The Hindu Business Line : Smaller construction cos may be worst hit

The mounting price of steel is likely to impact construction companies, especially those that have a higher proportion of fixed price contracts and also real estate developers. The price of hot rolled steel has seen over 30 per cent increase between December 2007 and March 2008. The recent increase in HR coils would take the user price close to Rs 50,000 per metric tonne.

Infrastructure

Steel typically accounts for about 15 per cent of the total construction cost for an infrastructure company, but it varies based on the nature of the project. Profit margins of larger infrastructure companies have reasonably withstood input price pressures, as they usually have inbuilt price escalation clauses in their contracts. Such clauses allow the contractor to claim any increase in the raw material price (typically linked to Wholesale Price Index) from the project developer/awarder. However, in case of fixed price contracts, such increase in raw material prices cannot be passed on to the awarder of the project, as a result of which margins take a hit.

For companies such as IVRCL Infrastructures and Nagarjuna Constructions, whose projects are mostly bagged from the Government, price escalation clauses have ensured growth in profit margins over the past few quarters. For instance, 91 per cent of IVRCL’s projects either have such price hike agreements or the raw material is supplied by the project owner. However, escalation clauses do not provide full protection against price hikes. They might at best cover a good proportion of such increase, leaving some portion to be absorbed by the infrastructure player.

Smaller players

Smaller construction players that execute contract work may feel the brunt of the hike as very few command favourable price terms with the project owner.

Smaller players such as Valecha Engineering have, however, witnessed a dip in their operating profit margins over the last couple of quarters. Similarly, companies such as Pratibha Industries, with backward integration into structural pipes, have limited options when it comes to negotiating lower prices from their vendors.

More worries

Steel accounts for a large chunk of cost for residential and office buildings. Unlike infrastructure developers, real estate players seldom have any agreement with the end users for raw material price hikes. According to industry players, prices of steel used in the real estate sector have seen a 70 per cent increase since December 2007.

With the property market in the Delhi, NCR regions as well as Mumbai showing signs of weakness, property developers may find it more difficult, than in the past, to command higher prices that would make up for the surging construction costs.

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