Risks and risk management
Foreign exchange risk
Currency risk arises when future business transactions, or reported assets or liabilities, are expressed in a currency which is not the Group’s functional currency.
The Group’s transaction exposure arises primarily in the Swedish companies where a large proportion of revenue is generated by the global sales organisation and is not in SEK. Other companies mainly conduct operations in their national markets where revenue and costs are in the same currency.
Aside from currency risks on sales by the Swedish companies, risks also arise from the import of raw materials and components. Altogether, the Swedish companies have a surplus inflow of foreign currency.The direct commercial foreign exchange flow, after net calculations of flows in the same currencies, shows a surplus of MSEK 294 (308). In addition to this, there is also an indirect impact in conjunction with the purchase of raw materials and components. This results, over time, in a lower net exposure for the Group.
The Group’s policy is to hedge all significant net cash flows. Incoming flows of foreign currency should be used for payment in the same currency. In addition, a certain portion of the anticipated net inflow from sales and purchases is hedged by means of forward contracts after individual assessment at 50 per cent for the coming six-month period. On statistical assessment of the foreign-exchange position, a change in the Swedish krona against other currencies of 1 per cent, with all other variables being constant, would impact the Group’s earnings by about MSEK 3 (3). The financial instruments are managed by the Parent Company’s senior management
Currency risk also arises in conjunction with the translation of foreign net assets and earnings, so-called translation exposure. This currency risk is not hedged and refers, primarily, to the translation of foreign subsidiaries’ income statements and balance sheets. Earnings from foreign subsidiaries are translated into Swedish krona based on the average exchange rate for the year. The exposure of the Group’s net assets outside of Sweden has increased as operations there have changed from previously pertaining to sales companies, to now also including production units. At the closing date, net assets in foreign companies corresponded to MSEK 1,444 (1,322) including goodwill. The Group applies hedge accounting where the purchase consideration for acquired companies has to some extent been financed through borrowing in the acquired company’s local currency. Net assets abroad that are subject to hedge accounting amount to MSEK 810 and accumulated borrowing MSEK 215. Translation differences that affected comprehensive income amounted to a negative MSEK 19.5 (neg: 25.7) before deferred tax of MSEK 4.3.
A weakening of the Swedish krona by 1 per cent with all other variables remaining constant would result in an increase in equity of MSEK 14 (13) largely due to gains/losses on the translation of EUR and GBP. A change in the Swedish krona of 1 per cent against other currencies would result in a direct impact on net sales in the subsidiaries of approximately MSEK 30 (28) whilst the impact on results in the foreign subsidiaries would be MSEK 3 (3).
Interest rate risk
Fagerhult holds no significant interest-bearing assets and, accordingly, the Group’s income and cash flow from operating activities are, in all material aspects, independent of changes in market interest rates.
The Group’s interest-rate risk arises in conjunction with long-term borrowing. In addition to pension liabilities of MSEK 66.4 (65.9), interest-bearing liabilities totalled MSEK 1,342.2 (1,327.5) and cash and cash equivalents were MSEK 471.9 (353.1). Borrowing on the basis of floating interest rates exposes the Group to interest-rate risk as regards cash flow. Borrowing on the basis of fixed interest rates implies an interest-rate risk for the Group in terms of fair value. During 2015 and 2014, the Group’s borrowings largely comprised loans with three-month fixed interest rates.
The Group analyses its exposure to interest-rate risk on a dynamic basis. Various scenarios are simulated, whereby refinancing, re-negotiation of existing trading positions, alternative financing and hedging are taken into consideration. Based on these scenarios, the Group calculates the earnings impact from a given change in interest rates. In each simulation, the same change in the interest rate is applied for all currencies. The scenarios are simulated only for those liabilities comprising the largest interest-bearing positions. Simulations performed show that the earnings impact of a 1 per cent change would be a maximum of MSEK 14, with the current capital structure. The simulation is conducted quarterly to verify that the maximum possible loss is within the limits established by the executive management.
If interest rates on borrowing in Swedish krona as of 31 December 2015 had been 10 points higher/lower, but all other variables had been constant, then gains after tax for the financial year would have been MSEK 1.0 (1.0) higher/lower, primarily as an effect of higher/lower interest expenses for borrowings with floating interest rates.
Credit risks are managed at Group level. Credit risks arise if the counterparty does not fulfil its commitments in conjunction with lending within the framework of cash management policies and through credit exposure to clients and banks, including receivables and agreed transactions. The investment of surplus cash is undertaken primarily in K1 graded commercial paper and with banks. Only banks and financial institutions with credit ratings of at least A from independent rating institutes are accepted. If the Group’s customers have received a credit rating from an independent rating institution, these ratings are used. Where no independent credit assessment exists, a risk assessment is made of the customer’s credit status in which the entity’s financial position is considered, as well as previous experience and other factors. Individual risk limits are set based on internal or external credit ratings, in accordance with the limits set by the Group management. The application of credit limits is frequently reviewed. No significant losses occurred in either 2015 or 2014. The majority of receivables from customers are guaranteed through credit insurance. A total provision of MSEK 23.5 (26.5) was made for those trade receivables not expected to be received.
Liquidity risk is managed by ensuring that the Group has sufficient cash and cash equivalents and short-term investments in a liquid market, available financing through agreed credit facilities and the possibility to close market positions. The Group has a strong financial position. At present, no new borrowing requirements exist, but should such requirements arise, there is currently no difficulty in obtaining external credit, as long as such credit meets certain covenants, on the borrower, such as debt-to equity and interest coverage ratio, which are at present satisfied. Management also meticulously follows rolling forecasts for the Group’s liquidity reserve on the basis of anticipated cash flows.
The above table presents an analysis of the Group’s financial liabilities to be settled net, specified according to the contractual time to maturity, as of the closing date. The amounts stated in the table are the contractual, undiscounted cash flows. Amounts falling due within 12 months correspond with the carrying amounts, as the effect of discounting is negligible.
The Group’s objective with regard to the capital structure is to secure the Group’s ability to continue operating, so that it can continue to generate returns for shareholders and benefits for other stakeholders, and to maintain an optimal capital structure to keep the cost of capital down.
To maintain or adjust the capital structure, the Group may change the dividend paid to shareholders, repay capital to shareholders, issue new shares or sell assets to reduce debt.
The Group monitors capital on the basis of debt/equity ratio. This ratio is calculated as interest-bearing liabilities in relation to equity.
The debt/equity ratio at 31 December 2015 was 65 per cent (78).
Price risk in the Group’s operations primarily arise in conjunction with the purchase of input material used in manufacturing. Dominant components, such as electronic control systems and sheet metal, have the single greatest impact on the cost of manufactured products, excluding processing costs. The Group’s exposure to price risk on financial instruments is minimal.
Risk associated with plants and inventories
In addition to the above risks, all of which, in principle, impact the Fagerhult Group’s cash flows, restricted capital in both non-current assets and inventories is also exposed to risk. Rationalisations and a high level of utilisation of investments made have meant the value of capitalised assets has been possible to maintain at a comparatively low level. Consequently, the risk of a permanent impairment of non-current assets is considered unlikely. Risks associated with inventories are primarily related to obsolescence resulting from overproduction and out-of-date technology. Fagerhult’s business concept includes customer-order driven production. This implies flexible production in which the need for inventories is reduced and with that, the risk of obsolescence
As computer-aided technology has assumed an increasingly greater scope within the companies, security requirements have also increased. The functional security of the databases and e-mail servers is checked via daily backups. Battery backup and diesel generators provide protection against operational disruption in the main manufacturing facility in Habo from where the majority of the Group’s computer operations are controlled. To date, no costs have arisen as a result of damage. The internet connection is fixed and completely isolated from other networks via hardware firewalls. Access via public networks is secured via security devices. User access to the system is regulated via Group authorisations and entitlements based on actual assignments and roles within the company.
The Fagerhult Group purchases and manages Group-wide insurance policies for property and liability risks, creating co-ordination gains and cost advantages.