Annual Report 2008 in PDF - GKN

38
Business Review: Financing and Risk continued
Refinancing risk
Committed revolving credit facilities totalling £350
million mature in July 2010 and all or part of these
facilities would normally be refinanced during 2009. The
terms of the refinancing, including the time frame, cost
and quantum, are expected to be more onerous given
the current credit market conditions. This is likely to be
further exacerbated by the downgrade of the Group’s
credit rating to sub-investment grade in January 2009.
Currency risk
The Group has transactional currency exposures arising
from sales or purchases by operating subsidiaries in
currencies other than the subsidiaries’ functional currency,
the most significant being the US dollar and the euro. Under
the Group’s foreign exchange policy, transaction exposures
are hedged, once they are known, mainly through the use of
forward foreign exchange contracts.
The Group has a significant investment in overseas
operations, particularly in continental Europe and the
Americas. As a result, the sterling value of the Group’s
balance sheet can be affected by movements in exchange
rates. In prior years, the Group sought to mitigate the
effect of these translational currency exposures by
matching the net investment in overseas operations with
currency borrowings, synthetically created using forward
foreign exchange contracts. This policy was suspended at
the end of 2008 due to the continuing volatility of foreign
currencies against sterling.
Interest rate risk
The Group operates an interest rate policy designed to
minimise interest cost and reduce volatility in reported
earnings. To achieve this, it maintains a target range of
fixed and floating rate debt for discrete annual periods.
Interest rates on all debt capital market issues remain at
fixed rates whilst the balance of debt is at floating rates.
At 31 December 2008, 83% of the Group’s gross financial
liabilities were at fixed rates of interest, whilst the
weighted average period in respect of which interest has
been fixed was 7 years.
Credit risk
The Group is exposed to credit-related losses in the
event of non-performance by counterparties to financial
instruments, which include trade debtors.
Credit risk relating to financial institutions is mitigated
by the Group’s policy of selecting only counterparties
with a strong investment graded long term credit rating,
normally at least AA– or equivalent, and assigning
financial limits to individual counterparties.
With the concentration of customers noted below, the
financial failure of any one of them could have a material
impact on performance. Increasing emphasis is placed on
the monitoring of credit exposures in the current economic
climate, with regular reporting to divisional management
and the Executive Committee. In addition, credit terms and
overdue debtors are closely monitored and appropriate
action taken. At 31 December 2008 the largest individual
debtor balance was 0.7% of Group sales. (For further
information see note 19 to the financial statements.)
In addition to the inherent specific financial risks and
their management referred to above, there are other,
more general, financial risks that could have a material
adverse effect on the business, its financial condition or
results of its operations.
Pension and retiree medical risk
We operate both defined benefit (DB) and defined
contribution (DC) pension plans, together with retiree
GKN plc Annual Report 2008
medical and life insurance arrangements. The majority of
the DB plans are in the UK, North America and continental
Europe. Retiree medical arrangements are limited to North
America and the UK, where all schemes are closed. Funded
obligation deficits, mostly in the US and UK, increased
by £402 million to £435 million at 31 December 2008.
Unfunded obligation deficits, primarily in continental
Europe, increased by £101 million to £399 million.
Deterioration in asset values, changes to real long
term interest rates or the strengthening of longevity
assumptions could lead to a further increase in the
deficit or give rise to an additional funding requirement.
Furthermore, foreign exchange rate volatility can impact
pension fund values.
Taxation risk
The Group operates in over 30 countries and as a
consequence is subject to many complex tax laws and tax
authority audit procedures.
Amounts accrued for tax liabilities are based upon
management’s judgement taking into account their
interpretation of tax law in each country and the
likelihood of settlement where there is a tax dispute.
Actual tax liabilities could differ from the accruals made
by management and the difference would give rise to an
adjustment in a subsequent period, which could have a
material impact on the Group’s income statement and/or
cash position.
Market and customer related risk
Global economic and political risk
GKN operates in a number of emerging markets including
Asia Pacific and Latin America. Whilst exposed to a
wide range of risks including political, regulatory,
environmental and socio-economic, it is also in a
position to benefit from potentially significant growth
opportunities and a diversified business base.
Cyclical nature of markets
Approximately 57% of 2008 sales of subsidiaries were to
automotive vehicle manufacturers and 23% for original
equipment on aircraft or aircraft components.
The automotive industry, in common with other capital
goods industries, is affected by macro-economic
conditions and consumer demand and preferences.
Economic conditions became extremely challenging
in many of the world’s economies in 2008. There has
been a material deterioration in the number of vehicles
manufactured and sold, which is likely to continue
throughout 2009 and potentially beyond.
The military aircraft element of our business is affected by
political and budgetary considerations, particularly in the
US. Civil demand is affected by the number of passenger
miles flown and revenue per seat which, in turn, is
a function of economic growth, fuel costs, personal
spending power and perceived security risk. In the civil
aerospace market, the current economic conditions are
beginning to impact demand with a further softening
anticipated during 2009 and 2010.
The availability of credit to consumers and airlines
could impact purchases of vehicles and aircraft with a
consequential effect on the level of build rates and orders
in all of our businesses.
The Group seeks to mitigate these risks by acting
aggressively to reduce its cost base when demand for its
products fall, through plant rationalisations, short-time
working, Lean manufacturing techniques and other cost
base reduction initiatives.