Principal risks, Brexit implications, free movement of goods, tariffs, exchange rate, business planning, mitigation, and COVID – 19

Electrocomponents plc – Annual report – 31 March 2020

Industry: distribution

Risks, viability and going concern (extract)

Principal risks in focus

Two of the Group’s principal risks require further explanation: the consequences of the COVID-19 pandemic and the UK’s exit from the EU.

1. COVID-19 pandemic

The COVID-19 pandemic is having far-reaching, and still-developing, impacts across the world. These effects are both on our personal ways of life and on business activities.

The Group has responded well and implemented its crisis management and business continuity processes quickly. At present all our distribution centres (DCs) around the world are open and operating effectively. Our online business model continues to differentiate us and has helped us to continue to serve our customers.

The pandemic is affecting some of our other, already identified, principal risks and these effects are explained in the relevant principal risk narratives, e.g. employee physical and mental health and information loss/cyber breach.

New principal risk

The pandemic has its own specific uncertainties therefore we have disclosed it as a separate principal risk.

These uncertainties include:

  • Reductions in demand across our diverse customer base, some of which may take time to become completely apparent across different sectors.
  • The risk of a deterioration in cash flow, specifically the recoverability of trade receivables, which is a key liquidity sensitivity.
  • Delays and difficulty sourcing inventory as suppliers’ production capabilities are affected by the pandemic and demand for certain product types exceeds the available capacity.
  • Significant transport constraints and resulting increased costs, in particular for air freight, with the substantial reduction in passenger flights which carry around half of all air cargo. This has impacted the Group’s activities for transporting inventory across its supply chain.
  • The uncertainty about the duration of the worldwide disease control activities, principally the significant people lockdowns, and the consequences on demand levels. This extends to the risk of further outbreaks of the virus (or a “W” scenario).
  • The difficulties managing the business’s return to partial office-based working as respective governments’ restrictions on people movement are eased.
  • When the pandemic passes, the speed and extent to which industries can recover from the effects is unclear.
  • The longer-term effects of the pandemic both on business activity and government finances and related levels of public expenditure.

Mitigating actions

There are some structural factors including the diverse nature of our customer base and our strong online capabilities, that have helped protect the business from some effects of the pandemic and enabled us to continue to support customers during the pandemic.

The business has taken a number of mitigating actions including:

  • A rapid implementation of the Group’s crisis management and business continuity plans with most of our office-based staff working from home, and protection for our DC employees.
  • Swift cost actions taken to protect profit including controls on procurement and discretionary spend (see page 12).
  • A focus on maintaining cash flow. Tight working capital management including controls over customer credit and conversion of trade receivables and actions to lower capital expenditure.
  • Actions to improve balance sheet flexibility including securing additional funding facilities (see page 12).
  • Supporting employees’ physical safety in our DCs and mental wellbeing for those during extended periods of home working.
  • Refocused cyber monitoring and training reflecting the changed business working environment and increased external threats.

Other activities include business planning for the trading environment following the passing of the pandemic to ensure that the Group can provide the necessary levels of customer service to meet customer demands and quickly identify and develop opportunities.

The effectiveness of the business’s operational controls in the current COVID-19 environment are being reviewed by the Group’s internal audit team on a risk-based approach (see page 81).

2. The UK’s exit from the EU

The principal risk which has been subject to ongoing focus and activity in the Group during the financial year has been that associated with the UK’s exit from the EU. The Group has undertaken a number of significant activities across many business areas to mitigate, insofar as is possible, any potential and negative future effects of the UK leaving the EU. The planning and actions involved considering various scenarios for the UK’s exit. These scenarios looked beyond the current transition period and the potential relationship between the UK and the EU. These included a more significant and immediate UK exit from the EU without agreed trading arrangements. In such a case the UK trading relationship with the EU would be governed by World Trade Organisation (WTO) rules (this is often termed as Hard Brexit).

We judge the key risk to our business from the UK exiting the EU without agreed trading agreements to be across four key areas. In each of these four areas we have undertaken mitigating actions to attempt to reduce the impact of these risks on the business.

i. Reduced free movement

A restriction on the smooth passage of goods across the UK/EU border leading to disruption to customer service is a key risk.

  • In anticipation of a UK exit from the EU without a withdrawal agreement earlier in calendar year 2019 and potential delays at the UK/EU border, we invested in additional fast-moving inventory across our European network to lessen any customer service impact. This investment would be reinstated if there was a risk of such delays following the UK’s exit in December 2020.
  • We have established combined contingency plans with our freight forwarders to protect service levels in the event of a hard Brexit.
  • In the medium term, the expansion of our DC in Germany will provide increased capacity in Continental Europe and reduce the impacts on the business of reduced free movement of goods across the UK/EU border.

ii. Increased tariff and duty costs

Following the UK’s exit from the EU, goods moving between the UK and EU member states and potentially 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. However, we believe the more notable area of risk is for goods sourced from the EU into the UK or where products are shipped from the UK to the EU.

  • We have reviewed our current transport routes against individual product demand and will use our international distribution network to mitigate this risk, as best we can, to continue to offer our customers the market-leading service they expect.
  • We have reviewed the potential tariff impacts on our top-selling product lines to optimise product sourcing to mitigate any incremental duty impact. Where this is not possible we will look to pass on tariffs and duties in the form of price increases.

iii. Increased administration

We anticipate increased requirements for data collection as shipments move across the UK/EU border. More information may be required for customs declarations and import/export forms for each consignment shipped into the EU. We could also be required to make additional payments for customs clearance charges for goods moving across the UK/EU border.

  • We have invested in IT systems to automate the customs declaration process.
  • We have reviewed our current people resources to support our existing skilled export teams as required.

iv. Sterling depreciation

Sterling could depreciate materially in the event of the UK leaving the EU on 31 December 2020 with no agreed trading arrangements in place.

  • To hedge against transactional foreign exchange risk, we currently maintain three to seven months of cover against freely tradeable 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.