Cheesegrated expectations - Having a market to itself is still no guarantee a business will succeed


Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

In April 2011, in Creative destruction, we suggested structural steel fabricator Severfield-Rowen, which has supplied such high-profile projects as the Olympic stadium and the Shard at London Bridge, was well-placed to capitalise from the departure of a number of weaker competitors from its sector.

“Investors are often quick to identify the short-term pain whilst ignoring the potential long-term gains,” we concluded. “the process of ‘creative destruction’, as the economists call it, can be very beneficial for those companies able to stick around for the long term – not to mention their investors.”

Theory is one thing, reality another and, some two years later, the operative word in that final sentence turns out to have been “can”. On 23 January, Severfield issued a trading update, in which it admitted its UK performance had been “further, and materially, adversely affected by cost overruns on our 122 Leadenhall contract”.

Better known as the ‘Cheesegrater’ project in the City of London, this was a significant deal for a structural steel company to win. Indeed, with few businesses left in the UK market with the ability to service that sort of contract, it was part of our original case for a potentially brighter future for Severfield.

Nevertheless, even though the company has a shrinking number of major competitors, something obviously went wrong – possibly incorrect pricing or cost mismanagement – and the upshot is that the company will make a negligible profit this year and indeed it could very well make a loss. Furthermore, it will more than likely need to go back to its banks to discuss its funding arrangements and may well breach its banking covenants.

It is very difficult for any investor on the outside to appraise a company on a contract-by-contract basis and inevitably businesses such as Severfield will have deals that go wrong from time to time. Investors just have to hope that companies do their best to ensure that these things happen as infrequently as possible and, that when they do happen, the losses are manageable. It also tends to be the case that when times are tough and companies are keen to win large projects like the Cheesegrater, that corners get cut and slip-ups become more likely.

While the company’s profits and share price have now both suffered setbacks, none of the longer term positives were highlighted two years ago have necessarily changed. Something that has changed though is the company’s balance sheet, with tough trading and tightening working capital terms taking their toll and pushing debt higher.

As we’ve said many times before, the more debt a company has the greater the risk that short term problems will prevent shareholders benefitting from its long term potential. This is because in order to placate its lenders companies may be forced to do anything from pay higher interest rates and fees to see debt providers take over some or all of the business.

The process of ‘creative destruction’ that we sought to highlight in our April 2011 piece continues to change the corporate landscape. Whilst the retail sector – with the insolvencies of Comet, HMV and Jessops amongst others – has had the headlines recently, the phenomenon is at work throughout the economy. the rewards for the firms that make it through intact are potentially considerable but, as Severfield reminds us, having a strong balance is the best way of protecting against any nasty surprises that might pop up along the way.  


Andrew Lyddon

Andrew Lyddon

Fund Manager, Equity Value

I joined Schroders as a graduate in 2005 and have spent most of my time in the business as part of the UK equities team. Between 2006 and 2010 I was a research analyst responsible for producing investment research on companies in the UK construction, business services and telecoms sectors. In mid 2010 I joined Kevin Murphy and Nick Kirrage on the UK value team.

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