Brexit risks and proposed mitigation, additional warehousing, inventory, imports and exports, tariffs, no deal Brexit

Victrex plc – Annual report – 30 September 2019

Industry: manufacturing

Financial review (extract)
Brexit
As previously communicated, the Group continues to consider the potential impact of Brexit, with a team in place comprised of senior leaders to manage various contingencies through any transition period and beyond. For now, existing laws and trading arrangements are unchanged.

Victrex has indicated previously that the principal risk is a sustained period when the Group may not be able to import certain raw materials or export finished goods through customs, which could curtail sales if regional inventory levels were depleted. As part of our contingency plans, additional warehousing for finished goods stock was secured in mainland Europe (Germany) and China with a minimum of eight weeks of finished goods stock held outside the UK. Our German warehouse has been operational since February 2019, with capability to supply European customers. We also secured additional raw material stocks. Group inventories reached £92.2m in FY 2019 as a consequence (FY 2018: £69.3m) and with continued uncertainty over Brexit, as well as reduced production availability in our polymer assets due to debottlenecking, we anticipate maintaining a continued higher level of inventory through FY 2020.

Whilst we note the political uncertainty, our assessment of the potential financial impact of a ‘no deal’ Brexit is based on standard WTO tariffs being applied, bringing increased costs in the short term through the application of duties to the import of certain raw materials and on the export of finished goods. This short-term cost would be partially mitigated by the impact on the unhedged portion of our currency flows in the event of any weakening of Sterling. Once existing hedges roll off, there is also the potential for weaker Sterling to provide a tailwind in the event of a ‘no deal’ scenario. As the only current manufacturer of PEEK products in the EU, we also have the opportunity to seek tariff mitigation that may be available to us, although we note this option could reasonably be expected to take up to a year to secure.

Going concern and viability statement (extract)
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 Groups business model (detailed on pages 8 and 9) and strategy (detailed on pages 10 to 13 and pages 16 and 17), which are fundamental to understanding the future direction of the business, while factoring in the Group’s principal risks (detailed on pages 27 to 29). The Directors have also considered the Group’s current strong financial position, including the level of cash at 30 September 2019 and the Group’s ability 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 options to increase our polymer manufacturing capacity 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 is reviewed and approved by the Board with the latest strategy (covering the five years to September 2024) being approved in March 2019. Subsequently, the more detailed budget for the year ending 30 September 2020 has been finalised, which upholds the key assumptions in the 2019 strategy.

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. 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 2024, 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 March 2019 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. The risks have been assessed for their potential impact on the Group’s business model, future trading and funding structure.

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

victrex1

The scenarios tested on page 30 were carefully considered by the Directors, factoring in the potential impact, the probability of occurrence and the effectiveness of the mitigating actions. In addition, whilst considered implausible, a combined scenario 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. 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, 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 viable and maintain liquidity over the assessment period. The lowest cash balance was in scenario 6, in which the cash balance remains positive, whilst maintaining the regular dividend, and without use of the RCF facility which has recently been extended through to October 2024.

Approximately 40%–50% of the Group’s revenue is derived from Europe. The impact of Brexit continues to be considered by the Board, supported by the executive-led Brexit Steering Committee. Contingency plans were implemented during 2019 to mitigate the principal risk of Brexit, being a sustained period when the Group was unable to import certain raw materials or export finished goods. This included securing additional warehousing in Germany and China and increasing the proportion of inventory held in regional warehouses with a target cover of three months in each geography.

Due to the political uncertainty that exists, there remains a wide range of potential outcomes, including a ‘no deal’ Brexit. No scenario has been run specifically for Brexit given the range of potential outcomes, which could be favourable (driven by a further devaluation of Sterling) or adverse (for example, tariffs or restrictions of raw material and finished product flows); however, scenarios 2 and 4 above have an adaptation to potential Brexit outcomes.

The Board has also considered the impact of the debottlenecking project commencing in 2020. While this will restrict manufacturing capability, the shutdowns required will be carefully managed with assets taken down in series not parallel and short-term demand trends assessed before each asset is taken out of service so as not to restrict supply. Inventory has been specifically built to mitigate this risk and cover the forecast plant shutdowns. Scenario 2 covers the risk of supply disruption which would be the result of delayed completion of the project.

4. Viability statement
Based on the results of this analysis, the Directors have a reasonable expectation, 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, 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 2024.