After weeks of what the Conservative party insisted was mere speculation, Prime Minister Rishi Sunak finally killed off the extension of the HS2 high-speed rail network from Birmingham to Manchester, pledging to use “every single penny” of the £36bn of savings on other transport schemes across the north and Midlands.
He announced a new package of measures titled Network North that will fund projects to speed up east-west rail links across the north of England. He also pledged money to extend the West Midlands Metro and for a tram system for Leeds, as well as £3.3bn to fix northern potholes. “As a result of the decision we're taking today, every region outside of London will receive the same or more government investment than they would have done under HS2 with quicker results,” he said.
However, scrapping HS2 is seen as a blow to the government’s “levelling-up agenda” to strengthen economic activity in the North and the Midlands. Labour’s mayor of Greater Manchester, Andy Burnham, and council leader Bev Craig wrote to Sunak ahead of the announcement arguing that the north of England “should not have to pay for the government’s mismanagement of the HS2 budget”.
HS2 was originally budgeted at £37.5bn in 2013. The last official estimate of its cost was around £71bn in 2019, but soaring steel and concrete prices since meant it would likely have taken more than £100bn to complete.
Delays clearly haven’t helped. The four major contract packages were awarded to the consortiums building them in 2017, but the scheme was then placed under review and a ‘notice to proceed’ paving the way for a start on site was only given in April 2020, by which time supply chains were being upended by a global pandemic. Opposition to the scheme also ramped up costs by forcing more of it underground. Phase 1 contains 32 miles of tunnels, as opposed to the 18 miles originally proposed.
Phase 1 is now 40 per cent complete, with some 30,000 people currently working on it.
It is being delivered by contracting heavyweights from across Europe (see box below), as well as UK-listed entities including Balfour Beatty (BBY), Costain (CST) and Kier (KIE). Other UK equities with exposure to the project include steelmaker Severfield (SFR) and groundworks contractor Keller (KLR), according to broker Liberum.
No phase 2 assumptions
Contractors working on the scheme have been keen to stress that the upheaval won’t affect financial forecasts. Kier reported its full-year results when news of phase 2’s potential axing first broke last month. Chief executive Andrew Davies told shareholders that it had “no assumptions in any of our financial forecasts for any work on Phase 2a or Phase 2b”, particularly as rephasing of the latter meant there was unlikely to be any budget for work for several years into the future.
Balfour Beatty did have to contend with some phase 1 rescheduling earlier this year, but said when reporting half-year results in August that it had rebalanced workloads and saw “no material changes” to its forecasts.
The contractor most exposed is Costain, whose consortium is due to deliver the tunnels connecting the Old Oak Common station in West London to Euston. This leg of the project was paused in March and Costain's share price swung wildly earlier this week as rumours swirled about its fate. It was spared, saving a headache for Transport for London as passengers would have overwhelmed the Elizabeth Line when trying to get into central London. Responsibility for the Euston station site was stripped from HS2, however, and will be handed to a newly created Euston Development Zone, Sunak said.
Liberum analyst Joe Brent said the cancellation of phase 2 was unlikely to change the forecast horizon for most UK-listed contractors given that contract awards were so far off. Work on phase 1 stretches out into 2032 and there are still some major packages to be won, such as the installation of power lines.
This isn’t to suggest that there’s been no harm done. Mark Reynolds, whose project management firm Mace is working on two major station contracts, said the decision not to proceed with phase 2 "will seriously undermine business and investor confidence in the UK and our ability to deliver on our pomises – as well as having a chilling effect on the UK construction industry".
Several big engineering consultancies have either been bidding for, or have actually won, big pieces of work on the now-scrapped portion. A development partner and engineering consultants were first appointed for phase 2b (Crewe to Manchester) in 2017. Three bidders were shortlisted for design work on phase 2a (Birmingham to Crewe) in 2021 and a winner was supposed to be announced last year. Just last week, HS2 awarded £300mn of ground investigation contracts – consultancy Aecom (US: ACM) picked up an £85mn deal to oversee the project, while nine contractors (including a subsidiary of Van Elle (VANL) were appointed to a framework that was meant to deliver it.
The High Speed Rail Group said scrapping phase 2 would add to the perceived risk of doing business in the UK, and to "the cost of each and every infrastructure project in the future”.
Government pledges to reinvest the money saved also face some scepticism. Alasdair Reisner, chief executive of the Civil Engineering Contractors Association, said the industry would have “lower confidence that these would not then themselves be quietly cancelled further down the line”. “Government no longer looks like a reliable customer to industry,” he added.
Liberum analyst Brent was more phlegmatic, arguing that “prudent companies always expect a degree of dithering and delay from government”. Besides, contractors’ shares “are still in the bargain basement”, he said, with Kier and Costain shares both priced at just five times FactSet consensus forecast earnings, while Balfour Beatty is priced at just eight times.
Such low valuations are “not deserved given the strong outlook, improved business models and strengthened balance sheets” of the trio, Brent added.
