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- Thanks Reto and hello everybody. My name is JP. I am leading KPMG’s Val and FinMod practice in CH
- I am sure many of you try to assess intensively the impact of the SFr/EUR exchange rate these days: currency translation is certainly a key action another area might be your business plans
The purpose of business planning is very broad: Impairment testing Management reporting: annual budgets, mid-term planning (short-term) liquidity planning … is all effected by the 20% value increase of the SFr against the EUR
The use of these financial forecast is also quite diverse: Disclosures to your financial reporting 2014 might require certain quantification Ad-hoc media questions need to be answered, your next earnings call is coming, your IR department needs guidance The whole financing and related coverage ratios require an updated view
- I want to use the impairment test as a guideline for the next couple of minutes, as most of the considerations are valid for any type of business plan
- And I will also make some comments around the cost of capital in light of the SNB’s adjustment of benchmark interest rate
- Different business models are impacted differently
- Some of you might benefit form a natural hedge – buying supplies and selling products or services in the same or in different non-SFr currencies
- You should not be impacted by the FX turmoil as long as you are selling mainly in Switzerland to Swiss residents – a good example would be Swisscom
The issue arises when the value creation is in Switzerland … and you are selling your goods and services in EUR or any other foreign currency – e.g. the watch industry is massively challenged by this situation … or you will face issues if you are selling to a non-Swiss customer base – like the tourist sector
- Of course, the financial service sector depends significantly on FX rates as well as indicated in the graph with the SIX index for Finance companies
- So, how much “Swisscom”, “swatch” and “Jungfraubahn” do you have in your business model?
- But even if you are naturally hedged – e.g. Holcim – the capital market anticipates certain issues
- In that context we should clearly not forget about other foreign currencies like the USD, the Ruble or other; most of them lost value against the SFr as well
- What to do in practice? First, it’s worth to distinguish btw the technical adjustments of the FX rates in your models on one side, and any economic impact on the business itself on the other side
- Assessing the appropriate FX rate in the short, medium and long term is clearly the key challenge these days. The last long-term fair value range was typically estimated between 1.10 to 1.30 SFr for 1 Euro. With the global and European monetary outlook, in particular with respect to the anticipated QE program of the ECB, market participants now try to figure out what the “new” fair value of the SFr. During the last days we saw SFr futures traded at around parity to the Euro. Well … what ever that means for the next weeks and months
- A first critical aspect here in your model is the point whether you apply spot rates or forward looking rates. This needs to be carefully reflected in light of the underlying currencies used to develop the financial projections.
- As no one can reliably estimate the future FX rates these days – neither the level nor the timing – we believe the only way to cope with this situation are scenarios, simulations and sensitivities
- From a technical perspective the key questions are the following: Have your models the appropriate granularity to assess the FX rates on material items individually? Is your business model integrated and flexible enough to simulate scenarios and sensitivities appropriately?
- A challenge in that respect is to find the right balance of necessary accuracy and a reasonable level of pragmatism
- Of course, very important is the assessment of the economic and commercial impact of the appreciation of the SFr. And there are many areas which might be impacted, e.g.:
A reduction in sales volume … will our customers stay in business? Any adjustments of the cost basis … this could have positive effects as well, when importing goods or services What will be the magnitude and timing of a potential reduction of personnel costs? How will domestic and foreign suppliers pass on their own price and margin effects? How secure is the supply chain? Will new hedging strategies on sales and costs create more expenses?
Is there a need to revalue your financial investments, in particular with the recent change in law?
More general, what about pending investment decisions in CAPEX, WC, or even in M&A? Will these projects be delayed?
What about the financing terms? There might be a slight positive effect for borrowers on debt interest rates … maybe not too excessive Can you keep the coverage ratios in line with your financing terms & conditions?
- Sure, there are many more items to be considered
- Good business planning is relying on a sound verification of the assumptions. You may use: Historical trends of the own business Sector expectations regarding growth and profitability based on analyst reports and capital market consensus Benchmark data of peer companies Macroeconomic trends … all those sources are typically very helpful … but they most likely facing the same issues regarding the FX uncertainties
- Looking at the market cap in case you are publicly listed might be misleading, if we assume a temporarily irrational capital market. But when will the equity market be back to normal?
In an IFRS impairment testing environment we refer to the Value in Use or the Fair Value less Cost of Disposal concepts
We may see significant deviations between the ViU and the Market Cap over the next weeks or months
But can the entire gap be explained by the combination of a different “technical” FX assessment and an overreaction of the capital markets? To what extent is the “economic impact” factored into the share price?
In anyway, you may consider to change the applied concept from FVLCD to the ViU concept to better monitor and control the underlying assumptions and to reflect your specific circumstances
However, also under the ViU concept, any new operational measures you will put in place to face the FX issues may classify as an improvement which can not necessarily considered in a next impairment test
For certain decisions, or regularity requirements, a value of your business or for key assets is needed, e.g. for impairment testing, investments, financing, or also pension valuations As usual an appropriate cost of capital are required, reflecting the risk and the maturity of the underlying cash flows
We know that the SNB has also further dropped the target range for the 3-month Libor by 50 bps to between minus 0.25% and minus 1.25%
Does this mean that my cost of capital go down as well? Let me ask you two key questions in that respect: - Has the return expectation of equity investors changed? - Has the risk of the expected cash flows changed? First, you may say interest rates for governmental bonds, which are considered to be “risk free”, cannot go further down substantially … well, a 30-year Swiss government bond traded below zero the last days which is approx. 100 bps lower than before Second, we may argue, if the alternative investments in bonds have a lower yield, I value my current cash flow stream from my equity investment higher. However, if we look back over the last few years we have seen – on average – decreasing interest rates but relatively constant total returns for equity investors; this is demonstrated in the lower graph on this slide. This observation does NOT support a reduction of the cost of capital due to the recent drop in the benchmark interest rate by the SNB Further, if we consider the uncertainty looking forward one might even argue for an additional risk premium on the cost of capital. I would not recommend such an approach … … but rather encourage the application of different cash flow scenarios, which can be weighted based on your assessment of likelihood. These risk weighted cash flows reflect the uncertainty clearly more transparently compared to a risk premium on the discount rate
We touch upon financing already. There are clearly some specific issues for banks and insurances. I hand over to Philipp Rickert to talk about those specifics a bid more.
Good morning also from my side. My name is Philipp Rickert, I’m leading Financial Services at KPMG. The decision of the Swiss National Bank to let CHF float again against the EUR provides undoubted a number of additional challenges to Financial Institutions.
As an immediate consequence, impacts on the 2014 financial statements of Banks and Insurance Companies have to be assessed. This is our focus today. Topics could be: Unexpected increase in credit and market risk exposures, including potential jumps to default in the loan books; Collateral shortfalls and failed margin calls; Increased credit risks in trading of financial instruments, in particular on derivate and structure products; Suddenly emerging counterparty credit risks; and Impacts on forward looking disclosures in the financial statements, including risk disclosures and sensitivity analysis.
Mid term, for the year 2015 and the upcoming reporting seasons, assessment will be required to gain clarity on impact of the SNB decision on business resilience, earnings and dividend potential, legal and regulatory risks, capital, solvency and liquidity ratios.
Our teams will work very closely with you to reach common understanding on all this topics and to navigate through the upcoming months.
SNB Abandon of Euro Cap - Actions for Finance Directors
of Euro Cap
Friday, 23 January 2015