workers and ban visitors to construction sites. Eliminate non-essential travel.
- Consider “forward-paying” subcontractors whose construction sites have been shut down due to COVID-19 containment efforts.
- Establish risk-mitigation programs for employees who still need to work on-site. Invest in education campaigns for front-line employees who have to be on-site so they know what to do to minimize the spread of the disease and what to do if they experience symptoms.
- Consider potential workforce scenarios to help reduce immediate labor costs.
- Gather necessary data on employees (geography, visas, etc.) and track movements during the crisis.
- Consider which functions may be outsourced to help trim operating costs.
Operations and supply chain
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?
Steps to consider
- Work with local, state and federal governments — and your subcontractors — to help assess which construction projects may be shut down, and prepare accordingly.
- Transfer new knowledge down the supply chain. Update leading practices as the situation evolves, and assist subcontractors and governments in implementing them. This may require increasing transparency in the supply chain through daily self-reporting with critical suppliers.
- Gain a keener, real-time situational awareness of your supply chains, especially those affecting critical materials and components. Identify potentially weak links in the supply chain — especially in geographies currently affected by COVID-19 and those that could be impacted in the future.
- Prepare for supply chain pivots that could mean identifying alternative suppliers.
- Prioritize cybersecurity and system resiliency in response to significantly higher levels of remote access to core systems, and because employees and management could be more susceptible to social engineering efforts in the midst of a crisis.
- Evaluate the use of automation solutions to reduce the number of workers on sites. Companies that have piloted solutions should ramp them up carefully, while others should start exploring them. Focus on autonomous materials movement (e.g., autonomous forklifts and cranes and high-payload drones) and the automation of repetitive tasks.
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.
Steps to consider
- Broaden disclosures to go beyond what’s required in financial statements. For example, you might consider disclosing management’s analysis of the current and potential future impact of liquidity and credit crunch on the business.
- Plan for impairment and disclosure considerations, particularly if your company’s fiscal year ends on or after Jan. 1, 2020, as any adverse financial implications may be considered a Type I subsequent event (vs. a Type II).
- Plan for disclosures about risks, such as how recent events may impact current and future judgments and the estimates inherent in financial reporting (e.g., inventory obsolescence, receivables collectibility or debt covenants).
- Proactively communicate with lenders and other stakeholders to avoid surprises and enable potential rescheduling of debt or alternative financing sources.
Tax and trade
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.
Steps to consider
- Plan for — and assess — potentially major tax-related changes announced by the government that could impact your employees (e.g., payroll tax cut, sick leave pay).
- Companies with extensive international supply chains should consider the tax and transfer-pricing components of restructuring their supply chains. Planning should go deeper than merely identifying alternate suppliers. Implications could include customs and duties, as well as transfer-pricing considerations if the substitute components or materials are internally sourced.
- Companies need to consider trade and customs impacts. Global companies should evaluate whether it is advantageous to repatriate overseas cash from foreign subsidiaries.
- Companies with stronger balance sheets may have M&A opportunities.
- Plan for the prospects of tax benefits from fiscal stimulus packages, which could include payroll tax reduction, NOL carrybacks, delay of effective date of certain TCJA provisions, add back of depreciation and amortization for Section 163(j) purposes, and deferred amortization of R&D expenditures. Also, prepare for the prospect of the stimulus including guaranteed loans.
- Address mobility and immigration issues for employees moving in and out of areas affected by COVID-19. Consider the tax implications of mobility. Depending on where you temporarily host employees, the company — and the employees — may face unintended tax consequences.
- Plan strategically. Operations in one jurisdiction may be more favorable — both tax-wise and operationally — than another during this crisis.
- Assess the countries in which your company may be vulnerable — both in repatriating cash and in stranded assets. Monitor and reassess other geographies on an ongoing basis and adjust your cash-flow strategies as needed.