Published: 2018-11-08 07:00:00 CET
Nordecon
Quarterly report

2018 III quarter and 9 months consolidated interim report (unaudited)

This announcement includes Nordecon AS’s consolidated financial statements for the third quarter and nine months of 2018 (unaudited), overview of the key events influencing the period’s financial result, outlook for the market and description of the main risks.
Interim report is attached to the announcement and is also published on NASDAQ Tallinn and Nordecon’s web page (http://www.nordecon.com/for-investor/financial-reports/interim-reports).
Period’s investor presentation are attached to the announcement and are also published on Nordecon’s web page (http://www.nordecon.com/for-investor/investor-presentations).

Condensed consolidated interim statement of financial position

EUR ‘00030 September 201831 December 2017
ASSETS  
Current assets  
Cash and cash equivalents9,3648,915
Trade and other receivables38,54335,193
Prepayments2,5621,641
Inventories20,66423,230
Total current assets71,13368,980
 

Non-current assets
  
Investments in equity-accounted investees2,2751,888
Other investments2626
Trade and other receivables9,1638,950
Investment property3,5494,929
Property plant and equipment12,23512,566
Intangible assets14,64914,639
Total non-current assets41,89742,998
TOTAL ASSETS113,030111,978
   
LIABILITIES  
Current liabilities  
Borrowings21,49116,197
Trade payables36,76735,926
Other payables9,7795,654
Deferred income5,7843,651
Provisions591664
Total current liabilities74,41262,092
 

Non-current liabilities
  
Borrowings5,00713,955
Trade payables9898
Other payables7171
Provisions1,1121,273
Total non-current liabilities6,28815,397
TOTAL LIABILITIES80,70077,489
   
EQUITY  
Share capital16,32118,263
Own (treasury) shares -1,223-1,349
Share premium617589
Statutory capital reserve2,5542,554
Translation reserve2,0941,992
Retained earnings11,20211,089
Total equity attributable to owners of the parent31,56533,138
Non-controlling interests7651,351
TOTAL EQUITY32,33034,489
TOTAL LIABILITIES AND EQUITY113,030111,978

Condensed consolidated interim statement of comprehensive income

EUR ‘000 9M 2018Q3 20189M 2017Q3 20172017
Revenue  

167,588
 

61,930
 

174,909
 

71,408
 

231,387
Cost of sales -160,900-58,441-168,14167,779-222,692
Gross profit 6,6883,4896,7683,6298,695
       
Marketing and distribution expenses -470-139-448-114-623
Administrative expenses -4,977-1,591-5,375-2,297-6,936
Other operating income 1,2251,0059844107
Other operating expenses -743-130-23-141
Operating profit  2,3922,7679131,2391,102
       
Finance income 241-1442,8022,5982,901
Finance costs -741-155-726-298-1,570
Net finance costs/income -500-2992,0762,3001,331
       
Share of profit of equity-accounted investees  

844
 

392
 

518
 

325
 

485
       
Profit before income tax 2,7362,8603,5073,8642,918
Income tax expense -582-182-791-251-1,193
Profit for the period  2,1542,6782,7163,6131,725
       
Other comprehensive income
Items that may be reclassified subsequently to profit or loss
      
Exchange differences on translating foreign operations 102162259132446
Total other comprehensive income 102162259132446
TOTAL COMPREHENSIVE INCOME 2,2562,8402,9753,7452,171
       
Profit attributable to:      
- Owners of the parent 1,9722,5042,9783,8681,388
- Non-controlling interests 182174-262-255337
Profit for the period  2,1542,6782,7163,6131,725
       
Total comprehensive income attributable to:      
- Owners of the parent 2,0742,6663,2374,0001,834
- Non-controlling interests 182174-262-255337
Total comprehensive income
for the period
 2,2562,8402,9753,7452,171
       
Earnings per share attributable to owners of the parent:      
Basic earnings per share (EUR) 0.060.080.100.130.04
Diluted earnings per share (EUR) 0.060.080.100.130.04

Condensed consolidated interim statement of cash flows

EUR ‘0009M 20189M 2017
Cash flows from operating activities  
Cash receipts from customers1201,839186,228
Cash paid to suppliers2-171,860-170,133
VAT paid-5,892-4,479
Cash paid to and for employees-16,764-17,063
Income tax paid-582-325
Net cash from/used in operating activities6,741-5,772
   
Cash flows from investing activities  
Paid on acquisition of property, plant and equipment-384-292
Paid on acquisition of intangible assets0-5
Proceeds from sale of property, plant and
equipment
2248
Disposal of a subsidiary and a joint venture02,744
Loans provided-22-38
Repayment of loans provided101,487
Dividends received249153
Interest received8377
Sale of own shares0153
Net cash used in/from investing activities-1174,627
   
Cash flows from financing activities  
Proceeds from loans received1,9167,457
Repayment of loans received-3,513-3,189
Finance lease principal paid-1,365-1,758
Interest paid-588-589
Dividends paid-2,627-2,488
Net cash used in financing activities-6,177-567
   
Net cash flow447-1,712
   
Cash and cash equivalents at beginning of period8,9159,786
Effect of movements in foreign exchange rates2-12
Increase/decrease in cash and cash equivalents447-1,712
Cash and cash equivalents at end of period9,3648,062

1 Line item Cash receipts from customers includes VAT paid by customers.

2 Line item Cash paid to suppliers includes VAT paid.

Financial review
Financial performance
Nordecon Group ended the first nine months of 2018 with a gross profit of 6,688 thousand euros (9M 2017: 6,768 thousand euros) and a gross margin of 4.0% (9M 2017: 3.9%). In an environment of continuously stiff competition, the Group’s gross margin for the first nine months remained basically at the same level as in the same period last year. However, the gross margin for the third quarter improved, rising to 5.6% (Q3 2017: 5.1%). The gross margin of the Infrastructure segment increased to 6.7% for nine months and 10.1% for the third quarter compared to 3.9% for nine months and 6.5% for the third quarter in 2017. Among other factors, the rise in profitability is attributable to intra-Group restructuring undertaken to increase operating efficiency and provide better-quality service to customers. However, we would like to see an improvement in the profitability of the Buildings segment whose gross margin dropped to 3.4% for nine months and 3.7% for the third quarter (2017: 4.3% for nine months and 4.5% for the third quarter). The profitability of the Buildings segment, particularly in the first half of 2018, was influenced by the fact that a significant share of the Group’s revenue results from the construction of apartment buildings. The margins of long-term contracts secured in 2016 and 2017 were undermined in the performance phase by a continuous rise in subcontracting charges, particularly labour costs. Profitability was also lowered by the conclusion of an insufficient volume of new contracts in Sweden, which caused uncovered fixed costs. We rigorously monitor the proportions of different segments in the Group’s portfolio in order to better manage the risks resulting from changes in input prices.
The Group’s administrative expenses for the first nine months of 2018 amounted to 4,977 thousand euros. Compared to the same period last year, administrative expenses decreased by around 7.4% (9M 2017: 5,375 thousand euros) and the ratio of administrative expenses to revenue (12 months rolling) was 2.9% (9M 2017: 3.0%).   Both in the reporting and the comparative period, administrative expenses were influenced by changes on the Group’s board (see also the chapter Employees and personnel expenses). However, our cost-control measures continue to produce good results and we have been able to keep administrative expenses below the target ceiling of 4% of revenue.
The Group’s operating profit for the first nine months of 2018 amounted to 2,392 thousand euros (9M 2017: 913 thousand euros). EBITDA amounted to 3,879 thousand euros (9M 2017: 2,419 thousand euros).
Finance income and costs for the period continued to be influenced by exchange rate fluctuations in the Group’s foreign markets. Although the Ukrainian hryvnia strengthened slightly against the euro and the Group recognised an exchange gain of 29 thousand euros (9M 2017: an exchange loss of 247 thousand euros) on the translation of a loan provided to the Ukrainian subsidiary in euros, the Swedish krona weakened against the euro by around 5% and the Group recognised an exchange loss of 124 thousand euros (9M 2017: nil euros) on the translation of a loan provided to the Swedish subsidiary in euros.
The Group’s net profit amounted to 2,154 thousand euros (9M 2017: a net profit of 2,716 thousand euros), of which the net profit attributable to owners of the parent, Nordecon AS, was 1,972 thousand euros (9M 2017: 2,978 thousand euros).
Cash flows
In the first nine months of 2018, operating activities produced a net cash inflow of 6,741 thousand euros (9M 2017: an outflow of 5,772 thousand euros). Positive net operating cash flow is attributable to growth in the Group’s own development operations and the collection of the contractual retentions (5-10% of the contract price) of major construction projects which have been completed. Operating cash flow continues to be strongly influenced by the fact that the contracts signed with public and private sector customers do not require them to make advance payments while the Group has to make prepayments to subcontractors, materials suppliers, etc. Cash inflow is also lowered by contractual retentions, which extend from 5 to 10% of the contract price and are released at the end of the construction period only. 
Investing activities of the first nine months produced a net cash outflow of 117 thousand euros (9M 2017: an inflow of 4,627 thousand euros, which was influenced by the sale of a subsidiary and a joint venture). The largest items were payments for property, plant and equipment of 384 thousand euros (9M 2017: 297 thousand euros) and dividends received of 249 thousand euros (9M 2017: 153 thousand euros).
Financing activities generated a net cash outflow of 6,177 thousand euros (9M 2017: an outflow of 567 thousand euros). The largest items were loan, finance lease and dividend payments. Proceeds from loans received amounted to 1,916 thousand euros, consisting of development loans and overdraft facilities used (9M 2017: 7,457 thousand euros). Loan repayments totalled 3,513 thousand euros (9M 2017: 3,189 thousand euros), consisting of scheduled repayments of long-term investment and development loans. Finance lease payments amounted to 1,365 thousand euros (9M 2017: 1,758 thousand euros). Dividends paid in the first nine months of 2018 totalled 2,627 thousand euros (9M 2017: 2,488 thousand euros).
At 30 September 2018, the Group’s cash and cash equivalents totalled 9,364 thousand euros (30 September 2017: 8,062 thousand euros). Management’s commentary on liquidity risks is presented in the chapter Description of the main risks.

Key financial figures and ratios

Figure/ratio for the period9M 20189M 20179M 20162017
Revenue (EUR ‘000)167,588174,909133,570231,387
Revenue change-4.2%30.9%17.6%26.2%
Net profit (EUR ‘000)2,1542,7163,3151,725
Net profit attributable to owners of the parent (EUR ‘000)1,9722,9782,4371,388
Weighted average number of shares30,986,58530,913,03130,756,72830,913,031
Earnings per share (EUR)0.060.100.080.04
Administrative expenses to revenue3.0%3.1%3.5%3.0%
Administrative expenses to revenue (rolling)2.9%3.0%3.8%3.0%
EBITDA (EUR ‘000)3,8792,4194,7233,123
EBITDA margin2.3%1.4%3.5%1.3%
Gross margin4.0%3.9%6.4%3.8%
Operating margin1.4%0.5%2.5%0.5%
Operating margin excluding gain on asset sales0.8%0.5%2.4%0.5%
Net margin1.3%1.6%2.5%0.7%
Return on invested capital5.4%6.5%6.8%5.9%
Return on equity6.4%7.2%9.0%4.8%
Equity ratio28.6%29.3%33.2%30.8%
Return on assets1.9%2.4%3.3%1.6%
Gearing29.1%31.6%28.3%32.7%
Current ratio 0.961.041.051.11
As at30 Sept 201830 Sept 201730 Sept 2016 31 Dec 2017
Order book (EUR ‘000)131,953 142,553133,846144,122

Performance by geographical market
The contribution of the Group’s foreign markets has remained stable in the past three years. In the first nine months of 2018, revenue earned outside Estonia accounted for 6% of our total revenue.

 9M 20189M 20179M 20162017
Estonia94%95%93%94%
Ukraine3%1%2%2%
Sweden2%3%4%3%
Finland1%1%1%1%

The share of the Group’s Ukrainian revenues grew substantially compared to the same period last year. In Ukraine, we provided general contractor’s services under one infrastructure and two building construction contracts and the share of concrete works performed in the building construction segment also increased significantly. The share of Swedish revenues decreased year on year. During the period, we provided services under one construction contract secured as a general contractor. Our Finnish revenues resulted from concrete works in the building construction segment.
Geographical diversification of the revenue base is a consciously deployed strategy by which we mitigate the risks resulting from excessive reliance on one market. However, conditions in some of our chosen foreign markets are also volatile and affect our current results. Increasing the contribution of foreign markets is one of Nordecon’s strategic targets. Our vision of the Group’s foreign operations is described in the chapter Outlooks of the Group’s geographical markets.

Performance by business line
Segment revenues
We strive to maintain the revenues of our operating segments (Buildings and Infrastructure) as balanced as possible because this helps to diversify risks and provides better opportunities for continuing construction operations in more challenging market conditions where the volumes of one or several sub-segments decline substantially.
Nordecon’s revenues for the first nine months of 2018 totalled 167,588 thousand euros, a roughly 4.2% decrease from the 174,909 thousand euros generated in the same period last year. Revenue generated by the Infrastructure segment grew by around 10% but this did not counterbalance the decline (7.5%) in revenue generated by the Buildings segment. In the first nine months of 2018, our Buildings and Infrastructure segments generated revenue of 120,766 thousand euros and 46,454 thousand euros respectively. The corresponding figures for the first nine months of 2017 were 130,618 thousand euros and 42,303 thousand euros (see note 8). The current revenue structure is also reflected in our order book where building construction contracts continue to prevail.

Operating segments*9M 20189M 20179M 20162017
Buildings71%75%72%74%
Infrastructure29%25%28%26%

* In the Directors’ report, projects have been allocated to operating segments based on their nature (i.e. building or infrastructure construction). In the segment reporting presented in the consolidated financial statements, allocation is based on the subsidiaries’ main field of activity (as required by IFRS 8 Operating Segments). In the consolidated financial statements, the results of a subsidiary that is primarily engaged in infrastructure construction are presented in the Infrastructure segment. In the Directors’ report, the revenues of such a subsidiary are presented based on their nature. The differences between the two reports are not significant because in general Group entities specialise in specific areas except for the subsidiary Nordecon Betoon OÜ that is involved in both building and infrastructure construction. The figures for the parent company are allocated in both parts of the interim report based on the nature of the work.

Sub-segment revenues
In the Buildings segment, the largest revenue source is the commercial buildings sub-segment. In the first nine months of 2018, its revenue grew significantly: by around 39% year on year. During the period, we completed the construction of an office building at Lõõtsa 12 and a multi-storey car park at Sepise 8 in Ülemiste City in Tallinn and the Møller Auto sales and service centre in Rae parish near Tallinn. We continued work on the Omniva logistics centre in Rae parish near Tallinn and a 14-floor commercial and residential building in the WoHo quarter at Mustamäe tee 3 in Tallinn. We began the reconstruction and extension of the building of Terminal D in the Old City Harbour in Tallinn. On the basis of the order book, we expect that in 2018 the revenue of the commercial buildings sub-segment will increase compared to 2017.
The revenue of the public buildings sub-segment increased by 12% year on year. The results of the sub-segment continue to be strongly influenced by investments made in national defence. During the period, we continued to build infrastructure for armoured vehicles and two barracks at the defence forces’ base at Tapa as well as the Estonian Academy of Security Sciences building in Tallinn. We delivered the Abja Health Centre to the customer. 
The proportion of revenue generated by the apartment buildings sub-segment decreased by more than a third compared to the same period last year. In Estonia, a substantial share of our apartment building projects is located in Tallinn. In the period under review, the largest of them included apartment buildings at Sõjakooli 12 (phase III) and Lesta 10 as well as two projects which we completed and delivered to customers: the Meerhof 2.0 apartment building complex at Pirita tee 20a and apartment buildings at Sõjakooli 12 (phase II). Foreign markets continue to contribute a major share of the sub-segment’s revenue. In Ukraine, we continued the construction of a residential quarter in the city of Brovary in the Kiev region. In Sweden, we completed the design and construction of an eight-floor apartment building in Stockholm.
We continue to carry out our own housing development projects in Tartu and Tallinn (reported in the apartment buildings sub-segment). During the period, we completed the development of a new residential area in the Tammelinn district in Tartu. In the course of development, which began in March 2014, we built nine apartment buildings with a total of 193 apartments (www.tammelinn.ee). We also began work in new development projects at Nõmme tee 97 in Tallinn where we are going to build a four-floor apartment building with 21 apartments (www.nommetee.ee) and at Aruküla tee in Tartu where we are going to build three apartment buildings with 10 apartments each (www.kaldakodu.ee). We continue to sell apartments in the above development projects in Tartu and Tallinn as well as in the projects completed in 2017 at Magasini 29 (www.magasini.ee) and Hane 2 and 2a (www.hane.ee) in Tallinn. The period’s housing development revenues totalled 5,556 thousand euros (9M 2017: 4,627 thousand euros). In carrying out development activities, we closely monitor potential risks in the housing development market that stem from rapid growth in the supply of new housing and relative growth in input prices.
The revenue of the industrial and warehouse facilities sub-segment decreased substantially compared with the same period last year. The largest project was the construction of the Metsä Wood plywood factory in Pärnu, which was successfully completed. The volumes of the sub-segment continue to be supported by orders placed by the agricultural sector. During the period, the largest of these included the construction of the Mätliku robotic dairy shed, a cattle shed for Kraavi Põllumajandus OÜ and the Lähtru grain terminal as well as the reconstruction (phase IV) of the fattening unit of the pig farm of Rakvere Farmid AS (EKSEKO).

Revenue breakdown in the Buildings segment9M 20189M 20179M 20162017
Commercial buildings36%24%15%25%
Public buildings27%22%31%19%
Apartment buildings22%31%32%30%
Industrial and warehouse facilities15%23%22%26%

For a long time, the Infrastructure segment has been dominated by the road construction and maintenance sub-segment whose relative importance has been increasing year by year. During the period, a significant portion of its revenue resulted from major projects performed under contracts secured in 2017: the reconstruction of the Haabersti intersection in Tallinn, the reconstruction of a section of the Tallinn ring road (km 0.6-2.8) and the construction of passing lanes for a 2+1 road on the Valmaotsa–Kärevere section of the Tallinn–Tartu–Võru–Luhamaa road. A substantial share of the period’s revenue also resulted from forest road improvement services provided to the State Forest Management Centre. We continued to render road maintenance services in Järva and Hiiu counties and the Kose maintenance area in Harju county. We expect that road construction will remain the largest revenue source in the Infrastructure segment through 2018.
Contracts secured by the environmental engineering and other engineering (utility network construction) sub-segments are generally small. The contract signed in the reporting period for the performance of earthworks on the Kiili-Paldiski section of the mainland part of Balticconnector (a natural gas pipeline), creates a basis for certain growth in other engineering revenue.

Revenue breakdown in the Infrastructure segment9M 20189M 20179M 20162017
Road construction and maintenance91%84%86%86%
Other engineering6%12%9%8%
Environmental engineering3%4%5%6%

Order book
At 30 September 2018, the Group’s order book (backlog of contracts signed but not yet performed) stood at 131,953 thousand euros, a decrease of roughly 7% compared to the same period last year.

 30 Sept 201830 Sept 201730 Sept 201631 Dec 2017
Order book (EUR ‘000) 131,953 142,553 133,846144,122

At the reporting date, contracts secured by the Buildings segment and the Infrastructure segment accounted for 73% and 27% of the Group’s total order book respectively (30 September 2017: 78% and 22% respectively). Compared to 30 September 2017, the order books of the Buildings segment and the Infrastructure segment have decreased by 3% and 17% respectively.
The order books of the commercial buildings and apartment buildings sub-segments account for an equal share, approximately a third each, of the order book of the Buildings segment. In the commercial buildings sub-segment, the largest projects in progress are in Tallinn: the reconstruction and extension of the building of Terminal D in the Old City Harbour at Lootsi 13/4 and the design and construction of an eight-floor accommodation building on the property at Liimi 1B. The order book of the apartment buildings sub-segment includes mainly contracts for the construction of apartment buildings in Tallinn. However, in the third quarter of 2018 the Group also secured a housing development project in the Stockholm area in Sweden. The order book of the public buildings sub-segment, which accounts for 19% of the order book of the Buildings segment, has grown as well. A major share of it is made up of contracts secured in the reporting period for the construction of a state secondary school at Kohtla-Järve and the Peetri sports and leisure centre in Rae parish. The Group continues to build the Estonian Academy of Security Sciences building in Tallinn and infrastructure for armoured vehicles and two barracks at the defence forces’ base at Tapa. The order book of the industrial and warehouse facilities sub-segment has decreased.
The order book of the Infrastructure segment continues to be strongly influenced by the contracts of the road construction and maintenance sub-segment which account for around 76% of the Infrastructure segment’s order book. The road construction order book includes the remaining portions of contracts signed in 2017 as well as two new contracts secured in 2018 for the construction of the Veskitammi intersection on the border of Tallinn in Laagri and passing lanes for a 2+1 road on the Pikknurme-Puurmani section (km 142.2-146.9) of the Tallinn–Tartu–Võru–Luhamaa road. The Group continues to provide road maintenance services in three road maintenance areas: Järva, Hiiu and Kose. In July this year, the Group signed a contract for the performance of earthworks on the 53 kilometre-long Kiili-Paldiski section of the mainland part of Balticconnector (a natural gas pipeline), which made a strong contribution to the order book of the Infrastructure segment. Although according to our projections in 2018 public investments will not increase substantially, our order book allows us to expect that in 2018 the revenue of the Infrastructure segment will grow somewhat compared to 2017 (for further information, see the Business risks section of the chapter Description of the main risks).
Based on the Group’s order book and known developments in our chosen markets, we expect that the Group’s revenue for 2018 will decrease slightly compared to 2017. In an environment of stiff competition, we avoid taking unjustified risks whose realisation in the contract performance phase would have an adverse impact on the Group’s results. Our preferred policy is to keep fixed costs under control and rigorously monitor market developments.
Between the reporting date (30 September 2018) and the date of release of this report, Group companies have secured additional construction contracts in the region of 5,586 thousand euros.

People
Employees and personnel expenses
In the first nine months of 2018, the Group (the parent and the subsidiaries) employed, on average, 697 people including 425 engineers and technical personnel (ETP). The number of employees, particularly workers, decreased by around 6% year on year, mostly because the contract for providing road maintenance services in the Keila maintenance area expired.

Average number of the Group’s employees (at the parent and the subsidiaries):

 9M 20189M 20179M 20162017
ETP425425374426
Workers272314305309
Total average697739679735

The Group’s personnel expenses for the first nine months of 2018, including all taxes, totalled 16,820 thousand euros. In the same period of 2017, personnel expenses amounted to 16,343 thousand euros. The roughly 3% growth in personnel expenses is mainly attributable to pay rises.
The service fees of the members of the council of Nordecon AS for the first nine months of 2018 amounted to 140 thousand euros and associated social security charges totalled 46 thousand euros (9M 2017: 120 thousand euros and 40 thousand euros respectively).
The service fees of the members of the board of Nordecon AS amounted to 536 thousand euros and associated social security charges totalled 177 thousand euros (9M 2017: 923 thousand euros and 272 thousand euros respectively). The figures include termination benefits of 180 thousand euros paid to a member of the board and associated social security charges of 60 thousand euros. In the comparative period in 2017, board members’ service fees included termination benefits of 550 thousand euros paid to two members of the board and associated social security charges of 182 thousand euros.

Labour productivity and labour cost efficiency
We measure the efficiency of our operating activities using the following productivity and efficiency indicators, which are based on the number of employees and personnel expenses incurred:

 9M 20189M 20179M 20162017
Nominal labour productivity (rolling), (EUR ‘000)318.6308.1245.1314.9
Change against the comparative period, % 3.4%25.7%12.7%17.6%
     
Nominal labour cost efficiency (rolling), (EUR)9.610.38.210.1
Change against the comparative period, %-6.7%24.8%-0.6%12.6%

The Group’s nominal labour productivity increased year on year, mainly through a decrease in headcount. Labour cost efficiency declined because the rise in personnel expenses outpaced revenue growth.

Description of the main risks
Business risks
The main factors which affect the Group’s business volumes and profit margins are competition in the construction market and changes in the demand for construction services. Demand for construction services continues to be strongly influenced by the volume of public investment, which in turn depends on the co-financing received from the EU structural funds.
Competition continues to be stiff in all segments of the construction market and in 2018 public investment is not expected to grow compared to 2017. Thus, builders’ bid prices are under strong competitive pressure in a situation where the prices of construction inputs have been trending upwards moderately but consistently. Bidders for contracts include not only rival general contractors but also former subcontractors. This is mainly attributable to the state and local governments’ policy to keep the qualification requirements of public procurement tenders low, which sometimes results in the sacrifice of quality and adherence to deadlines to the lowest possible price. We acknowledge the risks inherent in the performance of contracts signed in an environment of stiff competition and rising input prices. Securing a long-term construction contract at an unreasonably low price in a situation where input prices cannot be lowered noticeably and competition is tough is risky because negative developments in the economy may quickly render the contract onerous. In setting our prices in such an environment, we focus on ensuring a reasonable balance between contract performance risks and tight cost control.
In the light of the above factors, we expect that in 2018 as a whole our business volumes will decrease slightly compared to 2017. Our action plan foresees flexible resource allocation aimed at finding more profitable contracts and performing them effectively. According to its business model, Nordecon operates in all segments of the construction market. Therefore, we are somewhat better positioned than companies that operate in one narrow (and in the current market situation, particularly some infrastructure) segment.
Our business is also influenced by seasonal changes in weather conditions, which have the strongest impact on infrastructure construction where a lot of work is done outdoors (road construction, earthworks, etc.). To disperse the risk, we secure road maintenance contracts that generate year-round business. Our strategy is to counteract the seasonality of infrastructure operations with building construction that is less exposed to seasonal fluctuations. Our long-term goal is to be flexible and keep our two operating segments in relative balance (see also the chapter Performance by business line). Where possible, our entities implement different technical solutions that allow working efficiently also in changing conditions. 
Operational risks
To manage their daily construction risks, Group companies purchase contractors’ all risks insurance. Depending on the nature of the project and the requests of the customer, both general frame agreements and special, project-specific insurance contracts are used. In addition, as a rule, subcontractors are required to secure the performance of their obligations with a bank guarantee provided to a Group company or the Group retains part of the amount due until the contract has been completed. To remedy construction deficiencies which may be detected during the warranty period, Group companies create warranty provisions based on their historical experience. At 30 September 2018, the Group’s warranty provisions (including current and non-current ones) totalled 920 thousand euros (30 September 2017: 1,085 thousand euros).
In addition to managing the risks directly related to construction operations, in recent years we have also sought to mitigate the risks inherent in preliminary activities. In particular, we have focused on the bidding process, i.e. compliance with the procurement terms and conditions, and budgeting. The errors made in the planning stage are usually irreversible and, in a situation where the price is contractually fixed, may result in a direct financial loss.
Financial risks
Credit risk
During the period, the Group did not incur any credit losses. In the comparative period in 2017, credit losses totalled 37 thousand euros. The overall credit risk exposure of the portfolio of receivables is low because the solvency of prospective customers is evaluated, the share of public sector customers is large and customers’ settlement behaviour is continuously monitored. The main indicator of the realisation of credit risk is settlement default that exceeds 180 days along with no activity on the part of the debtor that would confirm the intent to settle.
Liquidity risk
The Group remains exposed to higher than usual liquidity risk. At the reporting date, the Group’s current ratio was 0.96 (30 September 2017: 1.04). The key factor which influences the current ratio is the classification of the Group’s loans to its Ukrainian associates as non-current assets and the banks’ general policy not to refinance interest-bearing liabilities (particularly overdrafts) for a period exceeding twelve months.
Because the political and economic situation in Ukraine is still complicated, we believe that the Group’s Ukrainian investment properties cannot be realised in the short term. Accordingly, at the reporting date the Group’s loans to its Ukrainian associates of 8,715 thousand euros were classified as non-current assets.
For better cash flow management, we use overdraft facilities and factoring by which we counter the mismatch between the settlement terms agreed with customers and subcontractors. Under IFRS EU, borrowings have to be classified into current and non-current based on contract terms in force at the reporting date. At 30 September 2018, the Group’s short-term borrowings totalled 21,491 thousand euros.
At the reporting date, the Group’s cash and cash equivalents totalled 9,364 thousand euros (30 September 2017: 8,062 thousand euros).
Interest rate risk
The Group’s interest-bearing liabilities to banks have both fixed and floating interest rates. Finance lease liabilities have mainly floating interest rates. The base rate for most floating-rate contracts is EURIBOR. During the period, interest-bearing borrowings decreased by 2,512 thousand euros year on year. Factoring and finance lease liabilities decreased whereas current loan liabilities increased (see also the section Liquidity risk). At 30 September 2018, interest-bearing borrowings totalled 26,498 thousand euros (30 September 2017: 29,011 thousand euros). Interest expense for the first nine months of 2018 amounted to 612 thousand euros (9M 2017: 487 thousand euros). In the reporting period, we had a large volume of contracts with long (up to 90-day) settlement terms. For better management of their cash flows, we used factoring, which caused year-on-year growth in interest expense. 
The main source of interest rate risk is a possible rise in the variable component of floating interest rates (EURIBOR, EONIA or the creditor’s own base rate). In the light of the Group’s relatively heavy loan burden, this would cause a significant rise in interest expense, which would have an adverse impact on profit. We mitigate the risk by pursuing a policy of entering, where possible, into fixed-rate contracts when the market interest rates are low. As regards loan products offered by banks, observance of the policy has proved difficult and most new contracts have a floating interest rate. We have signed a derivative contract to manage the risks resulting from changes in the interest rate of the finance lease contract of an asphalt concrete plant acquired in 2016.
Currency risk
As a rule, the prices of construction contracts and subcontracts are fixed in the currency of the host country, i.e. in euros (EUR), Ukrainian hryvnias (UAH) and Swedish kronas (SEK).
The exchange rate of the hryvnia is unstable because the political and economic environment in Ukraine continues to be strained due to the conflict between Ukraine and Russia which broke out at the beginning of 2014 and at the beginning of 2015 the National Bank of Ukraine decided to discontinue the determination of the national currency’s indicative exchange rate. In the first nine months of 2018, the hryvnia/euro exchange rate remained essentially at the same level as at the end of 2017. Due to a slight (1%) strengthening of the hryvnia, the Ukrainian subsidiary had to translate its euro-denominated loans into the local currency, which gave rise to a foreign exchange gain of 29 thousand euros (9M 2017: an exchange loss of 247 thousand euros). The exchange gain and loss on financial instruments have been recognised in Finance income and Finance costs respectively. Translation of receivables and liabilities from operating activities did not give rise to any exchange gains or losses.
Our Ukrainian and non-Ukrainian entities’ reciprocal receivables and liabilities that are related to the construction business and denominated in hryvnias do not give rise to any exchange gains or losses. Nor do the loans provided to the Ukrainian associates in euros give rise to any exchange gains or losses to be recognised in the Group’s accounts.
In the first nine months of 2018, the Swedish krona weakened against the euro by around 4.5%. Due to adverse movements in the krona/euro exchange rate, the translation of operating receivables and payables resulted in an exchange loss of 61 thousand euros (9M 2017: 8 thousand euros). The exchange loss has been recognised in Other operating expenses. The translation of a loan provided to the Swedish subsidiary in euros into the local currency gave rise to an exchange loss of 124 thousand euros. The exchange loss has been recognised in Finance costs. In the comparative period, there was no exchange loss.
We have not acquired derivatives to hedge our currency risk.
Employee and work environment risks
Finding permanent labour is a serious challenge for the entire construction sector and one of the main factors that influences business results. The Group depends extensively on its subcontractors’ ability to ensure the availability of skilled labour. To strengthen Nordecon’s reputation as an employer and make sure that we can find employees also in the future, we collaborate with educational institutions.
As a construction company, we strive to minimise the occupational health and safety risks of people working on our construction sites including both our own employees and the teams of our subcontractors. The goal is to make sure that all measures required by law are applied in full. In addition, the parent company follows the requirements of international occupational health and safety management standard OHSAS 18001. Subcontractors must ensure that their employees follow applicable work safety requirements; the Group’s role is to work with them and create conditions that enable and foster compliance.
Environmental risks
Construction activities change landscapes and the physical environment of cities and settlements. The Group’s goal is to do its work and at the same time protect the natural environment as much as possible. Our assets and operations which have the strongest impact on the environment and, thus, involve the highest environmental risk are asphalt plants, quarries and road construction sites. To prevent leaks, spills, pollution, destruction of wildlife and other damage to the environment, we comply with legal requirements. All of our largest construction entities have implemented environmental management standard ISO 14001.
Corruption and ethical risks
As one of the leading construction companies in Estonia, we realise that it is important to be aware of the risks involved in the breach of honest and ethical business practices and to make sure that our entities’ management quality, organisational culture and internal communication emphasise zero tolerance for dishonest, unethical and corrupt behaviour.

Outlooks of the Group’s geographical markets
Estonia
Processes and developments characterising the Estonian construction market:

  • In 2018, public investments that have a strong impact on the construction market will not increase compared to 2017. In terms of the market as a whole, investments made by the largest public sector customers (the state-owned real estate company Riigi Kinnisvara AS, the National Road Administration, etc.) that will reach signature of a construction contract in 2018 will not grow substantially. The Ministry of Defence has been a positive exception for builders as its needs and use of a single agency, the Centre for Defence Investment, for carrying out new procurement tenders and placing orders have made a major contribution to market revival. Hence, on the whole, the Estonian construction market (particularly the infrastructure construction segments) will remain relatively stable.
  • Competition remains stiff across the construction market, intensifying in different segments in line with market developments. A continuously high number of bidders for construction contracts reflects this. It is clear that in an environment of rising input prices, which has emerged in recent years, efficiency is the key to success.
  • In new housing development, the success of a project depends on the developer’s ability to control the input prices included in its business plan and thus set sales prices that are affordable for prospective buyers. Despite the market situation it is expected that the housing market, which accounts for a somewhat disproportionately large share of the total construction market and thus amplifies associated risks, will also sustain growth in 2018.
  • There is a growing contrast between the stringent terms of public contracts, which impose an increasing number of obligations, strict sanctions, different financial guarantee commitments, long settlement terms, etc. and the modest eligibility criteria. Lenient qualification requirements and the precondition of making a low bid have made it relatively easy for an increasing number of builders to win a contract. However, they have also heightened the financial, completion delay and quality risks taken by customers during the contract performance and the subsequent warranty periods.
  • Recent years have brought a rise in the prices of construction inputs, particularly in building construction. Initially, general contractors tried to absorb the cost increase by making margin concessions but their capacity for doing so has been practically exhausted. The construction market includes a growing number of areas where changes in the environment (e.g. materials producers’ rapid and successful entry into foreign markets) may trigger a sharp price increase. The rise in housing construction has lengthened the supply terms of various essential materials and services considerably, making it impossible to carry out all processes in the former optimistic timeframes. As a result, activities require more extensive planning or may need to be postponed.
  • The persisting shortage of skilled labour (including project and site managers) is restricting companies’ performance capacities and affecting different aspects of the construction process, including quality. Labour migration to the Nordic countries remains steady and it is not likely that workers who have left will return to the Estonian construction market in large numbers. Migrant workers who in turn have started moving to Estonia are not able to fill the gap. All of the above factors sustain pressure for a wage increase, particularly in the category of the younger and less experienced workforce whose natural mobility and willingness to change jobs is higher.

Ukraine
In Ukraine, we mainly offer general contracting and project management services to private sector customers in the segment of building construction. Political and economic instability continues to restrict the adoption of business decisions but construction activity in Kiev and the surrounding area has picked up in recent years. In 2018, we will continue our Ukrainian operations in the Kiev region. Despite the military conflict in eastern Ukraine, for Nordecon the market situation has improved compared to a year or two ago. Hard times have reduced the number of inefficient local (construction) companies and when the economy normalises we will have considerably better prospects for increasing our operations and profitability. The Ukrainian government’s recent crackdown on cash-in-hand work is definitely a step in the right direction. In the longer term, this should improve our position in the Ukrainian construction market. In 2018, our business operations in Ukraine will increase compared to 2017.
We assess the situation in the Ukrainian market regularly and critically and are ready to restructure our operations as and when necessary. Should the crisis in eastern Ukraine spread (which at the date of release of this report is highly unlikely), we can suspend our operations immediately. We continue to seek opportunities for exiting our two real estate projects, which have been put on hold, or signing a construction contract with a prospective new owner.
Finland
In Finland, we have mainly been providing subcontracting services in the concrete work segment but, based on experience gained, have started preparations for expanding into the general contracting market. The local concrete work market allows competing for projects where the customer wishes to source all concrete works from one reliable partner. However, our policy is to maintain a rational approach and avoid taking excessive risks.
Sweden
We have been operating in Sweden since July 2015. In the Swedish market, we offer mainly the construction of residential and non-residential buildings in the central part of the country. In gaining experience in the new market, we have prioritised quality and adherence to deadlines over profitability. As regards our longer-term goal and the plan to build a viable and strong organisation that would compete successfully in the Swedish market, we are positive about the developments so far and see potential for further growth and ensuring profitability in a large market when we have been able to stabilise our order book growth at the desired level.


Nordecon (www.nordecon.com) is a group of construction companies whose core business is construction project management and general contracting in the buildings and infrastructures segment. Geographically the Group operates in Estonia, Ukraine, Finland and Sweden. The parent of the Group is Nordecon AS, a company registered and located in Tallinn, Estonia. The consolidated revenue of the Group in 2017 was 231 million euros. Currently Nordecon Group employs close to 700 people. Since 18 May 2006 the company's shares have been quoted in the main list of the NASDAQ Tallinn Stock Exchange.

Andri Hõbemägi
Nordecon AS
Head of Investor Relations
Tel: +372 6272 022
Email: andri.hobemagi@nordecon.com
www.nordecon.com

Attachments


Nordecon_Interim_report_Q3_2018.pdf
Investor presentation 9m 2018.pdf