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Realtors put cost-escalation clauses in sale agreementsBy Dr arvind, Section GN
Hit by the rising commodity prices and increasing interest rates, construction companies are working on alternative ways to keep themselves afloat. They have started incorporating costescalation clauses into agreements with the clients rather than getting into fixed-rate, fixed-time contracts. In some cases, companies are getting into contracts where materials are supplied by the clients.
"The infrastructure sector is under pressure as the economy is facing challenges like inflation and soaring interest rates. All the new contracts are putting cost-escalation clauses to mitigate the risk," E Sudhir Reddy, chairman and managing director of IVRCL, said. According to analysts, the adequacy of escalation clauses built into construction contracts such as full pass-through, indexlinked and fixed-price contracts will determine margins of the infrastructure companies in the coming months. The construction firms, especially those with huge exposure in built-operate-transfer (BOT) and annuity projects, are reeling under margin pressure due to spurt in commodity prices. Prices of steel and cement comprise nearly one-third of the total cost of the projects. In the last six months, steel prices in the domestic market have gone up by 30%. Click on "Full Story" for more..
"RBI's tight monetary policy has made things worse for the fixed-price projects," industry officials feel. Also, lack of alternative source of funds has put serious spanner in the investments in the infrastructure sector. The focus of these companies has been shifted to managing inflation, they added.
Companies such Gammon India, Hindustan Construction (HCC), Nagarjuna Construction and IVRCL are badly hurt due to their large exposure to fixed price contracts. According to the latest industry update by Citi Global Markets, fixed price constituted around 35-36% of Gammon India and Nagarjuna Construction's total order book. Amit Srivastava, an analyst with Karvy Stock Broking, said, "We believe the rising interest rates coupled with higher raw material cost would hit the profitability margin further. It would lead to de-rating of valuation parameters. That's why the valuation of some infrastructure companies does not look attractive even after a sharp correction in the recent past. In addition, higher borrowing cost and the general elections next year would slow down the growth in order inflow." In fact, margins of mid-cap construction companies declined across the board in the first quarter of 2009. Companies like Nagarjuna Construction and IVRCL were no exceptions which suffered from erosion of operating profit margins of in the June quarter. Also they suffered from rise in interest costs. For example, in case of IVRCL interest cost rose by up 505% year-on-year while it was 242% for Gammon India. Source: ET, Aug-25-08
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