I think the margin disappointment is clearly what the Street is reading into. In the previous calls you have been very confident about margins recovering quite substantially due to internal efficiencies and a number of other factors. Why then have you guided for lower margins this time around?
If you recall the last quarterly conversation that we had around the results of the third quarter, I did mention about 50 bps pressure that we are experiencing in the margins of our major EPC business. Let me explain to you that how this problem is a transitionary problem and has to be viewed in perspective. The order book much of it that is getting executed in FY23 has been based on commitments that we had picked up the year ahead, that is in FY22. And normally the projects being 24-36 months duration, the purchase commitments are also made that much earlier. So the consumption of materials that had gone into FY23 is largely arising out of commitments made in FY22 and a little beyond for long lead items. And you know that the inflationary pressures were intense in FY22 and first half of FY23. The commodity prices have corrected their courses in the second half of FY23 and they continue to remain within moderate levels currently. So as we execute the old orders and order backlog, it is but inevitable that the cost that we had committed on those projects gets to be consumed. The fact is that much of these projects have some element of flexibility to converse with the customers about the time overruns because COVID did cause a lot of time overrun. So time extensions was required and also the fact that very unusual spike in the material price, supply chain getting disoriented because of the war etc., these are unusual situations.
So I think the clients also understand and appreciate. So our focus has been in FY23 to complete our commitments as much as we have scheduled to, so that the conversations around what compensations to be made to the contractor can happen at the backend of the contract.
So my own sense is that we should be able to recover some portion of this margin decline over the future period. But the way the accounting standards are under accounting policies are, the cost have to be absorbed as they are incurred and the relief would come in the subsequent period. And nature of the projects being what they are, all of the relief will not get added up in one quarter where you will see a spike. In fact, you will see slow drip of the credits over future quarters.
In subsequent two quarters also, I expect the margins to be soft because that is where the peak of the execution of the past contracts are happening. It is only in 24-25 that you will see the benefit of the current contracts that we have won that will start playing out in the P&L charts. So as a company, we are bracing ourselves for first half of next year, the current year, as well to be a little tougher on the margin front.
But then I think things will ease going forward. We are confident overall that the jobs that we are executing will turn out to be profitable. How far they are to the estimated profit is something that we need to see as we go forward.
So since you have said that the second half of FY24 to FY25, you will see your margins recover. Can you just walk us through the best case scenario in terms of what you are working with by way of a number?
We had guided before all of this happened that our margins would be around 9-9.5% and we are running at about 8.6% today. So the effort would be over two steps or two years to get back to those levels. The construct of the EPC contract does not permit margins to be 12%, 13%, 14% that the manufacturing businesses have and neither does the construct have margins to be around 20% which the services business have. In our revenue mix, you would have possibly noticed that a third of our revenues in the group level comes from services which has a richer margin by comparison. About 10% or so comes from manufacturing which has the mid-teen margins. And two thirds of our business is from construction projects EPC business which has as I mentioned to you, the margin level around this 9% band. So on a blended basis, I think we should be able to recover as we ramp up our services business and hopefully the manufacturing business on the back of the push that the government is giving for manufacturing sector.
Hopefully if those move up, then the ratios become a little more balanced and that should enable the overall recovery of the margins. But in a given year, given the wide diversity of businesses that we have, we would have pockets where margins are modest and pockets where margins are healthy. So the blend is something that we will have to manage as we have been doing all this while. And going forward, we expect to do that as well.
Point taken. Now it has certainly been a flourish when it comes to the order inflow this time around and the prospects for your order inflows down the line as well seem to be fairly strong. Owing to the tailwinds from the infrastructure sector, what is it you are working with in terms of what will be your order inflow drivers down the line and what are you targeting?
I think the biggest upside that we have is the congruence of where our skill sets are and where the country seems to be investing. I think infrastructure is the place where a lot of investments are happening both at the central level and at the state level and that is our strong point in any case. So I think we have an environment where the investments and what we can deliver are actually meeting quite nicely. What is going to be the key driver for us to be relevant in this context is going to be obviously cost competitiveness. End of the day, I think most of the projects are determined based on the L1 prices. So there is a bid, there is a tender and we will have to submit our prices. And the person who puts in the most competitive prices walks away with the project so I think cost competitiveness is going to be key.
To enable us to be cost competitive because price is not something we are controlling, the clients are controlling it and competition will make sure that the prices stay competitive. What is in our control is the cost levers and productivity levers. What we are doing as a company and we are investing in these issues and that is also partly reflected in the margins getting softer is investment on automation, investment on technology, investment on better methods of constructing and executing projects. Now, all of this would mean that the engineering quality and excellence that we need to bring in in terms of technology has to go a notch up. And as you know, nothing is free. Technology investment also means some costs to be allocated for that which we are doing. We do think that given the opportunity spectrum that we have for the country over the next three-five years and given the fact that our capacity is well geared towards these opportunities; the focus of the company would be on cost management and cash management.
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