Financial risks and opportunities
The Wilo Group’s global presence makes it important to manage changes in exchange rates. Currency risk for the Wilo Group primarily results from its operating and financing activities. The currency risk that largely relates to the supply of goods and services to Group companies is limited with same-currency offsetting transactions and derivative financial instruments.
The occurrence of exchange rate risks from the operating activities of Group companies with third-party customers and suppliers is probable, but the Wilo Group rates the associated earnings impact as low. These activities are predominantly transacted in local currency.
Currency risk from financing activities results in particular from foreign-currency borrowing from third-party lenders. There is also foreign-currency lending to Group companies for financing purposes. Such currency risks are reduced by the use of derivative financial instruments.
To prepare the consolidated financial statements, the annual financial statements of the subsidiaries that are based outside the euro area, or whose functional currency is not the euro, are translated into the reporting currency (euro). Changes in the average exchange rate of a currency can therefore notionally influence both net sales and income as a result of translation. However, this translation risk is not associated with any effects on the cash flows in local currency.
Further information on currency risks in accordance with IFRS 7 and a corresponding sensitivity analysis can be found in section (13) “Risk management and derivative financial instruments” of the notes to the consolidated financial statements on page 000 et seq.
Overall, the occurrence of currency risks is considered likely, but the Wilo Group classes the associated impact on earnings as low.
The interest rate risk mainly results from floating rate financial liabilities and the investment of cash. Both rises and falls in the yield curves result in interest rate exposure. The Wilo Group mitigates adverse changes in value from unexpected interest rate movements by using derivative financial instruments. The occurrence of interest rate risk is considered possible, and the impact on net finance costs is rated as low as most financial liabilities have fixed long-term interest rates. By contrast, favourable interest rate developments could have a positive effect on net interest income. Group Treasury monitors and analyses developments on the financial markets in order to optimise the balance between liquidity retention and the investment of cash in term money with a maximum time horizon of up to twelve months.
The Wilo Group is mainly exposed to commodity price risk as a result of price fluctuations on the global markets for copper, aluminium, stainless steel and their alloys. The Wilo Group uses commodity derivatives in a targeted manner to minimise commodity price risk. They are used if the effect on earnings from the change in commodity prices is significant to the Wilo Group and corresponding financial instruments are available and can also be used efficiently. In addition, the development of prices and supply of rare earth elements is monitored extremely closely.
The prices for most of the copper procurement volume for the 2017 financial year have already been determined in order to minimise the impact on earnings from the change in copper prices for the Wilo Group.
In contrast, the prices for the procurement volume for stainless steels and their alloys are not hedged, because the available financial instruments are not suitable for effectively minimising the risk of price changes for these commodities. According to current information, the Wilo Group’s results of operations could primarily be affected by price fluctuations on the global markets for copper and aluminium from the 2018 financial year.
The Wilo Group regards the commodity price risk arising from the procurement of rare earth elements as low at this time. Despite this risk classification and given the lack of corresponding derivative financial instruments to hedge this commodity price risk, the Wilo Group is taking pains to use appropriate substitutes and to identify further suppliers for these commodities. As things stand, the future price development of rare earth elements can continue to affect the Wilo Group’s results of operations both positively and negatively.
Commodity price risks are possible, but the Wilo Group classes the associated impact on earnings as low.
The Wilo Group counters customer credit risk with a uniform and effective Group-wide system. It encompasses systematic receivables management and the monitoring of payment behaviour. Dependency on individual customers is limited as the Group does not generate more than 10 percent of its total net sales with any one customer. The Wilo Group did not experience any significant negative influence from its customers’ payment practices in the past financial year. The possible effect on earnings of default is currently also considered low for 2017.
There is also a risk of default with regard to the banks with which investments are conducted, at which credit facilities are held, or with which hedges are concluded. The potential default of these partners would have a negative impact on the Wilo Group’s financial position and results of operations. All in all, however, the occurrence of this risk is considered to be unlikely as Wilo enters into such transactions only with those banks that have good to very good credit ratings. Group Treasury permanently monitors the credit ratings of these banks and takes appropriate measures as required.
Financing and liquidity
Liquidity risk stems from a potential lack of cash for paying due liabilities in full and on time in the agreed currency. In addition, there is a risk of having to accept unfavourable financing terms in the event of liquidity bottlenecks and volatility on the international financial and capital markets. To minimise these liquidity and financing risks, and thereby to make a valuable contribution to the profitable growth of the Wilo Group, the Wilo Group aims to ensure long-term, cost-effective coverage of liquidity and capital requirements at all times. Various financing instruments are used for this purpose.
These include committed cash credit facilities for the parent company and subsidiaries of more than EUR 200.0 million with international banks of good to very good credit standing. EUR 15.3 million of the cash credit facilities had been utilised as at 31 December 2016. Furthermore, as at 31 December 2016, there were also promissory note loans of EUR 10.0 million and senior notes of EUR 112.0 million that were issued in US private placements.
At 31 December 2016, the Wilo Group reported its net financial position (financial liabilities less cash) as excess liquidity of EUR 41.0 million and was thus free of net debt. The ratio of net financial liabilities to EBITDA (leverage) improved from 0.01 to -0.26.
In order to achieve a needs-driven supply of cash with matching maturities and the optimum allocation of cash within the Group, the Wilo Group prepares corresponding liquidity and finance plans based on the budget planning and strategic five-year planning process in addition to the year-to-date forecast. Rolling three-month liquidity planning is also prepared on a monthly basis for each Group company. The cash directly available to the Wilo Group over the course of 2016, including committed cash credit facilities, was at all times higher than the minimum reserve of EUR 100.0 million defined by the Executive Board of WILO SE.
The Wilo Group uses cash pooling, netting and borrowing arrangements to the extent advisable and permitted under local commercial and tax regulations. At Group level, all financial transactions are tracked by central treasury software and monitored by WILO SE, enabling risks to be balanced between the individual companies of the Group.
The Wilo Group is required to maintain standard financial ratios (financial covenants) under the terms of its long-term financing agreements. If it falls short of certain minimum values, the lenders are entitled to demand early repayment, among other things. As such, a failure to meet the agreed minimum values would potentially have a substantial financial impact. These figures are regularly reviewed, planned and reported to the Executive Board of WILO SE in order to ensure compliance with the required minimum values at all times and to enable suitable countermeasures to be initiated at an early stage as necessary. Due to its strong equity base and profitability, the Wilo Group still expects to comply with its financial covenants throughout the term of the existing financing agreements.
The Wilo Group believes that liquidity and financing risks are unlikely to arise on account of the cash and credit facilities available, the financing structure and the business model. The financial impact on the Group is therefore rated as low.