Budget cuts start to bite Whitehall's contractors

As the Government outlines its public spending cuts, companies are beginning to feel the pinch

RM, a company that makes educational software and electronic whiteboards, tried to put a brave face on it all yesterday, stressing that it was "well placed" to adapt to changes in its industry.

The market was not convinced. At one point the group's shares dropped by more than 10 per cent after RM told investors that it was exposed to seven contracts under the Government's Building Schools for the Future programme, worth £200m, which could now be axed under plans to review the cost of the project.

RM is not alone, and yesterday it joined a growing list of nervous companies that have put their heads above the parapet, telling investors that because of the huge spending cuts announced by the Government, life is going to get a lot tougher.

Two weeks ago, shares in Connaught tanked after it issued a statement at five minutes past four on a Friday afternoon, saying it had identified 31 projects in its social housing division "where a proportion of the value relating to capital expenditure has been deferred".

Despite the carefully worded statement, and an effort to reassure backers that Connaught is "ideally placed to meet the emerging requirements of this market," the company has lost 65 per cent of its value since the announcement.

Until recently, government ministers, chief executives and everyone else spoke about cuts to public spending – expected to be as high as 40 per cent in some departments – in abstract terms. The cuts would be deep, they all promised, but most company trading statements continued to use the ubiquitous, and largely meaningless, phrase that the chief executive was "cautiously optimistic" about the future.

"There are a number of sectors that will be hit directly by the cuts," said Kirsten Tompkins, an analyst at Ernst & Young. "Any group in the support services, IT or construction industries will know that they will be affected, and in some cases severely. Of course, there are others, like many of the non-food retailers and the travel groups, that will be hit indirectly."

Ms Tompkins' predictions are already starting to ring true. Balfour Beatty, the infrastructure group, also issued a trading update yesterday arguing that it has long been "positioned" to deal with the anticipated cuts. The group said that its order book is healthier than in the past, but that has still not stopped its shares sliding by nearly 20 per cent in the last three months, as the markets grew nervous about the 20 per cent of its revenues that come from public contracts.

The Government has maintained that the public spending cuts are vital to reduce the UK's yawning budget deficit. The Conservatives made great play in during the general election campaign that it had the support of top business leaders. But that has not stopped some of the new Government's business champions complaining about the measures. The clothing retailer Next, led by its Tory cheerleading chief executive, Lord Wolfson, issued a trading statement on the day before the vote saying: "We remain very cautious in our outlook for the year ahead," blaming the anticipated cuts for expected falls in consumer spending. Carpetright, led by another Conservative grandee, Lord Harris, said last week that it expects consumer demand to remain "subdued".

The construction industry is also likely to come under huge pressure as the cuts bite. The UK's biggest housebuilder, Persimmon, was another to update the market on its progress yesterday. The group was able to impress, saying that sales and the operating margin were both up significantly on last year. But its chief executive, Mike Farley, sounded a warning that it will take some time before the full effect of cuts will be known. "How severe[ly] people take the Budget, that is the fundamental issue for us, that is something we won't know more about until the autumn," he said.

Analysts at Investec said the group's outlook statement had a "noticeably hesitant tone".

Economists differ on whether the Chancellor, George Osborne, has got the scale and timing of the cuts right, but nearly all agree that the effect will be fewer public-sector jobs and some companies going to the wall. "In reality none of us is prepared for what is the biggest fiscal retrenchment since the war," said Grant Lewis, the head of economic research at Daiwa Securities. "This will lead to hundreds of thousands of public sector job losses, and a number of companies that depend on public sector contracts really struggling."

A Treasury spokeswoman said that the Office for Budget Responsibility's forecasts "show a gradual rebalancing of the economy, with business investment and exports playing a greater role than government spending, and growth in private-sector employment offsetting reductions in the size of the public sector".

On the whole, companies such as RM and Connaught are big enough to battle through the tough times ahead. But for smaller companies, many of which depend on government contracts for much of their revenues, the cuts could be damaging.

"We are very concerned about spending cuts on many small businesses, from building firms to travel companies and everything in between," said Stephen Alambritis, the chief spokesman at the Federation for Small Businesses. "The situation is not great already with only 15 per cent of government contracts going to small companies, but with the cuts coming along, there's likely to be even less to go around. The VAT rise in January is not going to help either."

The Government's decision to increase VAT to 20 per cent has led to warnings about the resulting drop in consumer spending. Responding to the Budget, the British Retail Consortium's director general, Stephen Robertson, said that while the Government has tough choices to make, the VAT hike will hit "jobs, consumer spending, the pace of recovery and add to inflation".

The make-up of UK plc could change dramatically, with groups hit hard taken out by rivals. But some will not even be that lucky. As Daiwa's Mr Lewis points out, the cuts are likely to lead to some companies going out of business altogether: "The final impact of the cuts cannot be known yet, but some firms that have a huge reliance on public-sector contracts will just not be viable. Some will shrivel up and disappear."