Home / Companies / News /  More firms push for escalation clauses in their supply contracts

Companies are increasingly pushing to rework supply contracts to factor in likely cost escalations, as volatility in commodity prices puts pressure on their margins.

Price escalation clauses, which have been largely limited to contracts in power and infrastructure sectors, are making their way to sectors such as automobiles and cement, analysts said.

Sellers are pushing for pass-through clauses in contracts, which will allow them to cushion unforeseen cost pressures and protect margins.

“To address frequent price fluctuations, it is imperative to consider pass-through mechanisms in some sourcing vendor contracts with price benchmarking as is prevalent in some industries," said Sajid Mohamed, managing partner of Agrud Partners, a Mumbai-based corporate law firm.

Some analysts say it is better to review supply contracts more frequently since any under-recovery or over-recovery can be discussed with vendors and suppliers at the time of renewal.

For instance, auto companies review contracts with steel suppliers every six months; thus, after the April review, fresh contracts may come up at the end of September.

In case of high volatility, companies may get more room to adjust prices, as has been the case in metal prices.

Auto companies, though, are expected to see better June quarter performance on a year-on-year basis, thanks to the low base of last year due to the spread of covid-19.

On a sequential basis, the pressure may persist.

Analysts said that most auto companies would likely report a sequential margin erosion.

The first quarter will see an increase in commodity cost on account of prices in steel (where negotiations are ongoing) and crude derivatives, diluted by some softening in other commodities, as well as price hikes taken by vehicle makers.

“In some cases, companies are able to pass on the higher costs to end consumers,“ said a senior steel industry executive, who requested anonymity. “But the problem gets aggravated when passing on higher costs is no longer feasible to either the consumer or the vendor," he added.

Cement companies, which saw their Ebitda decline 14-29% in the March quarter, may see more pressure during the June quarter.

Analysts point out that the companies have raised prices by 20-25 per bag, against the requirement of about 50 per bag to cover the costs.

Analysts at Emkay Global Financial Services said, "Our coverage companies are expected to report a 26% YoY and 16% sequential decline in Ebitda in Q1FY23 due to the sharp rise in input costs". Overall Ebitda per tonne will decline by 200-250 in the first half of FY23 from the preceding three months, according to brokerage Emkay, due to higher costs and subdued realizations amid a seasonally weak demand period. Cement companies may also need to rework their supply contracts with pet coke and coal companies to ensure volatility gets cushioned substantially, Emkay analysts said.

ABOUT THE AUTHOR

Ujjval Jauhari

Ujjval Jauhari is a deputy editor at Mint, with over a decade of experience in newspapers and digital news platforms. He is skilled in storytelling, reporting, analysing and writing about stocks, investment ideas, markets, corporates and more. He is based in New Delhi.
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