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 functions consist of Financial Services and Treasury, which are responsible for the Group’s borrowing including securing financing needs, cash management including cash pools and handling the liquidity surplus, as well as currency and interest rate management. Treasury serves as an internal bank for the Group’s financial transactions. 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. To reduce Swedish Match’s financial exposure, derivative instruments, such as currency forwards, currency swaps and cross currency interest rate swaps are used.
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 gain of 7 MSEK (6) in operating profit and gain of 5 MSEK (3) in net finance cost.
A large part of the Group´s inflow and outflow in foreign currencies are matched, which effectively limits the Group’s transaction exposure. 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 of the Group is in NOK due to the sales of snus in Norway which is produced in Sweden.
The anticipated commercial net currency flow in the same currencies (transaction exposure) amounts to 1,549 MSEK on an annual basis. It is divided as following; 979 MSEK in NOK (63 percent), 213 MSEK in USD (14 percent), 243 MSEK in EUR (16 percent), 35 MSEK in GBP (2 percent), 40 MSEK in PHP (3 percent) and in other currencies 40 MSEK (2 percent). As Swedish Match’s transaction exposures are limited, few hedging transactions are executed. The hedging transactions are, if any, based on risk exposures, current market conditions and other strategic considerations. At December 31, 2019, no transaction exposure for 2020 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 146 MSEK (127), of which 98 MSEK in NOK, 21 MSEK in USD, 24 MSEK in EUR and in other currencies by 3 MSEK.
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, EUR, BRL and DKK. 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 3,751 MSEK in USD (80 percent), 281 MSEK in EUR (6 percent), 255 MSEK in BRL (5 percent), 269 MSEK in DKK (6 percent) and 129 MSEK (3 percent) in other currencies. The Group does not, as a general rule, hedge the net investments in foreign subsidiaries. If the SEK strengthens by 10 percent against all the currencies in which Swedish Match has foreign net assets, the effect on shareholders’ equity would be a total positive net amount of approximately 346 MSEK, of which 375 MSEK in USD, 28 MSK in EUR, 4 MSEK in GBP would give a positive effect and of which 25 MSEK in BRL, 27 MSEK in DKK, 7 MSEK in NOK and 2 MSEK in TRY would give a negative effect based on the exposure at December 31, 2019.
The Swedish Match Group’s sources of financing mainly comprise of 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. Cross currency interest rate swaps are used mainly to convert our borrowing in foreign currencies into SEK and fixed interest rates. At December 31, 2019, the average interest cost for outstanding bonds (including derivative instruments) on December 31, 2019 was 2.1 percent (2.2). The average interest maturity period for Group loans was 3.7 years (4.1 years), taking into account cross currency interest rate swaps.
At December 31, 2019, 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 (5) on an annual basis. The net interest-bearing debt (including net pension obligations and lease liabilities) at the same date amounted to 11,925 MSEK (10,843).
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 of 7 MSEK (9).
Refinancing risk and liquidity
Refinancing risk is defined as the risk 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 length on its gross borrowing, and not being dependent on individual sources of financing.
Swedish Match has a syndicated bank credit facility of committed 1,500 MSEK, which matures in December 2021. This was unutilized at year-end and contained no financial covenants. It is defined as a reserve facility. At year-end 2019, available cash funds and committed credit facilities amounted to 3,870 MSEK. Of this amount, confirmed credit lines amounted to 1,500 MSEK and cash and cash equivalents making up the remaining 2,370 MSEK. All cash and cash equivalents are available for use, none of this is pledged or similar.
Most of Swedish Match’s financing consists of a global medium-term note program (MTN) with a limit amount of 2,000 MEUR. The program is an uncommitted borrowing program and the availability could be limited by the Group’s creditworthiness and prevailing market conditions. In case of market stress, if this program cannot be efficiently used, the syndicated bank credit facility of 1,500 MSEK will be utilized if necessary. At December 31, 2019, a total of 13,453 MSEK of the global medium-term note program was outstanding. The average maturity of the Group’s bond borrowing at December 31, 2019 was 3.7 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 into SEK by cross currency interest rate swaps.
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 Group’s treasury unit. 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 in banks and institutions. At December 31, 2019, 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, 2019. No collateral has been received or pledged. The majority of the derivatives are related to the Group’s central funding.
Source: Swedish Match Annual Report 2019, Note 28 Financial instruments and financial risks.