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Vidya Bala

Efforts by infrastructure and construction companies to protect margins have revolved around attempts to pass on raw material price hikes to clients.

Steel, cement, bitumen and diesel can account for as much as 60-65 per cent of the total operating costs for these companies. Of this, while cement forms 15-30 per cent of the cost, steel can vary between 12-25 per cent.

Diesel, often used in construction equipment, accounts for 5-15 per cent of project costs, depending on its usage level.

While the prices of cement have remained flat in 2008, after a steep rise in 2007, price of steel rolled coils has jumped 47 per cent this year. As a result, operating profit margins have, on an average, dipped by up to 1 percentage point.

Companies with a larger proportion of projects that carry price escalation clauses (these allow pass-through of costs based on market prices or inflation indices) have fared better.

For instance, water project major IVRCL has protected over 90 per cent of its orders, either through pass-through clauses or by requiring the client to procure raw materials. Nagarjuna Construction, which has a higher proportion of fixed price contracts, witnessed a 1.2 percentage point decline in operating profit margins for the quarter ended June 2008.

Gammon India was also among the bigger players that witnessed margin pressure due to raw material hikes.

Infrastructure conglomerate Larsen & Toubro has started acquiring strategic stakes in vendors as a long-term measure to hedge against input price spikes. The company has so far managed to hold on to its profit margins.

Interestingly, pure construction companies such as B.L. Kaashyap & Sons and CCC have managed to adeptly handle the spike in commodity prices. B.L. Kaashyap & Sons uses pass-through clauses not only for steel and cement costs in its contracts, but also for labour and fuel costs!

CCC managed to expand its margins by 200 basis points to 10.2 per cent for the June quarter through a mixed strategy.

The company requires clients to supply raw materials for 40 per cent of the order value.

Another 53 per cent is on a recovery basis, not only are values linked to indices such as WPI and CPI, the contracts build in room for renegotiation in prices, if they move beyond a pre-determined range!

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