Going concern and viability statements, disclosure of scenarios with quantified assumptions, COVID – 19, cash and facilities, mitigating actions, covenants, reverse stress analysis

Victrex plc – Annual report – 30 September 2021

Industry: manufacturing

Going concern and viability statement

Going concern

The Directors have performed a robust going concern assessment including a detailed review of the business’ 24-month rolling forecast and consideration of the principal risks faced by the Group and the Company, as detailed on pages 39 to 41. This assessment has paid particular attention to the impact of the ongoing global economic challenges on the aforementioned forecasts. An update on the Group’s proactive approach to managing the challenges of COVID-19 is detailed on page 6 with the specific impact of COVID-19 on the Company’s going concern assessment detailed below.

The Company has maintained a strong balance sheet throughout the past two years despite seeing a significant impact from COVID-19, particularly during the second half of the year ended 30 September 2020. The combined cash and other financial assets balance at 30 September 2021 was £112.4m, having increased from £79.6m at 31 March 2021. Of the £112.4m, £12.5m is held in the Group’s subsidiaries in China for the sole purpose of funding the construction of our new manufacturing facilities. Of the remaining £99.9m, approximately 90% is held in the UK, where the Company incurs the majority of its expenditure. All funds are held either in instant access or deposit accounts with less than 95 days’ notice. The Group has no debt and has unutilised banking facilities of £40m through to October 2024, of which £20m is committed and immediately available and £20m is available subject to lender approval.

COVID-19 had a material impact on second half performance of the year ended 30 September 2020 with sales volumes down 19% on the same period in 2019 and 25% down on the first half; revenue was down 23% and 24% respectively. Quarter 4 was the weakest with revenue in July 2020 the low point of the year and volume averaging c.230 tonnes per month. Demand for the Company’s products has recovered through the FY 2021 with the second half being the strongest in the Company’s history in volume terms. Full year volumes are up 25% on FY 2020 and 52% up on the heavily COVID-19 impacted second half of 2020. As with the drop off in demand during the second half of FY 2020 the timing and speed of recovery has been felt differently across our markets and geographies with further detail provided in the Financial review on pages 23 to 28.

The 24-month rolling forecast is derived from the Company’s Integrated Business Planning (‘IBP’) process which runs monthly. Each area of the business provides revised forecasts which consider a number of external data sources, triangulating with customer conversations, trends in market and country indices, as well as forward-looking industry forecasts. For example, forecast aircraft build rates from the two major manufacturers for Aerospace and analysing IHS Markit data for the Automotive market through previous downturns, current trends and the latest 2022 and 2023 forecasts. The assessment of going concern included conducting scenario analysis on the aforementioned forecast which focused on one key question: Is the recovery during 2021 and the increasing economic confidence, derived from falling COVID-19 cases and the ongoing vaccination programme, sustainable, or will either the recovery run out of momentum in the face of further waves of new, vaccine immune, variants of COVID-19 or will the global economy be pushed back into contraction by supply chain issues, inflationary pressures or labour shortages?

The Company’s manufacturing assets remain operational, as they have done throughout the past 24 months, with revised procedures remaining in place to ensure social distancing is maintained along with proactive measures to protect employees such as offering the facility to conduct temperature checks each day before commencing work. Non-manufacturing staff have continued to work from home in the majority of our regions throughout FY 2021 as we continue with a safety first approach. A carefully managed Return to Site commenced in the UK in October 2021 in line with government recommendations. Other regions have started to move in line with local government guidance.

Using the IBP data and the key question noted above, along with consideration of the outputs from the longer-term viability assessment (noted below), management has created two scenarios to model the effect of reductions to revenue at regional/market level and aggregated levels on the Company’s profits and cash generation through to January 2023.

Scenario 1 – the global economy contracts again with sales returning to the low levels seen in quarter 4 of FY 2020, at c230 tonnes per month, from March 2022 (i.e. the first period post payment of the final and special dividends, therefore representing the cash low point of the year) for a period of six months (to mirror the length of the downturn in 2020) before a partial recovery to c280 tonnes per month for the remainder of the going concern period.

Scenario 2 – in line with scenario 1, c230 tonnes per month from March 2022, however, the economic contraction lasts for a full twelve months, i.e. throughout the remainder of the going concern period. This would give an annual volume of c2,760 tonnes, a level not seen since the financial crisis which impacted 2008 and 2009 (and lasted approximately twelve months). The Group considers scenario 2 to be a severe but plausible scenario.

Before any mitigating actions the sensitised cash flows show the Company has significantly reduced cash headroom. Under scenario 2 there is minimal cash generation through the going concern period and there is potential that the committed facility, for which the covenants would be met, would be required to manage intra-month cash flows. However, the Company has a number of mitigating actions which are readily available in order to generate significant headroom. These include:

  • Use of committed facility – £20m could be drawn at short notice. Conversations with our banking partner indicate that the £20m accordion could also be readily accessed. The covenants of the facility have been successfully tested under each of the scenarios;
  • Deferral of capital expenditure – the base case for financial year 2022 includes significant capital investment (£60m+) as major projects are completed in China and the UK. This could be reduced significantly by limiting expenditure to essential projects, deferring all other projects into 2023, with the exception of completing the manufacturing facilities in China which are committed and continue as planned;
  • Reduction in discretionary overheads – costs would be limited to prioritise and support customer related activity; and
  • Deferral/cancellation of dividends – the dividend payable in June 2022 could be deferred or cancelled. The Company’s intention is to continue payment of dividends where cash reserves facilitate but it remains a key lever in downside scenario mitigation.

Reverse stress testing was performed to identify the level that sales would need to drop by in order for the Group to run out of cash by the end of the going concern assessment period. Sales volumes would need to consistently drop materially below the low point in scenario 2 which is not considered plausible. As a result of this detailed assessment and with reference to the Company’s strong balance sheet, existing committed facilities and the cash preserving levers at the Company’s disposal, but also acknowledging the inherent economic uncertainty as the global economy emerges from the COVID-19 pandemic and faces a number of new challenges, the Board has concluded that the Company has sufficient liquidity to meet its obligations when they fall due for a period of at least twelve months after approval of this report. For this reason, it continues to adopt the going concern basis for preparing the financial statements.

Viability statement

1. Assessment of prospects

The Directors have assessed the Group’s longer-term prospects, primarily with reference to the results of the Board-approved five-year strategic plan. This is driven by the Group’s business model (detailed on pages 10 and 11) and strategy (detailed on pages 14 and 15), which are fundamental to understanding the future direction of the business, while factoring in the Group’s principal risks (detailed on pages 35 to 38). The Directors continue to consider the ongoing challenges to the global economy and the uncertainty this creates, particularly in the early years of the strategic plan. The Directors have also considered the Group’s ability to maintain a strong financial position throughout FY 2020 and FY 2021, including the level of available cash at 30 September 2021, and retains the strength to generate cash.

The strategic planning process is undertaken annually, and includes analyses of profit performance (including our core business and new product pipeline and ‘mega-programmes’), cash flow, investment programmes (including manufacturing capacity increases and our acquisition pipeline) and returns to shareholders. Completion of the strategic plan is a Group-wide process engaging employees throughout the business, including all senior management in their respective areas. The strategy was reviewed and approved by the Board in March 2021 (covering the five years to September 2026). The strategy is built market by market, geography by geography recognising the differing dynamics in each market, including the impact of and speed of recovery from COVID-19 and the longer-term impact of achieving net zero carbon. The Company also operates a more short-term rolling 24-month forecast, predicated on the IBP process, which forms the basis for the FY 2022 budget and key operational decisions over this shorter timeframe. The first two years of the strategy align to the rolling forecast.

The Board considers five years to be an appropriate time horizon for our strategic plan, being the period over which the Group actively focuses on its development pipeline and resulting capital investment programme. As part of our longer-term considerations, to support capacity planning and assessment of projects which will take longer to reach meaningful revenue, the Group does prepare forecasts for a period of more than five years; however, a period greater than five years is considered too long for the strategic plan given the inherent uncertainties involved.

2. Viability period

The Directors have assessed the viability of the Group over the five-year period to September 2026, being the period covered by the Group’s Board-approved strategic plan.

3. Assessment of viability

To make their assessment of viability, the Directors have tested a number of additional scenarios on the base case position of the five-year strategic plan. These scenarios encompass key trading assumptions combined with the potential impact of crystallisation of one or more of the principal risks over the five-year period. Whilst each of the principal risks has a potential impact, the scenario analysis has been focused on those considered to have the most significant financial impact, primarily to the revenue growth of the Group. The risks have been assessed for their potential impact on the Group’s business model, future trading and funding structure.

The continuing progress in the mega-programmes is forecast to have a material impact on the Company’s revenue over the strategic period. The business case behind each of these programmes remains robust, and in some cases enhanced, by both changing market dynamics caused by COVID-19 and the acceleration of the sustainability agenda and achieving net zero carbon, over the past twelve months. To date there has been limited evidence of any material slowdown in the overall mega-programme portfolio. COVID-19 has, however, presented challenges to several programmes hitting milestones and driving customer adoption in the short term, predominantly those which rely on medical trials. The Directors have incorporated this into scenario 3 described on page 41.

The impact on the strategy of achieving net zero carbon has been considered by the Group for several years but with more clarity on timings and targets (for example, net zero by 2030) over the past twelve months a far more detailed assessment has commenced ahead of the 2022 strategy review. The alignment of the strategy to sustainability goals is detailed in the Sustainability report on pages 42 to 63. This report outlines the numerous benefits PEEK applications can deliver in a sustainable world, with our assessment that this will have a positive impact on future revenue generation. The risk in the short term remains the cost base, with the manufacturing process involving use of electricity, gas, water and generating hazardous waste, all of which will potentially attract higher taxes/levies as governments push industry towards net zero carbon targets. This risk of a higher cost base is incorporated in scenario 4.

The downside scenarios applied to the strategic plan are as follows:

The scenarios tested were carefully considered by the Directors, factoring in the potential impact, probability of occurrence and effectiveness of the mitigating actions. In addition, whilst considered implausible, a combined scenario (scenario 6) was also tested, which contained an aggregation of all scenarios considered.

Further to the risk mitigation plans, the Group’s two distinct segments, both with diverse geographic markets, assist in reducing the risk of regional economic challenges and sector-specific issues. This diversity has been evidenced through the COVID-19 pandemic where the impact of and recovery from COVID-19 differed between business units, with Medical Implantable particularly impacted with the cancellation of elective surgery and a prolonged period where hospitals have been focused on COVID-19 patients, contrasting to, for example, Electronics within the Industrial segment, which has seen a sharp recovery as consumer spending habits have changed in its favour. Geographically the impact was much lower and shorter in length across Asia where demand quickly returned to pre-pandemic levels, compared to a later, deeper and longer impact in US markets which only returned to pre-pandemic levels in the second half of 2021. The strategy of partnering closely with customers to develop the right applications and our existing and growing list of specified products are also important mitigants.

The mitigation assessment also considered the Group’s ability to manage its cost base and raise new finance and the possibility of delaying capital programmes and/or restricting shareholder returns over the viability period if required.

The results of this stress testing showed that the Group would be able to remain solvent and maintain liquidity over the assessment period. The Group is profitable under all scenarios, including scenario 6. The lowest cash and cash equivalents balance was in scenario 6, in which the cash and cash equivalents balance remains positive albeit at a level where working capital will have to be carefully controlled or the RCF (available until 2024 with covenant compliance tested under scenario 6) will be required to manage intra-month flows, whilst maintaining the regular dividend. Due to the severity and implausibility of scenario 6 and an outcome that may require limited use of the RCF, this is considered akin to a reverse stress test.

4. Viability statement

Based on the results of this detailed analysis the Directors have a reasonable expectation that the Group will be able to continue in operation and meet its liabilities as they fall due over the five-year period to September 2026. This is predicated on the assumption that an unforeseen event outside of the Group’s control (for example, an event of nature or terror) does not inhibit the Company’s ability to manufacture for a sustained period.