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||11.2||10.0|
|Private placement notes||200.7||255.9|
|Loan notes and deferred consideration||2.7||3.0|
|Derivative financial instruments (liabilities)||3.8||2.0|
|Derivative financial instruments (assets)||(4.5)||(36.8)|
|Gross debt (after derivative financial assets)||389.3||384.9|
|Cash on deposit||(127.6)||(146.2)|
|Other financial assets||(1.1)||(1.3)|
The Group's gross financial liabilities can be further analysed as follows:
|Gross financial liabilities with a maturity profile of greater than five years||136.3||35%||52.0||16%|
|Gross financial liabilities held on an unsecured basis||377.5||97%||314.9||96%|
Details of derivative financial instruments are shown in Note 19 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 pension funds, and principal bank debt.
The maturity profile of the Group's debt facilities at 31 December 2016 is as follows:
|Date of expiry|
|Bank debt||350.0||161.9||188.1||May 2021|
|Private placement loan notes||20.0||20.0||–||November 2018|
|Private placement loan notes||25.6||25.6||–||October 2020|
|Private placement loan notes||17.1||17.1||–||October 2021|
|Private placement loan notes||42.7||42.7||–||October 2023|
|Private placement loan notes||93.4||93.4||–||August 2026|
During the year £131m of private placement debt matured and was repaid. In order to maintain the Group's level of liquidity, this debt was successfully refinanced through a combination of additional bank facilities and new bilateral private placement debt. The additional bank facilities were provided by SIG's existing bank group through an amend and extend of the existing committed Revolving Credit Facility ("RCF"), which was increased from £250m to £350m and the maturity date extended for a new five-year term to May 2021. There was no change to the key terms of this facility, which was just under 50% drawn at 31 December 2016 and represents the committed funding headroom of the Group. Additionally, a total of c.€110m new private placement debt was raised for a ten-year term from three bilateral investors at attractive rates of interest, and on the same terms as the existing bilateral private placement debt.
The refinancing undertaken in 2016 ensures that SIG has sufficient funding headroom and liquidity available to support its medium-term strategic plans.
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.
The percentage of net debt at fixed rates of interest at 31 December 2016 is 62% (2015: 57%) and on a gross debt basis is 62% (2015: 55%), which is within the Group's targeted medium-term range.
Foreign currency risk
SIG has a number of overseas businesses, the revenues and costs of which are denominated in the currencies of the countries where the operations are located. 52% of SIG's 2016 continuing revenues (2015: 48%) 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 Euros.
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.
At 31 December 2016, due to the goodwill and intangible impairment charge associated with Larivière (£100.4m), the percentage of Euro debt went above the Group's policy range. This was corrected in the first quarter of 2017.
SIG had the following net debt denominated in foreign currencies, held partially to hedge the assets of overseas businesses (including cash and cash equivalents):
currency net borrowings/(cash)
Sterling equivalent borrowings/(cash)
|2015 Sterling equivalent borrowings/(cash)|
|% of net debt||57%||37%|
Euro net debt at 31 December 2016 represented 59% of Group net debt (2015: 42%).
Impact of foreign currency movements in 2016
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 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 2016 these commodity derivative instruments had matured, and the Group has not entered into any further commodity derivative instruments.
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 2016 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, interest cover and consolidated net worth 1.
The ratio for each of the debt covenants is set out below:
|Requirement||Year ended |
|Year ended |
|Consolidated net worth1||>£400m||£538.8m||£648.7m|
|Interest cover ratio2||>3.0x||6.5x||8.1x|
- The consolidated net worth covenant is applicable to the private placement debt only.
- Covenant interest cover is the ratio of the previous 12 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 12 months ("EBITDA").
Detailed calculations of the interest cover ratio and leverage can be found in Note 32 to the Accounts.
As can be seen in the table above, the Group is in compliance with its financial covenants and has a reasonable level of headroom.
The 2016 year-end leverage has increased as a result of the weaker than anticipated trading conditions during the year, and is above its medium-term target of 1.0x – 1.5x. Going forward, the Group will prioritise leverage reduction by more tightly focusing on its cash generation, moderating capital expenditure and suspending its infill acquisition programme.
The Group is expecting leverage to increase at 30 June 2017 due to normal seasonal working capital patterns and the carry over of the weak second half of 2016 trading activities.
In accordance with the requirements of the 2014 amendments to the UK Corporate Governance Code ("the Code"), the Directors confirm that they 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 process and a description of the principal risks and uncertainties facing the Group are included in the Principal risks and uncertainties section.
The Board has determined that a three-year period to 31 December 2019 is the most appropriate time period for its viability review. This period has been selected since it gives the Board sufficient visibility into the future, due to industry characteristics and business cycle, to make a realistic viability assessment. As part of the Group's strategic planning process a three-year business model was produced covering the period to 31 December 2019. In order to assess the resilience of the Group to threats to its viability posed by those risks in severe but plausible scenarios, this model was subjected to thorough multi-variant stress and sensitivity analysis together with an assessment of potential mitigating actions. This multi-variant stress and sensitivity analysis included scenarios arising from combinations of the following:
- the implications of both a challenging economic environment and a growing market on the Group's revenues (both pricing and volume impacts);
- the impact of the competitive environment within which the Group's businesses operate and the interaction with the Group's gross margin;
- global inflation and the impact on the Group's operating cost base;
- working capital requirements from investment and trading activities, taking into account normal seasonality trends and short-term working capital management; and
- timing, delivery and efficiency of the Group's strategic growth priorities.
The resulting impact on key metrics, such as debt headroom and covenants, was considered.
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 31 December 2019.
Going concern basis
In determining whether the Group's 2016 Annual Report and Accounts can be prepared on a going concern basis, the Directors 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 Chairman's Statement and 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 taking into account normal seasonality trends and short-term working capital management;
- 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.
Having considered all the factors above impacting the Group's businesses, 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, they continue to adopt the going concern basis in preparing the Group's 2016 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 facing it. 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 a duly authorised committee of the Board of Directors on 13 March 2017 and signed on the Board's behalf by Mel Ewell and Nick Maddock.
13 March 2017
Chief Financial Officer
13 March 2017