Electrocomponents plc – Half year report – 30 September 2018
RISKS AND UNCERTAINTIES
The Group’s risk management process identifies, evaluates and manages the Group’s principal risks and uncertainties. These are reviewed by both the Group’s Risk Committee, comprising the Group’s senior managers, and the Board, which regularly discusses the principal risks and receives risk reports covering risk mitigations and controls.
The Group has a defined risk appetite, which has been adopted by the Board, and is considered across three risk categories: strategic, operating and regulatory / compliance. These categories use both quantitative and qualitative criteria.
Whilst the principal risks and mitigations disclosed in the 2018 Annual Report continue to be valid, we have included below an update on one of the Group’s principal risks being the consequences on the organisation of the UK exit from the EU.
Consequences on the organisation of the UK exit from the EU
In our 2018 Annual Report we reported that the UK’s exit from the EU was one of the principal risks to the Group. The UK formally leaves the EU on 29 March 2019. In March 2018 the UK and EU negotiating teams reached an agreement, in principle, to a 21 month transition period through to 31 December 2020 to be included in the Withdrawal Agreement (which will define the terms of the UK’s exit). Under this agreement the free movement of goods and people would continue until 31 December 2020. On 14 November 2018 the UK and EU negotiators reached an agreement on the Withdrawal Agreement for the UK’s exit from the UK. However, at this stage it has not been approved by either the UK parliament or the EU council, as such it remains uncertain whether the 21 month transition period will be agreed.
Group business planning
Following the referendum result, the Group created a steering committee to assess and plan to mitigate the key business risks associated with the UK’s exit from the EU. The steering committee has met regularly and has been planning for a range of potential UK exit scenarios. We have performed an externally facilitated group risk assessment to review our readiness and implement, where necessary, mitigating actions to address as much of the identified risk as possible.
We have also begun to implement mitigating actions to ensure we are prepared, as best we can, for a UK exit from the EU without a final withdrawal agreement.
Principal risk areas and mitigating actions
We judge the key risks to our business from the UK exiting the EU without a withdrawal agreement to be across four key areas. In each of these areas we are undertaking mitigating actions to attempt to reduce the impact of these risks on the business. We will continue to review and monitor the evolving external and internal risk landscape and, if necessary and appropriate, modify our actions accordingly.
- Reduced free movement of products, goods and services across the UK / EU border
A restriction on the smooth passage of goods across the UK / EU border has the potential to slow delivery times, which would impact the Group’s ability to maintain its high level of customer service.
- We are investing in additional fast-moving inventory across our European network in the short term to lessen the customer service impact of potential delays at the UK / EU border.
- We have had, and continue to have, dialogue with our suppliers and freight forwarders in respect of their preparedness.
- We have applied for Authorised Economic Operator accreditation, which should ensure that our shipments pass across the UK / EU border with reduced physical checks.
- Increased tariff and duty costs on goods moving between the UK and EU
Following the UK’s exit from the EU goods moving between the UK and EU member states, and other areas of the world, may be subject to additional tariff and duty costs. At this stage, before we know the detail of any exit deal and any reciprocal agreements, the exact impact of tariffs is difficult to assess. At present around 60% of our Group cost of goods sold flows through the UK. Over 70% of the product coming into the UK comes from suppliers based in the UK with the balance from suppliers outside the UK (from both the EU and the rest of the world).
- Our international distribution network means we can work to mitigate this risk over time and continue to offer our customers the market-leading service they expect.
- Based on our assessments we believe that over time the vast majority of inventory needed to meet our EU customer needs could be sourced and retained directly within the EU post the UK’s exit. Under this scenario we would look to change product sourcing and supply routes and seek to source and hold as much inventory as feasible directly within our Continental Europe network.
- Where product cannot be sourced directly into the market we will look to pass on tariffs and duties in the form of price increases.
- Increased administration to process the required cross border data flows
Increased requirements for data collection may be required as shipments move across the UK / EU border, including more information for customs declarations and import / export forms for each consignment shipped into the EU. It is possible that this may require additional payments for customs clearance charges for goods moving across the UK / EU border.
- We are engaged with the relevant authorities and continue to monitor guidance in all these areas closely.
- To reduce any potential increase in the administrative burden we are introducing an electronic trading system ahead of March 2019.
- We will recruit and train additional resource to enhance our existing skilled export teams as necessary, although we do not expect the cost of this additional resource to be material.
- We will seek to optimise our product flows across our network post March 2019 to minimise the movement of goods across the UK / EU border and therefore minimise the increased potential administrative requirement.
- Material movement in the value of sterling impacting the price of goods
Sterling could depreciate materially in the event of the UK leaving the EU on 29 March 2019 with no transition deal in place.
- To hedge against transactional foreign exchange risk we currently maintain three months of cover against freely tradable currencies to smooth the impact of fluctuations in currency. We will maintain our existing hedging strategy to mitigate against any immediate devaluation in sterling.
- Our global trading mix and product sourcing arrangements mean that historically we have had a natural gross margin hedge against a depreciation in sterling at a Group level.