Notes to the financial statements
30 Financial risk management objectives and policies
The objective of the treasury function, which is accountable to the Board, is to manage the Group’s and Company’s financial risk, secure cost-effective funding for the Group’s operations and to minimise the effects of fluctuations in interest rates and exchange rates on the value of the Group’s and Company’s financial assets and liabilities, on reported profitability and on cash flows.
The Group’s principal financial instruments comprise bank loans and overdrafts, loan notes, finance leases and cash and short-term deposits. The main purpose of these financial instruments is to raise finance for the Group’s operations. The Group has various other financial assets and liabilities such as trade receivables and trade payables, which arise directly from its operations.
The Group also enters into derivative transactions; principally cross currency swaps and forward currency contracts. The purpose is to manage the interest rate and currency risks arising from the Group’s operations and its sources of finance. It is, and has been throughout 2013 and 2014, the Group’s policy that no trading in financial instruments shall be undertaken.
The main risks arising from the Group’s financial instruments are liquidity risk, interest rate risk, foreign currency risk, price risk and credit risk. Information on how these risks arise is set out below, as are the objectives, policies and processes agreed by the Board for their management and the methods used to measure each risk. Derivative instruments are used to change the economic characteristics of financial instruments in accordance with the Group’s treasury policies. The Group’s accounting policies in relation to derivatives are set out in the Accounting Policies note.
Liquidity risk
The Group’s objectives are:
- to ensure that forecast peak net borrowings, plus a prudent operating headroom are covered by committed facilities which mature after at least 12 months;
- to ensure that prudent headroom versus bank and loan note covenant ratios are forecast for the next three years;
- to maintain flexibility of funding by employing diverse sources of funds (eg: use of non-bank markets such as private placements); and
- to avoid a concentration of facility maturities in any particular year.
The maturity analysis of Group borrowings is set out in Note 19. At 31 March 2014 the Group’s total credit facilities amounted to £414.0 million (2013: £627.3 million) excluding finance leases of £1.8 million (2013: £5.5 million) and the impact of cross-currency swaps on US Dollar and Euro loan notes of £2.1 million (2013: £17.8 million). The facilities at 31 March 2014 and 2013 consisted of:
March 2014
- £170 million plus €90 million multi-currency revolving credit facility repayable at maturity in October 2016; and
- loan notes totalling £169.5 million repayable between April 2014 and November 2021.
March 2013
- £170 million plus €150 million multi-currency revolving credit facility repayable at maturity in October 2016; and
- loan notes totalling £330.4 million repayable between April 2013 and November 2021.
Undrawn revolving credit facilities at 31 March 2014 amounted to £208 million (2013: £297 million). Effective headroom including cash and short term deposits amounted to £275.7 million (2013: £573.1 million).
The Group aims to mitigate liquidity risk by closely managing cash generation by its operating businesses and by monitoring performance to budgets and forecasts. Capital investment is carefully controlled, with detailed authorisation limits in place up to Executive level and cash payback criteria considered as part of the investment appraisal process. Short-term and long-term cash and debt forecasts are constantly reviewed and there are regular treasury updates to the Executive highlighting facility headroom and net debt performance.
Day-to-day cash management utilises undrawn revolving credit facilities, overdraft facilities and occasionally short-term money market deposits if there is excess cash.
Interest rate risk
The Group’s exposure to the risk for changes in market interest rates relate primarily to the Group’s long-term debt obligations with a floating interest rate.
The Group’s policy is to manage its interest cost using a mix of fixed and variable rate debt. The Group’s long-term strategy is to keep between one third and three quarters of its borrowings at fixed rates of interest in the medium term. To manage this mix in a cost-efficient manner, the Group has issued fixed coupon loan notes and also enters into interest rate swaps from time to time on a portion of its floating bank borrowings, in which the Group agrees to exchange, at specified intervals, the difference between fixed and variable rate interest amounts calculated by reference to an agreed-upon notional principal amount. These swaps are designated to hedge underlying debt interest cash flow obligations. In the short-term the proportion of fixed and floating rate borrowings can go outside the long-term range.
At 31 March 2014, 83% of the Group’s borrowings were at a fixed rate of interest (2013: 100%). Following the maturity and repayment of loan notes in April 2013 the amounts drawn under revolving credit facilities have increased in 2013/14 and the fixed rate percentage of borrowings has fallen. In the medium term we expect the fixed proportion of borrowings to be in the target range.
The Group’s borrowing facilities require minimum interest cover of 3.0 times.
The Group’s exposure to interest rate risk is shown (by way of a sensitivity analysis) in Note 31.
Foreign currency risk
Following the sale of St Hubert SAS, the Group has no significant operations outside the UK. However it buys and sells a small amount of goods in currencies other than Sterling. As a result the value of the Group’s non-Sterling revenues, purchases, assets, liabilities and cash flows can be affected by movements in exchange rates – predominantly Euro/Sterling.
The majority of the Group’s transactions are carried out in the relevant entity’s functional currency and therefore transaction exposures are limited. It can be seen in Note 16 that the only significant non-Sterling debtors are in Dollars. The Group trades skimmed milk products and bulk butter mainly to customers in Europe and Central and South America. The Group also exports its own skimmed milk products, bulk butter and other branded products. The Group’s policy requires foreign currency sales and purchases through Philpot Dairy Products Limited, a subsidiary company, to be hedged by foreign exchange contracts once the transaction is committed so that the margin on the transaction can be fixed.
Currency exposures on other transactions, such as certain capital expenditure denominated in a foreign currency, are hedged following approval of the project using forward foreign exchange contracts. In 2006, 2007 and 2011 the Group issued loan notes denominated either in $US, € or £. Cross-currency swaps were implemented as required to hedge the interest and principal repayment cash flows. These have the effect of fixing the liability and coupon in Sterling. The principal amount and interest and principal payment dates on these swaps match those on the loan notes exactly and all swaps are with counterparties with strong credit ratings. There is no profit and loss exposure in relation to $US or € note debts as any retranslation impact on the profit and loss account is offset by reclassification of amounts from other comprehensive income into profit and loss.
Price risk
The Group is exposed to price risk related to certain commodities and their by-products used by the Group’s businesses. The principal non-milk commodities that affect input prices for the Group are vegetable oils, gas, electricity, diesel, heavy fuel oil and crude oil by-products (used in packaging).
The Group monitors prices on an ongoing basis in order to assess the impact that movements have on profitability and to assess whether the amount of forward cover is appropriate. This includes vegetable oil contracts and energy, which is generally contracted one season in advance for both Summer and Winter energy but with some requirement contracted at more regular intervals.
The Group regularly reviews relevant commodity markets and levels of future cover. Fixed price contracts are only entered into with the approval of the Commodity Risk Committee comprising senior operational and finance management and external advisers.
Credit risk
It is the Group’s policy that all customers who wish to trade on credit terms are subject to credit verification procedures. The Group only offers these terms to recognised, creditworthy third parties. In addition, receivables balances are monitored on an ongoing basis with the result that the Group’s history of bad debt losses is not significant.
The Dairies’ doorstep business trades with individuals and receives cash payments on a weekly basis. Cash and debt management is a crucial part of this business and cash collection and balances due are closely monitored to ensure write-downs are minimised.
Debtor days outstanding are closely monitored throughout the year and action is taken promptly when payment terms are breached.
With respect to credit risk arising from the other financial assets of the Group, which comprise cash and cash equivalents, trade and other debtors (excludes prepayments) and certain derivative instruments, the Group’s exposure to credit risk arises from default of the counterparty. The maximum exposure for the Group is equal to the carrying amount of these financial assets of £189.3 million (2013: £395.5 million). Following the sale of St Hubert the Group had significant cash deposits and until those funds were utilised to repay loan notes and provide one-off funding to the pension scheme in April 2013, no one financial institution had deposits in excess of £60 million and all institutions holding deposits were required to be rated A or above.
All revolving credit facility borrowings are through banks with long-term credit ratings of A or above. Funds temporarily surplus to business requirements are invested overnight through deposit accounts with mainstream UK commercial banks with a credit rating of A or better. The Group currently has no requirement to place deposits for a longer period, accordingly counterparty risk is considered to be acceptable. Derivative financial instruments are contracted with a range of banks with long-term credit ratings of A or above to avoid excessive concentration of financial instruments with one counterparty.
Capital management
The primary objective of the Group’s capital management is to ensure that it maintains an appropriate level of gearing in order to support its business and maximise shareholder value. In addition, the Group monitors its forecast net debt to EBITDA ratios in order that they are comfortably within its banking covenant requirements. The maximum net debt to EBITDA ratio for the purposes of bank covenants is 3.5 times. At 31 March 2014 the ratio of net debt to EBITDA was 1.3 times (March 2013: 0.6 times).
The Group monitors its capital structure and makes adjustments to it in the light of changes in economic conditions or changes in Group structure. Possible mechanisms for changing capital structure include adjusting the level of dividends, issuance of new shares or returning capital to shareholders. No significant changes in capital structure have been implemented in the year ended 31 March 2014 or 2013.
The Group monitors capital using a gearing ratio, which is net debt divided by shareholders’ funds. The analysis of net debt is included in Note 33. The gearing ratio at March 2014 and 2013 can be analysed as follows:
|
2014 £m |
2013 £m |
|||
|---|---|---|---|---|
|
Net debt |
142.2 |
59.7 |
||
|
Shareholders’ funds |
289.4 |
307.4 |
||
|
Gearing ratio |
49% |
19% |
Dividends
Details of dividends paid and proposed during the year are given in Note 7. The dividend policy following the sale of St Hubert is to maintain a progressive dividend whilst seeking to maintain a level of dividend cover between 1.5 and 2.5 times. The final proposed dividend for 2013/14 is 15.4 pence up 0.4 pence from last year (2013: 15.0 pence). Total dividends paid and proposed in respect of the year ended 31 March 2014 amount to 21.3 pence (2013: 20.7 pence).