Kier Group plc (KIE) Earnings Call Transcript

Good morning, and thank you for joining us today. If I can make some introductions, I'm Andrew Davies, the Chief Executive Kier Group plc. And I'm joined today by Simon Kesterton, our Chief Financial Officer. I'll walk you through the full year results presentation, and there will be an opportunity for question and answers at the end of the presentation. And if I could ask, if there's any background noise, I could request all participants to place microphones on mute if they're not talking. So thank you for that. So if we go on into the substance of the presentation, obviously, the disclaimer. And the agenda we'll cover today at the presentation, I'll talk through the highlights of the full year 2020. I will then hand over to Simon, who will talk you through the group's financial performance. This will be followed by an operational update and then a question-and-answer session. So if we start by turning to the results summary and the key highlights for the financial year 2020. This slide sets out those financial results. It was a strong year, both financially and operationally despite COVID-19. We made significant progress with our strategic objectives to simplify the group, to better allocate capital and to generate improved profit and cash through our Performance Excellence culture. But I think before we go on, I'd just like to say a few words on the COVID-19 pandemic. The safety and welfare and well-being of our employees is paramount to us. At the start of the pandemic, we paused work at all our sites to enable the implementation of the new site operating procedures, which followed government guidance and which we keep under constant review to reflect the changing environment. This allowed our teams, customers and suppliers to operate safely in the light of social distancing requirements. The result of this action was to enable us to keep around 80% of all our sites operational during the lockdown period, albeit at lower levels of productivity. We are supporting vital public services, such as keeping hospitals operational, maintaining the road network and supporting utility companies that supply the water and energy needs of millions of households. And we also supported the NHS in building 3 new surge hospitals in Glasgow, Bristol and Swansea. I'm pleased to say we're now operating at near normalized pre-COVID levels of productivity. But nonetheless, I would like to thank all of my colleagues who have continued to work throughout the crisis for all of their efforts. So if we move on to the financial highlights. Kier delivered strong revenue of GBP 3.5 billion. COVID-19 has impacted our revenues by an estimated GBP 260 million in the last quarter. While this is combined with the previously indicated volume pressures in construction and infrastructure following the cycle of long-term investment programs, and our exit from nonstrategic businesses, it's resulted in a year-on-year decline in revenues from GBP 4.1 billion in FY '19 to GBP 3.5 billion in FY '20. We delivered a solid adjusted operating profit of GBP 41 million after the impact of COVID. And before COVID, the adjusting operating profit is GBP 87 million. And we generated strong operating cash flow of GBP 66 million. Significant progress has been made in delivering our operational strategy. Steps to improve cash generation through cost reduction have been successful. As we've previously advised, we've taken decisive management action to address our cost base and operating efficiency. We've rationalized our estate, including the closure of our HQ, Tempsford Hall, delayered our management structure, significantly reducing overheads and outsourced our commodity IT and fleet functions. And these changes have resulted in a reduction in headcount of 1,700 heads overall, which, together with the other actions, will result in an annual run rate savings of at least GBP 100 million by June 2021. And this was a much higher figure than the originally anticipated amount of GBP 65 million. We've moved quickly to change the culture at Kier through the launch of the Performance Excellence program, focused on operational improvement. We've introduced a new governance framework, so we don't return to the poor contracting and poor bidding ways of prior years. That was the past. So we have a new governance underpinned by an operating framework. And it's very much part of the back to basics approach, which we've demanded within the businesses. Doing the basics well, first and always. There's been strong order book momentum. The future of Kier is quite clearly underpinned by the strong order book. We remain focused on winning work by leveraging our core competencies: building on good customer positions we have, particularly with public bodies and regulated industry sectors; working through our long-standing relationships and established framework positions; and importantly, our regionally based operations. And the order book as of 30th of June stood at GBP 7.9 billion. We do expect to benefit from the increase in U.K. government spending given Kier's established position on those public sector frameworks. If we could remind ourselves of Kier's leading position across the industry sectors in which it operates. Last year, we announced the results of our strategic review. One of those conclusions was to focus on our core business of regional build, highways, utilities and infrastructure, operating in the construction and infrastructure markets. These businesses remain inherently cash-generative and operate under long-term frameworks through which we have the opportunity to tender for a range of projects, providing good visibility of future work with an appropriate risk profile. And if we look at each business in turn, in Construction, we are the U.K.'s leading regional builder, providing project delivery across key sectors of education, health, justice and defense for public and private customers. And such examples include Wellingborough Prison and Wexham Park Hospital. The Infrastructure Services sector comprises 3 business units: firstly, Highways, where we're the leading provider of highways maintenance and asset management services to our clients. And through the embedded expertise in designing, constructing and maintaining strategic and local road networks, Kier has delivered GBP 1 billion worth of highways projects designed since 2016 and is critical in maintaining 30,000 miles of the U.K.'s road network. In Utilities, we install and maintain connections in water, energy, telecoms and rail, with partners such as BT, Virgin Media, Yorkshire Water and Scottish Water to name but a few. And in Infrastructure, we undertake a range of major infrastructure projects in a number of sectors in the U.K., including Hinkley Point C Nuclear Power Station and HS2. If we move on to our strategic actions and look at the significant progress we've made. Before the new management team was appointed, Kier struggled with a number of legacy issues, which we've addressed over the last 12 months. We significantly strengthened our executive team. In addition to Simon as our new CFO, the team has been strengthened through the appointment of new group Managing Directors for the Construction and Highways businesses. And the central support functions have been enhanced through the appointment of new HR, IT, commercial and procurement directors and a new group financial controller. We've also refreshed the plc board with a new Chair and 3 new nonexecutives, including a new Chair of the Audit and Remuneration Committees. As I said earlier, we've delivered against our cost savings program. Group headcount reduced by 1,700, helping to realize a savings of GBP 100 million plus by June 2021. In February 2020, we exited from our office in London on Foley Street. In April 2020, we closed our former HQ in Tempsford Hall in Bedfordshire. And the closures are symbolic of a wider change in the organization on both culture and cost management. Our Environmental Services business, which is our waste collection and recycling service business, has been substantially exited with only 2 contracts remaining live together with our Pure Recycling business. Our Property business, which invests and develops some sites across the U.K., has reduced the capital allocated to the business, and we're looking at further opportunities for further release of capital from it. The Facilities Management, which provides management and maintenance solutions to clients. We've rationalized the business, exited loss-making contracts and we're looking at ways of unlocking synergies now of the residual business with our Kier Construction business. And Living, Kier's housebuilding business, is a strong business and operates in an attractive market, but it's not a natural fit with the remainder of the group. We've reorganized the business to become leaner and more cash focused, and we restarted the sale process previously paused due to the COVID pandemic. And we've agreed to a revised deficit recovery plan with our pension trustees that provide significant cash savings for the group as well. If we go on now to look at the COVID-19 impact on the business. Before COVID-19, we had made good progress in implementing a number of measures to reduce our net debt, strengthen our balance sheet and improve our cash management. There's no getting away from the fact that COVID-19 has hit the industry hard and Kier is not immune from its impacts despite maintaining a good level of operational output throughout the pandemic. On the impact side, the pandemic has impacted Kier across the fourth quarter of its financial year, typically a period of peak activity. The level of site activity was lower with a diminished level of new site starts. And Living missed this spring selling season, albeit activity has now returned to pre-COVID levels. This had an adverse impact on revenue, as I said earlier, of around GBP 260 million with a corresponding volume impact on adjusted operating profit of GBP 20 million and a further additional COVID costs of GBP 45 million. It had a large working capital impact. The business typically generates working capital inflows in May and June. The new management is focused on getting out of the cycle and into a more normalized position. And therefore, its average net debt has also been impacted as a result. Going back to the Living business. As with the rest of the house building industry, unit completions and house sales temporarily paused during the pandemic. I'm pleased to say the sales process was paused has now restarted. And our Property business had delayed transactions. But on a positive note, as I said earlier, 80% of our sites in the construction and infrastructure sectors remained open throughout the crisis, and almost all sites are now open and expecting full productivity in September. Our response to this crisis was on the right-hand side of this slide. And first, we dealt with cost reductions. We implemented temporary pay cuts of between 7.5% and 25% across our employees, and it was accepted by approximately 6,500 employees. We accelerated the exit of our HQ at Tempsford Hall. We reduced discretionary spend and further cuts were made despite its fairly strict application and we furloughed 2,000 employees at certain points to reduce costs in line with volumes. But pleased to say we stopped using the job retention scheme as at the end of July as all our sites return to work and productivity normalized. On cash, we maintained our disciplined approach to CapEx allocation and removed all nonessential capital expenditure. And in a manner consistent with our peer group, we engaged with our largest customer, the U.K. government, to ensure prompt payment for work done under [ procure notice 0220 ] and with the HMRC on the temporary deferral of tax contributions. And finally, on covenants. COVID-19 impacted covenant testing period of June 2020. A covenant waiver was obtained for 30th of June 2020 tests, and we're engaged with lenders to ensure flexibility on lending facilities going forward. I'd now like to hand over to Simon to take us through the financial.

Thanks a lot, Andrew. Good morning, everyone. So if we turn to Slide 10, it sets out our high level income statement for continuing operations, so excluding our Living business. Revenue, as Andrew mentioned, is 15% down, and that's impacted by COVID and the challenging market conditions that he described. And I'll walk us through a bridge on a later slide. Adjusted operating profit you can see, down to GBP 41.4 million but impacted by direct COVID costs. So if you add back those direct COVID costs, you can see this would have been GBP 87 million, and demonstrates the significant progress that's been made that we also saw in the first half. Large amount of adjusting items of GBP 218 million mainly relate to rightsizing the business and I'll talk through those in some detail later. Net debt of GBP 310 million for the year-end average and -- for the year-end, and the average of GBP 436 million are in line with our expectations given the impact of COVID. And with committed facilities of GBP 890 million and total facilities of GBP 912 million, the group has good liquidity. Moving on slight. This sets out the revenue bridge that I just mentioned. And it starts with last year's revenue of GBP 4.1 billion. And then as we move forward, we see the COVID impact estimated at GBP 260 million. And this represents just over 6% of the top line decline. The remaining 9% being consistent with what we saw at the first half, driven by those market conditions and the conclusion of several long-term investment programs on the businesses that Andrew just mentioned. Strategic exits. Obviously, lower volumes from exiting Environmental Services and Facilities Management contracts. And then Property, we see the impact there, reducing capital investment at GBP 60 million, bringing us to the just under GBP 3.5 billion of revenue that we see this year. Moving on to adjusted operating profit bridge for continued operations, and we start here with last year's operating profit of GBP 85.7 million. IFRS 16 is a good guy. So this is an accounting change related to leases, and that impacted our numbers positively by just over GBP 9 million. We now have another accounting change, IFRS 15, where there was a benefit last year that wouldn't be repeated this year, and that's a net change of GBP 20 million. Volume, price and mix shown there, including an estimate for the COVID volumes of GBP 20 million, and that totals GBP 33.4 million. Property, clearly, less capital, less invested in that business, less sales means less returns. So a GBP 17 million impact by that. A small amount of inflation, that's not passed through to clients, of GBP 2.4 million. And then you see the management actions which is GBP 65 million, which is cost reduction measures of approximately GBP 55 million and then the remaining GBP 10 million exiting loss-making businesses. That's an impressive performance from the team, especially given the COVID backdrop. The COVID impact we then see at GBP 45 million is a combination of the direct costs that have been incurred and also accruals for holiday pay. And that gives us the adjusted operating profit for the full year of GBP 41.4 million. And as I said, adjusted for COVID-direct costs of GBP 87 million. Moving on then to adjusting items. This table breaks those down into large segments and the largest one I'll explain in a bit further detail. So we have previous acquisition costs of GBP 5 million relating to the McNicholas acquisition in 2017. Next is business divestment expenditure, GBP 34 million, predominantly relating to exiting Environmental Services and Facilities Management contracts, but there's also an impairment of some IT systems and a fair value adjustment in there relating to our recycling business. Cost-saving programs next at GBP 156 million, and I'll unpack that in a bit more detail on a later slide. Amortization of GBP 24 million is acquired intangibles from previous years that we've seen historically. And then in terms of the other GBP 20 million, some balance sheet judgment changes given the external backdrop and additional compliance costs as well. We also note there, the cash cost of this GBP 242 million, being GBP 93 million, of which there's a further GBP 30 million expected to come in the future. So looking then at those cost saving programs in a bit more detail. We see the GBP 156 million comprising of redundancy costs of almost GBP 30 million. Adviser fees, which are related to some of those cost-saving activities and also, of course, the discussions that we've had with our stakeholders and the strategic actions that we've made during the period. Next is restructuring of our Construction business stream. So it's GBP 62 million. That's restructuring and reorganization of GBP 19 million, an adjustment to the Castlepoint outcome of GBP 10 million, and then the remainder is a restatement of the carrying value of certain assets given the post-COVID market conditions. Next, you see lease impairments. That's the exit of our London Foley Street office. Outsourcing costs of GBP 11 million, predominantly relate to the IT outsourcing activities and then we see a property impairment, which, of course, relates to exiting our Tempsford Headquarters in Bedfordshire. One of the benefits of that, you see on the right-hand side. So wages and salary savings of GBP 82 million. The outsourcing savings of GBP 7 million and a footprint savings of around GBP 11 million, brings us to at least GBP 100 million that we will see at run rate at the end of full year of 2021. Moving on then to Slide 15. We try and unpack free cash flow a little bit, and there's a few moving parts here, of course, including COVID. So we look at the EBITDA over the last 12 months due to the rightsizing of GBP 126 million. We then try and consolidate the impact of IFRS 16 to make things consistent. Working capital at an outflow of GBP 54.7 million is quite impressive given that we've borne down on our KEPs facility, so the supply chain facility of GBP 20 million. And of course, you've had underlying revenue reductions of about 9% that's included in that number. Net CapEx is a good guy. So bearing down on the CapEx that's been expended, it's about really focusing on the tools and assets that we've got at the moment rather than acquiring new ones, so GBP 8 million. You've then got some JV dividends that are higher than profits coming in and a small amount of other business, giving operating cash flow of GBP 91 million before you apply interest and tax charges and GBP 21 million of that is interest. You get a free cash flow of GBP 66 million. We then look at the bad guy, which is COVID, and this is predominantly reductions due to volume. So the negative working capital that's experienced on volume driven through May and June in the business, offset, of course, by deferrals of tax-related items, PAYE, NI and VAT. And of course, it's got those COVID cash costs in there as well, and that gives you a net free cash flow of GBP 8.3 million. If we then move on to what are the other moving parts in the net debt bridge. We start with last year's net debt of GBP 167 million. And then we can see the free cash flow there of GBP 66 million, and the impact of COVID at GBP 74 million. We then see those adjusted items that I talked through on the earlier slide at GBP 93 million. GBP 14 million of sales proceeds is due to us bearing down on the capital invested in our Property business. We then see discontinued items, which is our Living business. And investment in that business, roughly half of that is driven by reducing our supply chain finance, so KEPs facility. The other half is really driven by the fact that they were shuttered during their main selling season, which is really April, May and June. Other GBP 14 million is predominantly pension contributions, offset by some smaller good guys, and that results in the GBP 310 million closing net debt position. On to the next slide, financing and liquidity, and which look a little bit about the structure of the balance sheet. So we see net debt at GBP 310 million, and our average net debt of GBP 436 million. The debt is predominantly made up of USPP, obviously, our RCF facility, which is due for renewal in the middle of 2022 and then some further USPP and Schuldschein debt. We've obviously been negotiating with our stakeholders, and so we've agreed waivers at the end of June and covenant resets out to December 2021 and also added a minimum liquidity test of GBP 50 million. But you can see here, there's obviously good liquidity within the group. Next, pension. So a very important stakeholder, a very supportive stakeholder to us. So we've agreed, as expected, to a new deficit repayment plan. You can see there the size of the scheme and the financial accounting surplus. But still obviously an actuarial deficit and that deficit repayment plan, GBP 26 million, repayable between the beginning of this financial year through to the end of December and then GBP 4.5 million the next calendar year and then it's GBP 9 million per calendar year after that. And then there are several mechanisms there to -- basically, if we operate -- outperform operationally, and we add additional payments into the plan. Kier Living next. So this business is held as an asset for sale. It's a strong business, but limited synergies with the rest of the group. And you can see there the revenue impacted significantly by COVID. That said, we've got a new management team in place. They've rationalized the business, making a lot of savings to overheads. They're implementing standard building designs. They reinvigorated the sales and marketing team. And so we feel very confident of the outlook for this business. And of course, we're in the middle of our sales process, which is just getting back up and running. But given the impact of COVID, clearly, there's a lot of work to do with that process in terms of diligence in what is effectively a new business plan. Now I'll hand back to Andrew for an operational update.

Okay. Thank you, Simon. If we go to Slide 20, the operational update. And Slide 21, we'll first look at the Construction business. The Construction segment comprises the regional build business, the strategic projects business, the complementary housing maintenance business as well as the international business. It covers the U.K., delivering schools, hospitals, defense facilities and amenity centers for local authorities, councils as well as the private sector. In the year, the revenue did, as Simon said, decreased 15%, primarily due to the impact of initially the soft market conditions, which were then exacerbated by the effects of COVID-19 on both productivity of open sites and delays in starting new sites. Contract wins continue to be awarded, including securing places on the new GBP 1.5 billion YORBuild Major Works Framework also 7 lots of the GBP 2 billion Hyde Main Contractor Framework. And we're well placed to benefit from the GBP 5 billion new deal opportunities announced by the government, which focus on areas such as health, education and custodial services, where the group has specialist expertise and particular strengths. In the division, adjusted operating profit with corresponding market impact, plus the restructuring, as Simon said earlier, of the regional build business with a focus on the Southern regional build area. We remain focused business on long-term procurement frameworks and already hold strong positions in our core sectors of health, education, justice and defense. And we're awarded places on 16 frameworks in the financial year 2020, with an advertised value of GBP 38 billion over 4 years. In addition, we won education projects for 13 schools with a value of GBP 170 million of revenue. And Kier is the largest strategic supplier to the Department of Education. And we're well placed for the GBP 1.5 billion 10-year capital investment program for building, repairing and upgrading U.K. schools announced by the government on the 29th of June. 88% of our orders are secured in FY '21, and we're confident on the further pipeline. And continued work on existing large projects includes Wellingborough Prison, which I'll talk about on the next slide, and at RAF Lakenheath. And if we just move on, as an example, in a case study of what we do in the major strategic works business. This slide summarizes our evolving approach to design and construction projects in this Wellingborough Prison. That was a GBP 250 million revenue project with 8 blocks and 6 additional buildings in Wellingborough, obviously. It's adopted a modular approach to optimize delivery, which is best illustrated, as you can see in some of the pictures in the top right-hand corner. And it uses a Design for Manufacture and Assembly approach. And this has enabled the standardization of at least 80% of the work on-site with only 20% on a site-specific basis. It's also enabled, through that standardization, the just-in-time delivery method. And the benefits of improved productivity in the build of the site and the project reduce cost. It's clearly safer, bring work to sites in a modular form and better quality construction. If we move on to the Infrastructure Services sector. This comprises our Highways business, the Utilities business and the Infrastructure business. The revenue was down by 10%, impacted by lower volumes, the mix of work in highways and the regulatory transition to the AMP7 in our Utilities business. Adjusted operating profit reduced through the impact of the volume and mix. On the commercial side, in Highways, the Highways business builds and maintains roads for Highways England and a number of district and county councils. The business continued to win work at both national and local levels, including the Area 4 maintenance and response contract as well as local highway wins with Surrey, Birmingham and Northampton County Councils. During the year, 2 of our Smart Motorway projects on the M20 and the M23 were delivered on schedule, and we continue to successfully deliver the third on the M6. We continue to hold a market-leading position with Highways England, evidenced by our winning the Area 4 maintenance contract for Highways England, which is GBP 160 million revenue opportunity for us. We successfully delivered, as I said, the M20, M23 and M6 projects. And on Infrastructure, we're moving ahead well on the Luton DART project, and we're well positioned for further market opportunities. With respect to HS2, early mobilization on HS2 has commenced, and there's a strong potential for incremental work and contracts as work progresses on that project. Overall in the sector, we've got 78% of orders secured for FY '21. And as I said, we have a strong pipeline to enhance that figure. In Utilities, on telecoms, BT Openreach and Virgin have appointed Kier as partners for the telecom's broadband infrastructure rollout works, and we're well placed for anticipated increase in investment and volume in this area. And in Water, we're working with our new client, Yorkshire Water, on mobilizing the new capital works project. If we move on to our Property, Facilities Management and Environmental Services businesses. This segment comprises our remaining businesses, as I said, the Property, Environmental Services and Facilities Management, where revenue we saw was down 37% to GBP 370 million. Adjusted operating profit was down to GBP 5.1 million. The Property business invests and develops schemes and sites across the U.K. Profit for adjusting items was behind last year, principally due to delays in the completion of certain projects and the prudent allocation of capital, as Simon mentioned earlier. Management is reviewing options for further release of capital from this business. The Facilities Management business provides management and maintenance solutions to its clients. And consistent with our strategy, we've rationalized the business, which now seeks to identify, as I said earlier, synergistic opportunities with the Construction business for the benefit of the group. And finally, the Environmental Services business, which provides waste collection and recycling services, revenues were behind the prior comparative period, although losses significantly reduced as we exited loss-making contracts. And we have, in fact, substantially now exited this business with only 2 contracts remaining together with the Pure Recycling business, as I mentioned earlier. If we go on to Slide 25, our strong order book. The organic growth in the medium-term is underpinned by the strength of our order book. It stood at GBP 7.9 billion at the 30th of June 2020, and we continue to win work doing COVID across all of our core businesses. The GBP 4.6 billion order book in Infrastructure Services, GBP 2.3 billion in Construction and GBP 1.1 billion in other Kier businesses, which is mainly FM, are also supplemented by very strong framework positions and a strong pipeline of new opportunities. If we move to the culture within the business on Performance Excellence on Slide 26. Our Performance Excellence culture is an enduring way of working, a continual aim of always working to be better, that is fundamental to how we operate. It provides a clear and consistent framework with projects at its core to ensure we consistently deliver to our clients and their customers. For our Performance Excellence work streams, we've identified clearly defined outputs. Our new operating framework sets out the governance structure within which the group will operate. It also provides clarity on key roles and responsibilities. And alongside the new code of conduct, guides the behaviors expected from those who work for Kier and it provides clear delegations of authority for them. Our projects are our lifeblood, and our new project life cycle gated approach ensures we have a consistent, aligned and focused approach to our delivery. Each gateway, excuse me, has a clear set of mandatory requirements, which must be completed and approved before moving to the next phase. Our people make the biggest impact within our business and our new performance-centered leadership framework is our people operating system, a set of principles and processes that shape what we do and why we do it. It's designed to drive effective and consistent performance across the group and will support our employees and help them reach their potential. So if we move on then to Slide 27, the summary. We have put in place an experienced management team with a proven track record of operational and financial turnaround. And we are operating in strong market positions in Construction and Infrastructure that are aligned with and will benefit from increased government spending. We will drive profit and free cash flow generation by the implementation of our culture of Performance Excellence. And lastly, we will continue to focus on fixing the balance sheet, whether it's through cash generation, the sale of our Living business and a potential equity raise. So that draws a close to the formal presentation. And with that, I'd be very happy to open the floor to any questions you may have.

[Operator Instructions] Our first question is from Johnny Coubrough of Numis.

Can you hear me, okay?

Yes, we can hear you.

Fine.

Okay. 2 questions from me, please. Firstly, in terms of the cost-saving measures taken in the period. I wonder whether these have been modified versus what you're expecting to see earlier in the year as a result of pandemic and the changing market outlook. And then secondly, in terms of the direct COVID impact on profitability, would you expect this to be ongoing in the current year? And do you also foresee any further indirect impact through volume, price and mix?

Perhaps I'll just take the first one. There's 2 levels of cost savings, I think we were referring to in the presentation. The first one is the cost savings, which we launched last year, which we've indicated that we've now reached a GBP 100 billion run rate in June 2021. Those cost savings have been delivered. We'll see the benefits of those come through at that run rate from, as I say, June 2021. The COVID cost savings were separate from those, which were in response to the crisis as we saw it. So we did move pretty fast and decisively. And we asked our employees to take a pay cut, as I said, between 7.5% and 25% for a temporary period, which they did do up until the end of June this year. We also accelerated the closure, as I said, of our HQ in Tempsford and also curtailed what was already a fairly disciplined approach to discretionary spend and capital expenditure as well. And we did have to furlough 2,000 people to reflect the volumes that we were experiencing at that point in time. So there are really 2 different things. The COVID ones, as we've said, now have we unwound, there were temporary pay cuts. We have brought everyone back off furlough at the end of July. But obviously, the CapEx and the [ temp support ] ones will be enduring.

Yes. And I'll take the second one. With regard to the direct COVID impact, I mean, clearly, the bulk of that impact will be in Q4 of this financial year that we're presenting. Of course, lockdown ended in July. So the first quarter year will be slightly impacted, but it will be a much smaller impact than we've seen here, which was in Q4.

And your next question is from Andrew Nussey of Peel Hunt.

Again, a couple of questions from me. First of all, in terms of working capital, which was obviously disrupted in Q4 because of COVID. Can you give us any insight to how working capital trends are evolving now that sites are unlocking and when you might expect a sort of a degree of normalization from a trading perspective? And secondly, in terms of contract mix and obviously, the impact on margin. Just wondering, Andrew, if you can give us any insight to any normalization that might -- when you might expect some normalization within the Highways business, obviously, noting the Area 4 win ahead? And also, just any comments around sort of the regulated side and the water side, in particular, where I think some peers have noted some degree of sluggishness in terms of near-term contract awards and frameworks?

Yes. So I'll take the working capital one first, Andrew. So if you think about working capital, yes, I think it's pretty much returned to normal now. As activity picks up, that negative working capital comes in. That said, of course, our activity levels at this time of the year aren't as high as they would have been in Q4. So I wouldn't expect that strong working capital inflow to actually occur until Q4 of this financial year. Now holding that back will be the impact of COVID in terms of the support with regard to PAYE, NI and VAT deferrals that will actually unwind as we go throughout this financial year. So hopefully, that answered that question.

On your second question, Andrew, on the contract mix in our Infrastructure Services sector, it's a little bit of a mixed bag. Just answering your second question sort of first. We did do in COVID see in the utilities business, sort of, pulling back slightly of the medium and larger CapEx projects and the focus on repair and maintenance, as I said in my opening piece, in this. And that obviously did have a impact on the mix, on the volumes and on the margin as well. I don't think we've seen sluggishness. I think we've got a couple of new contracts, which are mobilizing and obviously, COVID has, to a degree, got in the way of that mobilization. But we believe that's a little more of a timing issue than anything else. And we have been mobilizing a fair few contracts, predominantly in the telco sector, which I mentioned, the BT, the Virgin Media broadband rollout, which we're currently mobilizing as well. So I think it has been slightly impacted. I don't think it's sluggish. I think it's more of a little bit of a timing issue due to the recent mobilizations, and we hope to see that coming through. And in Highways, I mean Highways all credit to Highways England and the local authorities. They had a major focus on keeping all the networks fully operational and functional. We handed over, at the height of the COVID pandemic, 2 of our Smart Motorways, M20 and M23, and Highways England were able to accept those. So they really had -- they really leaned forward into this pandemic as a client. There was a change in mix, which will, again, have had a slight change in volumes and therefore, in margin as well. But I think we've seen that unwind quite quickly in highways, and we're seeing quite normalized volumes and mix is now coming through.

Andrew, we have a question from Joe Brent of Liberum.

2 questions, if I may. Firstly, on residential, could you talk us through the impairment and whether that now represents a fair value you might look to get in the sale? And secondly, with regards to property. You've clearly got over GBP 100 million of assets there. What's your ambition for that? Are you going to kind of hold it steady or gradually reduce it?

Yes. So thanks for the questions, Joe. First, on residential, we obviously impaired that asset at the half year as well and [ adding ] to GBP 125 million. And there's been a further impairment, really incremental in the second half, down to GBP 110 million, and that clearly reflects the impact of COVID effectively and the expected outcome. That said, we're quite early on, on restarting the process and another diligence is there. So of course, that will be just a valuation made on an estimate by advisers. Now if we look at property, this is a good business. Unfortunately, if you go below about GBP 140 million invested in that business, it starts to become inconsistent. You're actually cutting your way at the fabric of a good business, which actually has good synergies with our other businesses, our Design and Construction, Utilities businesses would actually have great synergies with this business. So we see there really the capital invested to be in a range of between GBP 140 million to GBP 170 million in the medium term.

And then there [indiscernible] no plans to reduce that?

Not further than the GBP 140 million, no.

I think Simon has said previously, I think you said at the half year, it's been a case of reallocation of capital and where you want to put your priorities. So we sort of focused on that as where we'd like to put our discretionary capital as opposed to the CapEx, which you see has come down quite a lot. And I think that's the decision we've taken. Simon's implemented this. We're trying to sort of maintain a sensible level of capital at feeds that business, allows it to thrive with a lot of the great JV clients it has and relationships they have, which are synergistic with the business. So -- but that's the right level, we think, of capital that business needs.

Joe, we now have a question from Sam Dindol of Stifel.

A couple of questions from me. Firstly, on covenants. I mean that is a -- one question [indiscernible] [ I've been asked to ] and give any sense of what sort of the relaxations are through to the end of 2021? And then secondly, on sort of competition. I think you mentioned rising competition on the framework side when we last spoke a few months ago. Is that something you expect to accelerate post-COVID or sort of any views on [ post ] competition backdrop, that be great.

Yes. So firstly, on covenants, clearly, we've reset those, and you have to stress test those, as we've mentioned, Sam, under severe and plausible downside situations. So there's clearly reasonable headroom throughout those covenants, which have been relaxed going forward. Andrew, do you want to take that?

Yes, I think, Sam, on the framework position, obviously, you have to be in the framework to be able to compete in the framework. So the first case point is you've got to get in them. So I don't think that's the area where competition is. But I think we are seeing an increased competition within those participants on frameworks and hitherto has been the case. And that's not surprising because the government has offered very strong rhetoric in support of a lot of the areas which those frameworks cover like defense, justice, and in particular, health and education. So we see the market expanding. So we'd be looking certainly to expand our share with that market and maybe grow a little on the base of it. But we -- healthy competition is good, but it's competition within the framework, and I think that's the point to remember. And we do, as a point of strategy, make sure that we participate in as many of these key frameworks as we possibly can, and we'll continue to do so.

Sam, we have a question from Stuart Fraser of Trium Capital.

You mentioned on -- just back on the construction, you mentioned a soft market, then COVID. Could you outline what's happened since? And second point is, in answer to the question, you talked about the normal Q4 working capital inflow happening then. And then you referred to an unwind of PAYE and government support. Can you tell me how that will map out? And what will that will do to the average debt in the business?

So on Construction, we -- I think we said at half year, we have seen a slight softening in the market because the market conditions and in particular, around the government clients because of the issues relating to the CSR, the Brexit issues, the election, et cetera, et cetera. So that sort of predates COVID with a little softening of that. But I think we're now seeing the market come back a little bit as well as witnessed by some of the recent orders, which we've been getting. So I think we're moving to more normalized territory. And then obviously, on top of that, you are now getting the announcements from the government, and they'll be enacting those announcements as we go forward. So we feel that's -- there was a little softness there, but it's returning, and we're confident in the outlook.

Yes. And moving back to working capital, you're absolutely right. So in Q4, we should see that volume-related working capital benefit in this year come back, which we mentioned on Slide 15. I mean, that is going to be offset during the year as we'll have to repay back this deferred VAT, PAYE and NI. So that will almost go to offset that when you combine it with the fact that I also mentioned, there was about GBP 30 million of cash costs relating to adjusting items that will also come through. And those are all virtually going to net out across the year.

Will the average debt figure be falling significantly during the year?

No. I mean if you think about average debt, it's a mass number. So we're starting the year out as opposed to having GBP 167 million as the opening number, we're starting with GBP 310 million. So just that differential divided by 13 hits your net debt quite significantly. So if you work all that out, you're probably anticipating it's likely to be flat throughout the year.

Right. And where does that leave you vis-à-vis raising capital either through disposals, internal cash generation, which you said it's not going to happen this year or indeed equity?

Yes. So finally, when that unwinds, you do, do then have a business that should generate reasonable free cash flow. And of course, you do have the business to sell in terms of the Living business.