As a result of its international operations, Swedish Match is exposed to financial risks.
The term “financial risks” refers to fluctuations in Swedish Match’s cash flow caused by changes in foreign exchange rates and interest rates, and to risks associated with refinancing and credit. To manage its financial risks, Swedish Match has a finance policy in place established by the Board of Directors. The Group’s finance policy comprises a framework of guidelines and principles governing the management of financial risks and finance operations in general. The central treasury function is responsible for the Group’s borrowing, currency and interest rate management and serves as an internal bank for the Group’s financial transactions. In addition to ensuring that the Swedish Match Group has secure financing, financial transactions are conducted with the aim of limiting the Group’s financial risks. The Group’s financial risk management is centralized to capitalize on economies of scale and synergy effects, and to minimize operational risks.
Swedish Match uses various types of financial instruments to hedge the Group’s financial exposure arising in business operations and as a result of the Group’s financing and asset and debt management activities. In addition to loans, currency exchange and derivative instruments are used to reduce Swedish Match’s financial exposure. The most frequently used derivative instruments are currency forwards, currency swaps and interest rate swaps. A table showing all the derivatives that affected the Group’s balance sheet and income statement is provided below.
Exchange rate fluctuations affect Group earnings and shareholders’ equity in various ways:
- Earnings – when sales revenues and production costs are denominated in different currencies (transaction exposure).
- Earnings – when the earnings of foreign subsidiaries are translated to SEK (translation exposure).
- Earnings – if loans and deposits are made in other currencies than the unit’s functional currency (translation exposure).
- Shareholders’ equity – when the net assets of foreign subsidiaries are translated to SEK (translation exposure).
The consolidated income statement includes exchange rate gains of 8 MSEK (–3) in operating profit and gain 3 MSEK (1) in net finance cost.
For the Group as a whole, there is a balance between inflows and outflows in some of the major currencies such as EUR and USD, which effectively limits the Group’s transaction exposure. Limited transaction exposure arises when certain of the Group’s production units in Europe make purchases of raw tobacco in USD, and through the European operations’ exports of lighters and matches in USD. The largest exposure is in NOK due to the sales of snus in Norway which is produced in Sweden.
The anticipated commercial currency flow net of the reverse flows in the same currencies (transaction exposure) amounts to approximately 960 MSEK on an annual basis. It is divided as following; 623 MSEK in NOK (65 percent), 111 MSEK in USD (12 percent), 82 MSEK in PHP (9 percent), 55 MSEK in EUR (6 percent), 42 MSEK in GBP (4 percent) and in other currencies 47 MSEK (4 percent). Swedish Match’s policy for managing the Group’s transaction exposure is to hedge within certain limits. The hedging transactions are, if any, based on risk exposures, current market conditions and other strategic considerations. Transactions are mainly initiated via currency forward contracts with durations of up to 12 months, and relate to forecasted currency flows. At December 31, 2015, no transaction exposure for 2016 has been hedged. A general rise of 10 percent in the value of the SEK against all of the Group’s transaction currencies is estimated to reduce consolidated earnings before tax by 57 MSEK (112), which of 62 in NOK, 6 in EUR, 4 in GBP, –8 in PHP, –11 in USD and 4 in other currencies for the year ending December 31, 2015.
The most significant effect of currency movements on consolidated earnings arises from the translation of subsidiaries’ earnings. Earnings in Group companies are translated at average exchange rates. Effects mainly pertain to USD, NOK, BRL and EUR. The single most important currency is the USD.
When the net assets of foreign subsidiaries are translated to SEK, translation differences arise that are recognized directly in equity. The exposures of net investment are 5,549 MSEK in USD (90 percent), 340 MSEK in EUR (5 percent), 187 MSEK in BRL (3 percent) and in other currencies 105 MSEK (2 percent). The Group does not, as a general rule, hedge the net investments in foreign subsidiaries. If the SEK weakened by 10 percent against all the currencies in which Swedish Match has foreign net assets, the effect on shareholders' equity would be negative in an amount of approximately 562 MSEK, which of 555 in USD and 7 in other currencies based on the exposure at December 31, 2015.
The Swedish Match Group’s sources of financing mainly comprise shareholders’ equity, cash-flow from current operations, and borrowing. Interest-bearing loans and pension liabilities expose the Group to interest-rate risk. Changes in interest rates have a direct impact on Swedish Match’s net interest expense. Swedish Match policy is that the average interest maturity should be less than 5 years. The speed with which a permanent change of interest rate impacts net interest expense depends on the interest maturity periods of the loans. The Group’s objective for interest rate fixing is to achieve an even and low cost of interest. Interest rate swaps and currency swaps are used mainly to convert our borrowing into SEK and fixed interest rates. At December 31, 2015, the average interest maturity period for Group loans was 3.2 years (3.5 years), taking into account interest rate swaps.
At December 31, 2015, a general rise of 1 percent (100bp) in short term interest rates of debt with variable interest rates and cash surplus was estimated to increase consolidated earnings before tax by approximately 12 MSEK (18) on an annual basis. The net interest bearing debt (including net pension obligations) at the same date amounted to 7,922 MSEK (8,126). The assumption is based on the present level of net debt and average interest maturity period.
If interest rates were to rise with 1 percent (100bp), the total effect on equity due to cash flow hedges would have a positive impact on the amount by 1 MSEK (2).
Refinancing risk and liquidity
Refinancing risk is defined as the risk of that funds become scarce and thus more expensive than expected, and liquidity risk is defined as not being able to make regular payments as a consequence of inadequate liquidity or difficulty in raising external loans. Swedish Match applies a centralized approach to the Group’s financing, whereby as much external borrowing as possible is conducted centrally. Subsidiary borrowing can, however, take place in countries where regulations and taxes make central financing impossible or uneconomical. Swedish Match tries to limit its refinancing risk by having a good distribution and a certain length on its gross borrowing, and not being dependent on individual sources of financing.
Swedish Match has a syndicated bank credit facility of 1,500 MSEK, which matures in December 2020. This was unutilized at year-end and contained no financial covenants. At year-end 2015, available cash funds and committed credit facilities amounted to 3,232 MSEK. Of this amount, confirmed credit lines amounted to 1,500 MSEK and cash and cash equivalents making up the remaining 1,732 MSEK.
Most of Swedish Match’s financing consists of a global medium-term note program (MTN) with a limit amount of 1,500 MEUR. The program is an uncommitted borrowing program and the availability could be limited by the Group’s creditworthiness and prevailing market conditions. At December 31, 2015, a total of 8,287 MSEK of the global program was outstanding. The average maturity of the Group’s bond borrowing at December 31, 2015 was 3.3 years.
Under the global MTN program, Swedish Match has issued bonds in SEK, EUR, USD and CHF. Borrowing in EUR, USD and CHF is hedged by currency swaps and currency interest rate swaps. The average interest cost for outstanding borrowings (including derivative instruments) on December 31, 2015 was 4.2 percent (4.5).
Liquidity within Swedish Match is handled centrally through local cash pools. Group companies are required to deposit liquid funds in cash pool accounts or, if these are not available, with the Parent Company’s treasury units. Exceptions are only allowed when regulations prohibit cash pools or internal deposits.
Liquidity risks and credit risks
To limit liquidity and credit risks, investments and transactions in derivative instruments may be made only in instruments with high liquidity and with counterparties having high credit ratings. In addition to bank accounts, Swedish Match invests surplus funds mainly in bank deposits and bank certificates. At December 31, 2015, the average interest maturity for the Group’s current investments was less than 1 month.
The Group’s finance policy regulates the maximum credit exposure to various counterparties. The aim is that counterparties to Swedish Match in financial transactions should have a credit rating of at least category A from Standard & Poor’s or equivalent from Moody’s.
To reduce the credit risk in receivables from banks arising via derivative instruments, Swedish Match has entered into netting agreements, known as ISDA Master Agreements, with all of its counterparties. These agreements grant rights to net market valuations on assets and liabilities if the counterpart is in an event of default, as with suspended payments. The following table shows the netted exposures per December 31, 2015. No collateral has been received or pledged.
For more information see Note 17 Trade receivables in the Swedish Match Annual Report 2015.
Source: Swedish Match Annual Report 2015, Note 25 Financial instruments and financial risks.