Viability statement including base case (U) and severe but plausible (W) scenarios for COVID – 19, disclosure of assumptions, covenants, and stress tests for other principal risks including Brexit

Electrocomponents plc – Annual report – 31 March 2020

Industry: distribution

Viability statement

Assessment of prospects

The Group’s strategic priorities are focused on delivering sustainable growth and superior returns for all our stakeholders and includes a number of initiatives. They are discussed in more detail on pages 13 to 15.

Our business model, as described on pages 8 and 9, is structured so that the Group is a global omni-channel provider of industrial and electronic products and solutions to a very broad spread of customers both in terms of industry sector and geography. The Group is not reliant on one particular group of customers or suppliers, with its largest customer accounting for under one percent of revenue and its largest supplier less than four percent of revenue. Our business model is differentiated by: our global network of 12 DCs; our talented and customer-centric team; our strong supplier relationships; our broad range of products and value-added solutions capabilities; and our strong digital presence. The Group has high inventory availability with products sourced from a large number of suppliers and provides customers with a reliable and fast service.

The Group’s results and financial position are reviewed monthly by both our SMT and the Board. Every day the SMT receives an analysis of the previous day’s revenue and gross margin. The Board receives and reviews monthly management accounts, including cash flows, and also receives regular performance and forecast updates from the CFO and Chief Executive Officer.

The Group’s long-term prospects are assessed primarily through its strategic and financial planning process. This includes the preparation of a five-year strategic plan and, in normal years, a detailed annual target setting process involving both Group and regional management which are updated annually and reviewed and approved by the Board. The SMT receives and reviews a scorecard each quarter showing progress against the strategic plan objectives. The Board also receives updates and, if appropriate, the strategic plan is updated depending on progress and performance.

However, this year, given the unprecedented level of uncertainty surrounding the COVID-19 pandemic, we have taken a more dynamic approach to financial planning and so have not followed a detailed annual target setting process. Instead, we have modelled a range of potential scenarios for different durations and severities of the pandemic. These have been regularly updated to reflect latest trading trends and changes to our expectations. These are reviewed, and the assumptions approved, at the additional regular Board meeting calls that started on 21 March 2020. On these calls the Board also discusses and approves the various mitigating actions the Group should take for each scenario.

Our five-year strategic plan has been updated for a “U” shaped scenario. This scenario assumes the Group continues to see a like-for-like decline in revenue for June and July 2020, in line with what was seen during the first eight weeks of the year ending 31 March 2021 of 14%, before modest recovery commences reducing the like-for-like decline in revenue for the rest of the year. It assumes no further pandemics or recurrences of COVID-19 and a return to like-for-like revenue growth in the years ending 31 March 2022 and 2023. It assumes various cost mitigations are taken to protect profit, an additional impairment allowance against 2021 trade receivables, dividends continue to be paid and capital expenditure is reduced by approximately £20 million to around £60 million to conserve our liquidity.

Our capital position is supported by regular reviews of the Group’s funding facilities and banking covenants’ headroom, through the Board’s Treasury Committee. A weekly cash forecasting process and review covering the following two to three months has been recently instigated to closely track our net debt position during the COVID-19 pandemic, so we can take any necessary actions on a timely basis. Details of the Group’s sources of finance are outlined on page 142 with the earliest facility expiring being the Group’s syndicated multi-currency facility for US$75 million, £85 million and €50 million in August 2022. During the year, new private placement loan notes of €31 million and US$165 million with maturities from 2026 to 2031 were taken out and the old private placement loan notes of US$100 million and the £75 million term loan prepaid. Since the year end we have secured eligibility to participate in the Bank of England Covid Corporate Financing Facility (CCFF) and are negotiating an additional £100 million bank facility for a 12-month term plus six months as safety nets in case the macroeconomic environment deteriorates more than our worst case modelling assumes. We have no current intention to draw on the CCFF or additional bank facility and so have excluded these from all our modelling.

The Group’s debt covenants are EBITA to interest to be greater than 3 times and net debt to adjusted EBITDA to be less than 3.25 times. At 31 March 2020, EBITA to interest was 33.6x (2019: 37.7x) and net debt to adjusted EBITDA was 0.7x (2019: 0.5x) (see Note 3 on page 122 for reconciliations and the impact of IFRS 16 on these ratios) and under our updated strategic plan these are also comfortably met.

The Board also considers the long-term prospects of the Group as part of its regular monitoring and review of risk management and internal control system, as described on page 75.

Viability assessment period

In their assessment of viability, the Directors have reviewed the assessment period and have determined that a three-year period to 31 March 2023 continues to be most appropriate. The robustness of the strategic plan is significantly higher in the first three years with the final two years being a high-level extrapolation. The Group has few contracts with either customers or suppliers extending beyond three years and, in the main, contracts are for one year or less. The business operates with a minimal forward order book, generally taking orders and shipping them on the same day. In addition, as more business moves online and we become more agile, speed of change increases and so visibility is relatively short term. Of the Group’s long-term obligations, the UK pension scheme is the largest and its triennial funding valuation forms the basis of our agreeing its funding with its trustee.

Assessment of viability

The impact of the COVID-19 pandemic has crystallised elements, or raised the inherent likelihood, of some of our other principal risks. Consequently, the updated strategic plan is currently considered to reflect the Directors’ best estimate of the future prospects of the Group. Therefore stress tests were performed on this updated strategic plan to assess the Group’s viability on different durations and severities of the pandemic.

These severe but plausible stress tests included:

  • A recurrence of COVID-19 during the second half of our year ending 31 March 2021, a “W” shape, leading to a decline in like-for-like revenue during the assumed winter lockdown period in line with what was seen in our first eight weeks of 2021 and higher impairment allowances against 2021 trade receivables. This assumes further reductions in discretionary spend in 2021 and that other interventions and mitigations will be taken as and when we see fit, including no dividends paid in 2021. Recovery is assumed to start towards the end of the year with no further pandemics or recurrences of COVID-19 in the following two years, leading to double digit like-for-like revenue growth in 2022 and more normal growth levels in 2023. Dividends are assumed to be paid in 2022 and 2023.
  • A like-for-like revenue decline in our first four months of 2021double that assumed in our “U” shaped scenario.
  • Gross margin declining in 2021 by 4 percentage points.
  • Cash collection from trade receivables deteriorates a further 5% during the downturn in 2021.

These stress tests assume our banking facilities are refinanced before they expire in August 2022 but no additional facilities are taken out and we do not access the CCFF. They result in the Group meeting its debt covenants and having sufficient liquidity.

Each of the Group’s other principal risks on pages 40 to 42 also has a potential impact on the Group’s viability, although the followings risks are believed to be adequately covered by the above COVID-19 stress tests:

2 Consequences of the UK exit from the EU

3 Failure to respond to strategic market shifts e.g. changes in customer demands/competitor activity and  related stakeholder requirements

4 The Group’s revenue and profit growth initiatives are not successfully implemented

5 Failure to comply with international and local legal/regulatory requirements

11 Impact on the business if the macroeconomic environment deteriorates

For the remaining principal risks, the Directors determined an appropriately severe but plausible stress test for each. They decided which stress tests would have the most impact on the viability of the Group and developed appropriate scenarios to model for these. These scenarios were then modelled by overlaying them onto the updated strategic plan to quantify the potential impact of one or more of them crystallising over the assessment period.

The scenarios modelled and the principal risks to which they relate were:

  • A major incident at the largest DC destroying the building and its contents – tests principal risk 6 ‘Failure in the business’s critical infrastructure’.
  • • A major system failure (possibly caused by a cyber attack) leading to a serious loss of service, fines for data breach and loss of reputation leading to halving of sales growth – tests principal risks 7 ‘Prolonged system outage’ and 8 ‘information loss/cyber breach’.

The severe and plausible stress tests for the principal risks 9 ‘UK defined benefit pension scheme cash requirements are in excess of cash available’ and 10 ‘People resources unable to support the existing and future growth of the business’ were assessed to have less impact on the Group’s viability.

In performing the above tests on the remaining principal risks it was assumed that our debt facilities were refinanced before they expire although the CCFF was not accessed and no additional facilities were taken out, dividends were unchanged and no further mitigating actions were taken, including no further reduction to capital expenditure.

Reverse stress tests were also undertaken to assess the circumstances that would threaten the Group’s current financing arrangements and the Directors consider the risk of these circumstances occurring to be remote.

The results of the above stress tests for the remaining principal risks showed the Group would be able to withstand the impact of these scenarios occurring.

Confirmation of viability

Based on the assessment outlined above, 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 three years to 31 March 2023.

Going concern

Based on the assessment outlined above, the Directors also believe that it is appropriate to continue to adopt the going concern basis in preparing the Group’s accounts.