Peter Wallin, group CFO of construction and development giant Skanska and the keynote speaker at FDE’s December breakfast briefing, talks about why cash management and risk mitigation are key elements of the company’s growth strategy.
Heron Tower became the tallest building in the City of London when it opened its doors in April 2011. Along with the neighbouring 'Gherkin', this 230m-tall building ranks as one of Skanska's most impressive constructions. The Swedish construction and development group has also been busy in the US rehabilitating and reconstructing the Brooklyn and Manhattan Bridges, as well as designing and building the MetLife Stadium in New Jersey.
At the same time, Skanska continues to thrive in its original market of Scandinavia, and specifically Sweden, where it has been active for 125 years. The company is also a player within commercial, residential and infrastructure development. One of Skanska's recent projects, the Karolinska University Hospital - operated and financed under a public-private-partnership - is its largest-ever construction project.
Peter Wallin began his career at Skanska in 2000 as senior vice-president overseeing group investor relations. It wasn't long before he became CFO of the company's infrastructure development division, followed in 2008 by promotion to CFO of Skanska Sweden. Wallin's focus during this period was managing risk connected to the global downturn on the back of the weak financial markets. Mitigating risk remains a priority in his current role of Group CFO.
"We act within given risk parameters and in markets that have not been overly exposed to the European debt crisis," Wallin says. "We don't have business in any of the Mediterranean countries, or in Germany, which was tough after the unification."
In fact, the only euro-denominated country that Skanska operates in is Finland, arguably one of the continent's strongest economies. Wherever the company operates, it uses the same basic approach to building up value when investing in development operations; starting with a land plot or a development agreement, value is gradually created as the project is strategically managed through different steps in the value chain.
"When building a stable asset, you need to get certain things right," Wallin explains. "With commercial property, it's important to have a very good tenant structure, and in order to get that you have to have a good micro-location that creates a demand for your property."
Skanska's infrastructure development unit invests in traditional European public-private partnership (PPP) projects as well as the market-risk projects that are more common in the US and Latin America. But, even here, extensive project planning is needed. Investing in a road that people decide not to travel on, for example, can expose a construction and development company to significant price and volume risks.
The company's success is also rooted in its approach to risk management during construction and development operations. Each of Skanska's businesses has its own 'heat map' outlining the areas they can operate in, the kind of construction they can do, the amount of work they can carry out and the legal framework around the contract.
"If any project strays outside those parameters, a red or yellow flag will appear, which means that a more thorough risk analysis is needed," Wallin explains. "We also have a senior management committee that, in addition to the regular risk process, reviews the large and most complex projects every second week. And for the absolute biggest and most difficult projects, the board is part of the decision process. These projects are also followed and tracked throughout the entire lifecycle, looking at cash generation, profitability and their respective challenges."
Aligning cash and cost strategies
With traditional lines of bank credit remaining expensive and difficult to access, the need for treasury departments to become in-house banks that can fund growth - and in Skanska's case, new projects - is a priority.
"It's a stretch to say that what we're doing is hoarding cash," Wallin says. "It's about having the cushion to take on the volatility we're seeing in the market. The bank system is no longer the only source of funding for big corporations. CFOs need to secure it from other sources such as the corporate bond market."
Having the appropriate level of cashflow is particularly important in the construction sector, where the cashflow from customers to subcontractors and material suppliers, has to be managed in each and every project. Equally important to measuring the financial health of a project is capital efficiency - the ratio of output to cash outlays.
"In a company brought up under the construction umbrella, cost control and cost awareness are very important," says Wallin. "We always try to keep track of operating margins and capital efficiency - these are the core values of that business."
Skanska uses the cash generated by its construction business to invest in development operations. The focus is on using these funds as efficiently as possible and Wallin stresses the importance of looking at risk-adjusted returns on capital. In a company with different revenue streams - in this case, construction, commercial, residential and infrastructure development - an important part of the process is understanding the way in which the different parts operate, differentiating the various business models and then acting accordingly.
That philosophy also applies to Skanska's incentive structure. The division is clear; on the constructions side, incentives are based on absolute dollars produced in profit and cash generated; for development, it's based on absolute profit and returns on investment.
Wallin is keen to emphasise the importance of people in driving capital efficiency and of having a "cash consciousness". With 10,000 projects taking place around the world, an appreciation of cash management is a priority. For better or worse, construction is a decentralised business. That means that the project leaders need to have a good understanding of the capital they tie up and the cash they generate.
"We need our people to have good financial acumen," Wallin says. "It's about having a really widespread awareness out there in the organisation. If someone is not performing well they get to know the message very quickly."
With developing markets springing up around the world, geographical expansion is a hot topic on most CFOs' agendas. Occasionally, that excitement causes finance directors to overlook the potential of existing markets, but that's not the case with Skanska, as Wallin explains.
"We're one of the largest construction companies in the US, but we still have below 1% of the total market," he says. "We think that in order to be most risk-efficient and allocate our capital sensibly, we need to increase business within our existing geographies."