Cover Story

Beating the Odds

January 2012
When the going gets tough, the tough strategise. Developers, contractors, cement and steel companies alike rely on sound business practices and a futuristic vision to stay in the game, discovers Charu Bahri.

A slowdown has set in; and this time, the mood across some quarters of the construction industry is that challenging times are being lumped on the country by government indecision. At worst, it's being called policy paralysis, and put forward as, possibly, the incumbent government's undoing. While the jury is still out on that, the delay in rolling out infrastructure development projects is adversely impacting players directly involved as well as companies manufacturing cement and steel, the building blocks of construction. Add to this the fact that real-estate developers operating in some geographies and segments are finding themselves in a pickle because of sluggish markets.

Reality blues

"With the slowdown encompassing the real-estate sector, many listed players are facing an erosion of market capitalisation as a result of property price and rental corrections in micro markets," observes Rajeeb Dash, Head-Marketing, Tata Housing Development Company. Sliding stock market indices are hampering demand as well as making it impossible for real-estate companies to consider raising fresh capital. "Not only do investors lack capital to invest in real-estate projects, many investors are also being forced to sell off properties to adjust their share market losses," he adds.

"Adverse macroeconomic factors like rising home loan interests and soaring input costs are constraining both buyers and developers," notes Vishal Khetawat, Director, Rameswara Group. Where salary rises are not keeping up with sharpening interest rates and property prices, many potential buyers are being forced out of the market.

Real-estate firms are crying foul about supply side constraints that are posing significant  
liquidity challenges. Some say, rising input costs are rendering previously agreed property prices unviable, at a time when buyers (especially of residential properties) are holding out until a price correction. This is causing financial constraints to be cited as reason for delayed project completion as well as the rollout of new developments. Is any developer safe?

According to Dash, "Only players who have achieved substantial revenues from past deals can expect to rise against the tide. Also, trusted developers with an impeccable track record will witness steady sales. So far, Tata Housing has not been affected by the ongoing slowdown. But the scenario may worsen if the upcoming properties are not sold off." "Good properties with good demographics are always in demand," says Khetawat. "Buyers go by brand name and past performances of developers."

The game plan

What is the winning strategy of players that are recording steady, albeit slower, sales? Tata Housing's marketing strategy is to straddle consumer segments and key geographies, and its financial trump card is partnering landowners for joint development, to reduce upfront investments in land.

Brijesh Bhanote, Director-Sales & Marketing, The 3C Company, cites adoption of transparent methods like linking payment plans to construction as the 3C way to win customer confidence and keep sales ticking. This includes sticking to construction schedules. "Delivery is the name of the game because the market is still there, it is simply more price and product-conscious," he explains. "Problems start when real-estate developers start a project with inadequate funds or mix funds designated for one project with another. Nothing throws finances in disarray more than financial indiscipline. That upsets project schedules, property prices slump, and demand dwindles."

In times of rising input costs, real-estate developers with a sound backend, that is, those who work with good contractors, are better off. "Rising input costs are not a show stopper; they only affect bottom lines," cautions Bhanote. "It is prudent to cost for miscellaneous expenses in project budgets." For his part, Khetawat believes real-estate developers must gauge future demand correctly. "We feel the middle income group segment will see growing interests from end users and investors," he says. "Strategically, we are also diversifying in tier II cities, owing to an increase in demand for organised realty and availability of affordable land."

Contractors' woes

Dash expects the market conditions to continue for another two quarters. During this period, real-estate firms will continue to scale down targets, cut input costs, evaluate options of diversifying, as well as offer discounts on their prices or other freebies during festive seasons to push sales. Input costs can be reduced by taking initiatives to invest in technology and reduce the use of manual labour, turnaround projects faster to lessen interest burdens, and adopt efficient procurement methods. Buying materials in bulk, for instance, saves considerable money.

One section of the construction industry affects the other. Sluggish real-estate markets are  
seeing construction companies run shy of such contracts in a bid to reduce their exposure to working capital difficulties arising from lacklustre sales and consequent payment delays. According to Amitabh Mundhra, Director, Simplex Infrastructures Ltd, "Real-estate projects are a no go for most contractors nowadays, unless there is surety that the projects are fully financed." Ramky Infrastructure, for instance, has reduced its exposure to real estate to less than 5 per cent of its order backlog, most of which is in the company's own townships and industrial parks.

Offsetting slow markets

If listless real-estate markets were not enough, the slow takeoff of road, urban development, and other coveted infrastructure projects is further contracting opportunities for construction companies. "The indecision of the Central Government has slowed down the implementation of announced plans (such as NHAI projects and hydro sector projects) and is deferring future developments in the infrastructure sector," observes Yogen Lal, Group Director & Head Marketing, Pratibha Industries.

"While some targets set for the Eleventh Five Year Plan have been met by about 80 per cent, delays on the part of the government in taking some hard decisions as well as delays in receiving environmental clearances has delayed the rollout of a few much-awaited infrastructural projects, from the trans-harbour link to the dedicated freight corridor, nuclear power plants and hydroelectric power plant," notes Mundhra.

A handful of companies are hopeful of offsetting the adverse impact of the slowdown by bagging overseas contracts. For example, Ramky Infrastructure is hopeful of winning projects worth $300-400 million in Gabon to add to its current order worth $120 million to construct the Gabon Special Economic Zone, an industrial park in capital Libreville. "C&C Infrastructure is already executing infrastructure projects in Afghanistan and is hopeful of tapping prospects in Oman and Africa as well," says CS Sethi, Managing Director, C&C Construction Ltd.

Some construction companies are focusing on emerging geographies within the country where economic activity has a lot of catching up to do, to come up to speed. "We are focusing on private companies for orders as well as expanding to newer geographies like Bihar and West Bengal, which are still upbeat," shares Vikas B Sharma, Director, Supreme Infrastructure India Ltd.

Diversification: the safety net

Infrastructure development companies that pursue diversified projects are better off. "As Pratibha is focusing on opportunities across several verticals, like water, urban infrastructure and buildings, we have been reasonably insulated from the slowdown," shares Lal. "Also, our clientele is broad-based; we count state governments and leading municipal corporations as clients for our infrastructure business and public-sector understandings and reputed private-sector developers as clients in the building space. Our order inflow this financial year has so far been more than twice our annual revenue for the past year. Additionally, we emerged as lowest bidders for projects worth about Rs 750 crore."

"Diversification is one way to sustain top-line growth," adds Sethi. "We have entered the power transmission sector, which is still strong. Yet, remedial measures take time to reflect in financial results. The first year of executing infra projects is marked by spending; activities begin to reflect in bottom lines later."

The only ray of hope is that awarding activity in India has picked up in recent months; this should grow prospects in the coming quarters. "The tendering of sought-after infra projects is now getting off the ground, reaching the pre-implementation phase," adds Mundhra. Sharma expects significant improvement in the business scenario and working environment as a result of positive government actions in the next six to 12 months. With this in mind, he views  
the present time as, "an opportunity to build capabilities to take advantage of the huge flow of contracts likely to be awarded once the current impasse ends." It makes sense to be a few months early, in readying a team to make the most of opportunities as they emerge, as being  
late at a time when the industry is eagerly awaiting a turnaround could mean losing out.

The big 'F'

Finance with a capital 'F' has become the bane of many construction companies. As Mundhra observes, "More than keeping labour employed, it has become harder to tie up funds for infra projects." He believes the challenging situation is an outcome of the Indian banking system tracing its own learning curve. "Banks have faced difficulties as well, such as delays in repayment, and they have responded by introducing new covenants in financing contracts," he adds. "After all, infrastructure development has come into its own in the last decade or so. Now, older financial arrangements such as 85:15 or 80:20, debt-to-equity ratios are no longer acceptable. It is taking the construction industry some time to adjust itself to the new reality."

For his part, SV Rajadhyaksha, CEO, Leighton Contractors (India) Pvt Ltd, is of the opinion that contractors must adopt best financial practices and gain the confidence to make the most of every opportunity. "This involves verifying the financial fundamentals of the project promoter," he explains. "If these are of a reasonably high standard, there is no reason why contracting companies should shy away from any kind of project. I, for one, would not hesitate to participate in the project."

"The cost of funding has risen to the extent that it is pinching contractors hard. We are still not shying away from any particular segment of the industry, but are scanning our clients thoroughly to draw comfort from their business plans before taking up work," adds Sharma, suggesting that times of acute financial challenges present a chance to test business models, strengthen business operations, and review employee performances.

"Infrastructure development companies needn't stay away from any kind of project. Developers must judiciously and realistically assess returns from projects for which they intend to bid, by factoring in the prevailing cost of capital as well as associated risks. Currently, intense competition has led to a lot of bids being based on incorrect assumptions, thereby significantly eroding returns during the execution phase," suggests Lal, who is of the opinion that finance is always available for viable projects.

Best financial practices also include generating working capital from very healthy payment terms between the client and the contracting company, and exceptionally favourable terms with vendors and suppliers in favour of the contracting company. "The idea is to have a positive cash flow all through the tenure of a project,' says Rajadhyaksha. "Positive cash flows ensure the contracting company has sufficient working capital to sustain the targeted timelines, which nowadays are usually very challenging." Lal adds, "In addition to minimising debtor days, we are endeavouring to manage business with optimum levels of inventory and procure goods and sub-contracts at the best possible credit terms. We are conservative in raising debt and are reasonably leveraged today."

Cementing fortunes

Infrastructure projects may be rolling out slower than expected but construction companies and cement manufacturers alike are counting on the pace to pick up. "Frankly, there is no alternative but to aggressively develop infrastructure if the Indian economy is to find its place in the world," says Vinita Singhania, President, Cement Manufacturers' Association. "We are optimistic about the medium term."

The concerns of cement companies arise from the problem of plenty they face at present. There are few takers for cement as demand has slowed down. "Normally, demand grows at about 1.2 times the GDP over a cycle of five to six years," believes Ashish Guha, CEO & Managing Director, HeidelbergCement India Ltd. "That would mean that growth should be around 8.7 per cent if GDP is taken at 7.3 per cent as per the estimates of the Finance Ministry. Instead, the overall cement market has only expanded by 5 per cent to 6 per cent this year, which is below normal."

Consequently, there couldn't be a worse time to commission capacity expansions that were planned when the going was good. In the first quarter of 2012, HeidelbergCement India Ltd's  
capacity in central India will expand by 2.9 million tonne, taking the company's total capacity to 6 million tonne. While this rollout is strategic - the company's biggest customer base in the central region, independent housing builders (IHB), has been relatively unaffected by the slowdown - Guha does not see any major capacity build-up coming up in India because margins are so low that no project will give meaningful returns.

Singhania puts the ramifications of the present situation in perspective saying, "As the demand for cement continues to be low, several companies are operating their plants at less than full capacity. Companies are exploring all the possible avenues to cut down on production costs and logistics costs in order to compensate for the increased cost on account of lower production."

Nevertheless, as India is increasingly perceived as a long-term growth market, all eyes are on the future and on gaining a foothold on newer territories. "We anticipate that the growth deficit will be covered up in CY12 and CY13, and accentuated by the spillover effect of the unspent infra budget of the current five-year plan into the next," predicts Guha. "Upcoming elections in Uttar Pradesh will also hopefully expedite infrastructure and other projects in central India. For our part, we are seeding newer markets such as Bihar and will next turn our focus to Delhi, Haryana and Uttarakhand."

Steeling challenge

Concerns about the slow rollout of infrastructure projects are also being felt among steel companies. "This can hamper the growth of the steel industry," acknowledges Sandeep Jajodia, Executive Vice-Chairman & Managing Director, Monnet Ispat & Energy Ltd (MIEL). "Government policies must become more conducive to strong infrastructural development and a higher GDP. Steel companies have planned major expansions hoping to cater to the Indian growth story, but if plans get derailed or significantly delayed, especially non-integrated players could face increased pressures on margins in the medium term and will find it hard to sustain business. Huge amounts of public money could then be at risk." MIEL is substantially integrated in its operations and enjoys high margins, and hence has so far been able to run its plants at full capacity at its facilities in Raipur, Chhattisgarh.

Agreeing that his company has been impacted by the recent slowdown to some extent, Vikram Amin, Executive Director - Strategy & Business Development, Essar Steel, says, "We have stepped up our focus on operational cost control, new product development, application support and value-added products to mitigate the impact." Still, Amin feels that the recent slowdown in demand is a temporary blip and overall the steel demand outlook in India remains robust. "Investments worth $1 trillion are proposed in steel-intensive sectors like automobiles, shipbuilding, airports, power, and oil and gas, and construction will have a multiplier effect, auguring well for the domestic steel industry. These investments will create demand for all long and flat steel products in varied grades and forms."

Steelmakers' strategies

Essar Steels' 10 mtpa steel making facility in Hazira, supported by downstream facilities, processing and distribution mechanism of service centres and extensive network of retail outlets spread throughout the country, is fully geared to service the requirements of various steel-intensive sectors. This include advanced high-strength steel grades for auto, API grades for oil and gas pipelines, high strength and quenched and tempered plates for the construction segment, and heavy plates and welded beams for the power sector. Essar Steel's wide range of flat steel products also includes products for the shipbuilding, defence and consumer durables sectors, thereby shrinking dependence on any single product category, industry segment or customer. Thus, the more diversified the steel player, the brighter the scope for the future.

Jajodia feels that challenging times serve as a reminder of the need to embrace newer cost-effective technologies. MIEL is currently in the process of implementing a 1.5 million tonne per annum integrated steel plant at an investment of Rs 3,500 crore to produce plates, HR coils and rebars at its facility in Raigarh. Fortunately, the management does not fear compromising margins because of the sluggish market as the technology driving the integrated steel plant reduces dependency on expensive raw materials like coking coal and iron ore lumps by using inputs from captive and domestic resources instead, backed by cost-effective captive sources of power and ferro alloys. As the steel facility is designed to utilise waste heat and gases generated in the process, it is all the more energy-efficient. An iron ore palletisation plant along with the sinter plant as a part of the complex, would enable MIEL to gainfully use cheap and abundantly available iron ore fines.

Whatever it takes - that appears to be the mantra: embrace a winning attitude, formulate the right strategy, and act on it. Proof, if you've ever needed it, that when the going gets tough, the tough indeed get going.

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