Treasury risk – introduction
SIG's Finance and Treasury Policies set out the Group's approach to managing treasury risk. These policies are reviewed and approved by the Group Board on a regular basis. It is Group policy that no trading in financial instruments or speculative transactions be undertaken.
Funding of operations
SIG finances its operations through a mixture of retained profits, Shareholders' equity, bank funding, private placement and other borrowings. A small proportion of SIG's assets are funded using fixed rate finance lease contracts.
The Group's net debt is made up of the following categories:
|Obligations under finance lease contracts||10.0||10.5|
|Private placement notes||255.9||254.3|
|Loan notes and deferred consideration||3.0||1.9|
|Derivative financial instruments (liabilities)||2.0||1.1|
|Derivative financial instruments (assets)||(36.8)||(33.9)|
|Gross debt (after derivative financial assets)||327.7||239.6|
|Cash on deposit||(89.0)||(110.3)|
|Other financial assets||(1.3)||(0.9)|
The Group's gross financial liabilities can be further analysed as follows:
|Gross financial liabilities with a maturity profile of greater than five years||52.0||16%||78.8||33%|
|Gross financial liabilities held on an unsecured basis||314.9||96%||227.5||95%|
Details of derivative financial instruments are shown in Note 18 to the Accounts.
Management of treasury risks
Treasury risk management incorporates liquidity risk, interest rate risk, foreign currency risk, commodity risk, counterparty credit risk and the risk of breaching debt covenants. These specific risks, and the Group's management of them, are detailed below.
Liquidity risk and debt facilities
Liquidity risk is the risk that SIG is unable to meet its financial obligations as they fall due.
In order to mitigate the risk of not being able to meet its financial obligations, SIG seeks a balance between certainty of funding and a flexible, cost-effective borrowing structure, using a mixture of sources of funding in order to prevent over-reliance on any single provider. The key sources of finance are private placement note investors, being mainly US-based funds, and principal bank debt.
The maturity profile of the Group's debt facilities at 31 December 2015 is as follows:
|Date of expiry|
|Bank debt||250.0||90.0||160.0||October 2019|
|Private placement loan notes||130.6||130.6||—||November 2016|
|Private placement loan notes||20.0||20.0||—||November 2018|
|Private placement loan notes||22.0||22.0||—||October 2020|
|Private placement loan notes||14.7||14.7||—||October 2021|
|Private placement loan notes||36.7||36.7||—||October 2023|
The Group has in place a £250m committed Revolving Credit Facility ("RCF") provided by its five key relationship banks, which matures in October 2019. This facility was just over one-third drawn at 31 December 2015 and represents the committed funding headroom of the Group. Maturing in November 2016 is c.£130.6m of the private placement notes. The Group considers it has a number of options with regard to the refinancing of these notes, and is confident that this will be achieved on similar terms to existing facilities.
Interest rate risk
The Group's interest costs in respect of its borrowings will increase in the event of rising interest rates. To reduce this risk the Group monitors its mix of fixed and floating rate debt and enters into derivative financial instruments to manage this mix where appropriate. SIG has a policy of aiming to fix between 50% and 75% of its average net debt over the medium-term.
In order to manage its interest exposure within this policy, £30m of floating to fixed interest rate swaps were entered into in August 2015. The percentage of net debt at fixed rates of interest at 31 December 2015 is 57% (2014: 72%) and on a gross debt basis is 55% (2014: 64%), which is within the Group's targeted medium-term range.
Foreign currency risk
SIG has a number of overseas businesses whose revenues and costs are denominated in the currencies of the countries in which the operations are located. 48% of SIG's 2015 continuing revenues (2014: 51%) were in foreign currencies, being primarily Euros and Polish Zloty. Less than 2% of SIG's sales and purchases are cross-currency. When cross-currency transactions occur, it is SIG's policy to eliminate currency exposure at that time through forward currency contracts, if the exposure is considered to be material.
SIG faces a translation risk in respect of the local currencies of its primary foreign operations, principally being Euro and Polish Zloty sales and profits. SIG does not hedge the income statement translational risk arising from these income streams.
SIG also faces a translation risk from the US Dollar in respect of interest on its private placement borrowings. This risk has been eliminated through the use of cross currency swaps, which swap the US dollar private placement debt into Sterling.
The Consolidated Balance Sheet of the Group is inherently at risk from movements in the Sterling value of its net investments in foreign businesses and the Sterling value of its foreign currency net debt.
For currencies where the Group has significant balance sheet translational risk, SIG seeks to mitigate this risk by holding financial liabilities and derivatives in the same currency to partially hedge the net investment values. The Group's policy is that for currencies where a material balance sheet translational exposure exists, the Group will hold financial liabilities in that particular currency in proportion to the overall Group ratio of net debt to capital employed.
SIG had the following net debt denominated in foreign currencies, held partially to hedge the assets of overseas businesses (including cash and cash equivalents):
|2015 Local currency net borrowings/ (cash) LCm||2015 Sterling equivalent borrowings/ (cash) £m||2014 Sterling equivalent borrowings/ (cash) £m|
|% of net debt||37%||38%|
Euro net debt at 31 December 2015 represented 42% of Group net debt (2014: 48%).
Impact of foreign currency movements in 2015
The overall impact of foreign exchange rate movements on the Group's Consolidated Income Statement and Consolidated Balance Sheet is disclosed in the Financial Review of this Strategic Report.
The nature of the Group's operations creates an ongoing demand for fuel and therefore the Group is exposed to movements in market fuel prices. The Group enters into commodity derivative instruments to hedge such exposure where it makes commercial and economic sense to do so.
In Q1 2015 the Group entered into four commodity derivative instruments to hedge a portion of the UK, Polish and French fuel requirements for 2015 and 2016. At 31 December 2015 two of these commodity derivative instruments had matured and two remain outstanding, hedging c.59% of the Group's 2016 anticipated variable fuel cost. There were no commodity instruments outstanding at 31 December 2014.
Counterparty credit risk
SIG holds significant investment assets, being principally cash deposits and derivative assets. Strict policies are in place in order to minimise counterparty credit risk associated with these assets.
A list of approved deposit counterparties is maintained. Counterparty credit limits, based on published credit ratings and CDS spreads, are in place. These limits, and the position against these limits, are reviewed and reported on a monthly basis.
Sovereign credit ratings are also monitored, and country limits for investment assets are in place. If necessary, funds are repatriated to the UK.
The Company's debt facilities in place at 31 December 2015 contained a number of covenants to which the Group must adhere. The Group's debt covenants are tested at 30 June and 31 December each year, with the key financial covenants being leverage and interest cover.
The ratio for each of the debt covenants is set out below:
|Requirement||Year ended |
|Interest cover ratio*||>3.0x||8.1x||8.9x|
* Covenant interest cover is the ratio of the previous twelve months' underlying operating profit (including the trading losses and profits associated with divested businesses) to net financing costs (excluding pension scheme finance income and finance costs).
^ Covenant leverage is the ratio of closing net debt (at average exchange rates) to the underlying operating profit before depreciation, adjusted if applicable for the impact of acquisitions and disposals during the previous twelve months ("EBITDA").
As can be seen in the table above, the Group is in compliance with its financial covenants and is forecast to maintain a comfortable headroom.
The 2015 year-end leverage ratio has increased following net acquisition expenditure of £75.3m and as a result of the weaker than anticipated trading conditions during the year. Excluding acquisitions, leverage would have been less than 1.5x. Going forward SIG is aiming to return leverage to its target range of 1.0-1.5× by slowing the pace of its acquisition expenditure and moderating capital expenditure.
In accordance with the requirements of the 2014 amendments to the UK Corporate Governance Code ("the Code"), the Directors have performed a robust assessment of the principal risks facing the Group, including those that would threaten its business model, future performance, solvency or liquidity. Details of the risk identification and management processes and a description of the principal risks and uncertainties facing the Group are included in this Strategic Report. The Group's control processes are included in the Corporate Governance report.
While the Board has no reason to believe the Group will not be viable over a longer period, it has determined that the three years to 31 December 2018 is the most appropriate time period for its viability review. This period reflects the forecast period for the Group's strategic plans and industry forecasts. This gives the Board sufficient visibility of the future to make a realistic and reasonable assessment of longer-term viability.
As part of the Group's strategic planning process a three year business model was produced covering the period to December 2018. In order to assess the resilience of the Group to risks in severe but plausible scenarios, the model was subject to thorough multi-variant stress and sensitivity analysis, together with an assessment of potential mitigating actions. The resulting impact on key metrics, such as debt headroom and covenants, was considered.
In making this statement the Directors have also made the following key assumptions:
- The Group will be required to refinance at least a portion of the c.£130m of private placement notes that mature in November 2016, in order to provide the appropriate funding headroom. The Directors have concluded that they will be able to successfully refinance, on the basis of recent successful refinancing processes and the current and forecast position of bank debt and debt capital markets in 2016;
- There will be no severe prolonged downturn in the markets in which the Group operates; and
- In the event that the UK votes to leave the European Union, given the nature of SIG's operations, it would not be expected to have a direct, material adverse effect on performance.
After conducting their viability review, the Directors confirm that they have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the three year period of their assessment to December 2018.
Going concern basis
In determining whether the Group's 2015 Annual Report and Accounts can be prepared on a going concern basis, the Directors have considered all factors likely to affect its future development, performance and financial position, including cash flows, liquidity position and borrowing facilities and the risks and uncertainties relating to its business activities. These are set out in the Strategic Report and in the Notes to the Consolidated Financial Statements.
The key factors considered by the Directors were as follows:
- the implications of the challenging economic environment and the continuing weak levels of market demand in the building and construction markets on the Group's revenues and profits;
- projections of working capital requirements;
- the impact of the competitive environment within which the Group's businesses operate;
- the availability and market prices of the goods that the Group sells;
- the credit risk associated with the Group's trade receivable balances;
- the potential actions that could be taken in the event that revenues are worse than expected, to ensure that operating profit and cash flows are protected; and
- the committed finance facilities available to the Group and the ability of the Group to refinance the c.£130m of maturing private placement notes, as set out in the Viability Statement.
Having considered all the factors above, including downside sensitivities, the Directors are satisfied that the Group will be able to operate within the terms and conditions of the Group's financing facilities, and have adequate resources to continue in operational existence for the foreseeable future. Accordingly, the Group continues to adopt the going concern basis in preparing the Group's 2015 Annual Report and Accounts.
This Strategic Report has been prepared to provide the Company's Shareholders with a fair review of the business of the Group and a description of the principal risks and uncertainties it faces. It may not be relied upon by anyone, including the Company's Shareholders, for any other purpose.
This Strategic Report and other sections of this report contain forward-looking statements that are subject to risk factors including the economic and business circumstances occurring from time to time in countries and markets in which the Group operates and risk factors associated with the building and construction sectors. By their nature, forward-looking statements involve a number of risks, uncertainties and assumptions because they relate to events and/or depend on circumstances that may or may not occur in the future and could cause actual results and outcomes to differ materially from those expressed in or implied by the forward-looking statements. No assurance can be given that the forward-looking statements in this Strategic Report will be realised. Statements about the Directors' expectations, beliefs, hopes, plans, intentions and strategies are inherently subject to change and they are based on expectations and assumptions as to future events, circumstances and other factors which are in some cases outside the Group's control. Actual results could differ materially from the Group's current expectations.
It is believed that the expectations set out in these forward-looking statements are reasonable but they may be affected by a wide range of variables which could cause actual results or trends to differ materially, including but not limited to, changes in risks associated with the level of market demand, fluctuations in product pricing and changes in foreign exchange and interest rates.
The forward-looking statements should be read in particular in the context of the specific risk factors for the Group identified in the Principal Risks and Uncertainties section of this Strategic Report. The Company's Shareholders are cautioned not to place undue reliance on the forward-looking statements. This Strategic Report has not been audited or otherwise independently verified. The information contained in this Strategic Report has been prepared on the basis of the knowledge and information available to Directors at the date of its preparation and the Company does not undertake any obligation to update or revise this Strategic Report during the financial year ahead.
The Strategic Report was approved by the Board of Directors on 8 March 2016 and signed on its behalf by Stuart Mitchell and Doug Robertson.
Stuart MitchellChief Executive
8 March 2016
Doug RobertsonGroup Finance Director
8 March 2016