Lonmin Plc Risks and Risk Mitigation Strategies - Case Study Example

Lecturer: Lonmin Plc Risks and Risk Mitigation Strategies Introduction Lonmin Plc is a Britain-based company specializing in the mining, refining and sale of platinum group metals, with its operations mainly in South Africa, and few other West African countries (Lonmin Plc, 2014). The company firm is registered on the London stock market, but its main headquarters are situated in the South African capital of Johannesburg. The company is prone to some risks related to its operations, because it is a foreign company operating in a totally different geographical and political region from its mother land. Most especially, Lonmin Plc is exposed to country and political risk, not only since it is a foreign company operating in a different geographical region, but also because it operates in a very sensitive field of business; the mineral extraction and refinery field (Lonmin Plc, 2013). Additionally, Lonmin Plc is exposed to foreign exchange risks, because the company operates in different currencies, undertakes the sale of its products in different currencies. The overall outcome is that the foreign exchange rate fluctuations for the different currencies affect both the expenses and profitability of the company (Bartram, Brown & Minton, 2010). In this respect, this discussion seeks to establish the nature of the country, political and foreign exchange rate risks faced by Lonmin Plc, with a view to recommending the best strategies that the company can apply, in order to mitigate the adverse effects of exposure to these risks. Transaction risk management strategies are helpful in minimizing losses as a result of foreign exchange fluctuations. This is through minimizing the settlement in business contracts, especially where foreign organizations are involved (Moffet et al., 2012). Discussion Foreign Exchange Risks facing Lonmin Plc Foreign Exchange Risks is a major risk facing Lonmin Plc. The company operates in South Africa, yet most of its revenue streams in form of US dollars since it is the currency in which most of its platinum metal products are sold in the global market (Lonmin Plc, 2014). However, a majority of the Lonmin Plc expenses, costs and taxes are paid in the form of the South African Rand currency. This therefore means that the rate at which the US dollar exchanges against the South African Rand has a great bearing on both the expenses and revenues of the company. Additionally, there are other expenses and revenue items that are associated with the operations of Lonmin Plc in other regions such as West Africa, as well as its operations in the home office in Britain, all which use different currencies. The company, therefore, holds different assets and liabilities in different foreign jurisdictions, which are not in its functional currency of the South African Rand (Lonmin Plc, 2014). The effect is that the company is exposed to currency risks on the monetary items that come in denominations that are not in the form of the South African Rand, which is the functional currency of the company in South Africa (Lonmin Plc, 2013). Should the value of the other currencies increase compared to the South African Rand, and then, the assets and liabilities value of the company in different jurisdictions increases. Alternatively, where the South African Rand appreciates in value relative to the other currencies of the jurisdiction where Lonmin Plc holds assets and liabilities, the value of these assets and liabilities will depreciate. The graph below shows how the value of underlying operational profit/loss, underlying profit/loss, Equity and Earns per Share (EPS) of Lonmin Plc would change both for 2013 and 2014, if the value of the SA Rand appreciated by 10% in 2014. A GRAPH OF CHANGE IN ASSETS OF LONMIN PLC, IF THE SA RAND APPRECIATES VALUE BY 10% Source: Lonmin Plc 2014 Annual Financial Report- https://www.lonmin.com/Online_Annual_report_20141/notes/note_20.html According to the graph above, should the value of the SA Rand appreciate by 10% in 2014, then the operational profit of the company, its underlying profit, equity and earns per share would increase commensurately. If the value of the SA Rand depreciate by 10%, the underlying operational profit, the underlying profit, equity and earnings per share of the company is at the risk of decreasing by a similar value. A GRAPH OF CHANGE IN ASSETS OF LONMIN PLC, IF THE SA RAND, DEPRECIATES VALUE BY 10% Source: Lonmin Plc 2014 Annual Financial Report- https://www.lonmin.com/Online_Annual_report_20141/notes/note_20.html This means that the company is at a higher risk of having its assets depreciate on the event that the value of the sterling pound or the other currencies in which the assets of the company are held would depreciate. This is because, once the value of the sterling pound or that of the other currencies depreciate in value against the SA Rand, the total value of the assets of the company held in either of these currencies would equally depreciate (Bartram, Brown & Minton, 2010). Therefore, the mere fact that there are some of the assets of the Lonmin Plc which are held in other denominations other the SA Rand, means that the company is at a greater risk of losing value in its assets. The second foreign exchange risk that Lonmin Plc is exposed to is the risk of increased liabilities, in the event that the value of the sterling pound, the US dollar and other currencies in which the company holds liabilities appreciate in value relative to the value of the SA Rand. The table below shows the value of the assets and liabilities of Lonmin Plc as held in different currencies in the year 2014. SA Rand (million $) Sterling (million $) Other (million $) Total (million $) Current Assets 12 - 15 27 Non-Current Assets 120 346 1 437 Current Liabilities (314) (12) (1) (327) Non-Current Liabilities (88) - - (88) Owners Equity (270) 334 15 79 From the table above, it is observable that there are two major foreign exchange risks that Lonmin Plc is exposed to. First, Lonmin Plc is exposed to the risk of losing the value of its assets. In 2014, Lonmin Plc held a total of assets worth $132 million in South African Rand denomination, $346 million is Sterling pounds and $16 million in other currencies. The increase in the value of the other currencies that the Lonmin Plc holds liabilities in, might mean that the value of the liabilities will increase, requiring that the company will use more SA Rand to pay for debts, as opposed to when all the debts could have been held in the SA Rand currency (Bartram, Brown & Minton, 2010). Further, the exchange rate also impacts on the other expenses of the Lonmin Plc, meaning that it is a major risk for increasing operational expenses for the company. Deferred tax is one of the cost elements to the business of the company, which the company holds. This element is also exposed to the risk of exchange rate increase. For example, the closing Rand/Dollar exchange rates increased by 12% in 2007, causing “a debit of $51 million on the deferred tax balance of Lonmin Plc” (Lonmin Plc, 2007:3). Therefore, it can be clearly seen that an increase in the appreciation of the closing Rand/Dollar exchange rates caused the company to incur extra $51 million in differed taxes, which the company would have avoided, if it only transacted in SA Rand. The graph below shows how Lonmin Plc has increasingly incurred a burden on deferred tax, largely driven by exchange rate effects: In the financial year 2012, Lonmin Plc incurred an extra “$39 million, arising from the adjustment of the deferred tax, largely driven by exchange effects” (Lonmin Plc, 2012:41). The deferred tax for the company has also continued to increase, causing a great burden on the overall performance of the company. For example, the total differed tax on the Lonmin Plc balance sheet had increased to $461 million as denominated in SA Rand value by the year 2012, only reducing slightly to $388 million in 2013 (Lonmin Plc, 2013). The risk of exchange rate also continued to increase the burden of deferred tax charged on the company, where “the underlying tax charge is $27 million, largely driven by exchange effects” (Lonmin Plc, 2013:167). Country and Political Risks facing Lonmin Plc Lonmin Plc is exposed to numerous country and political risks, which have affected the performance of the business in the recent years. Political and country risks are the risks that are specifically associated with the physical and geographical environments in which a company operates, which affects the operations of such a company negatively (Fatehi, 2008). Lonmin Plc is a company operating in Britain, but it has its operations in South Africa and several other countries in West Africa. The political environment in South Africa has been very turbulent, mostly characterized by mine worker’s strikes in the mines that are owned by Lonmin Plc (Hickel, 2014). Therefore, Lonmin Plc s increasingly faced by the risk of disruption of its operations due to the workers strikes, which in turn means that the company loses its profitability. For example, the company has had a history of being a very profitable company throughout its operations, until the political situation changed in South Africa, due to the rise of the workers strikes, demand for increased pay. Consequently, the company transformed from a profit making company in 2011, when it made a profit of $166 million, to making huge losses in 2014, where the company made a loss of $188 million (Lonmin Plc, 2014). The political risks have seen the revenues of Lonmin Plc increasingly decline, due to disruption of its operations by the workers strike, coupled with the increased expenses associated with increasing the workers pay. The graph below indicates the change in the revenues of Lonmin Plc between 2011 and 2014. A GRAPH OF CHANGE IN THE REVENUES OF LONMIN PLC 2011-2014 DUE TO POLITICAL RISKS The political risk associated with the workers strikes has seen the profitability of Lonmin Plc change from $273 million to a loss of $410 million in the year 2012 (Lonmin Plc, 2014). The other political risk faced by Lonmin Plc is the risk of destruction of its assets. The fact that the company operates in an increasingly turbulent region, simply means that the company is always under the threat of having its properties, premises and assets targeted for attack and destruction (Brink, 2004). The series of workers strikes that have occurred in South Africa, specifically targeting Lonmin Plc, has seen most of the assets, machinery, and premises of the company vandalized in the course of the strike actions. This therefore means that the company has to incur extra costs of renovating its premises while also repairing its machinery and equipment that have been vandalized. Additionally, the political risk faced by Lonmin Plc is not only affecting the profitability of the company, but also the reduction in the value of assets of the company. The occurrence of workers strike was a prerequisite for the reduction in the price of the shares of the company by a higher margin starting 2012 (Yahoo! Inc Finance, 2015). A GRAPH OF CHANGE IN SHARE PRICES FOR LONMIN PLC (2011-2015) The other political and country risk faced by Lonmin Plc is the risk of safety, labor and community relations (Lonmin Plc, 2013). The environment in which the company operates means that it is increasingly exposing its workforce, most especially the expatriates and the foreign workers to the risk of being targeted by the riots and strikes that are facing the company every so often. South Africa has become a politically turbulent work environment, with increasingly reports of xenophobic attacks being targeted at business and people who are not indigenous citizens of the country (Hickel, 2014). What this means for Lonmin Plc is that; it is exposed to the risk of having its employees attacked by the rioters and rowdy masses during xenophobic attacks. Therefore the company is faced with the political risk of inability to maintain its current workforce, while also being increasingly faced by the political risk of inability to attract professionals and expatriates to work for the company in South Africa (Coplin & OLeary, 1994). This in turn places the company at an increasingly high risk of losing competitiveness in the mining and extraction industry which it serves due to lack of competent professionals willing to run its operations in South Africa, as a result of the political upheavals characterizing the country. Strategies for mitigating Exchange rate risks for Lonmin Plc Exchange rate risks are highly complex risks, owing to the fact that they are the types of risk which are beyond the control of a company. The rate of foreign exchange is determined by factors other than the internal control strategies or the competency of the management in applying measures that can alleviate risks (Marios & Spyros, 2007). This is simply because exchange rates are determined by the economic forces of demand and supply of the currency, as well as other factors that are external to the control of an individual company. Nevertheless, this fact does not mean that Lonmin Plc does not have some control over the risks posed to the company by the fluctuations in the exchange rate. One of the strategies that can be applied by Lonmin Plc to mitigate the exchange rate risks is reducing its deferred taxes, which have been causing the company a huge burden of incremental burden in the amount of taxes owed, due to exchange rate effects. Reducing the deferred taxes can help the company avoid the increment in the tax burden, for example, where the taxes for the company increased by $51 million in 2012, and then by $27 million in 2013 (Lonmin Plc, 2013). The other strategy that can be applied by Lonmin Plc to mitigate the exchange rate risks is holding lesser assets and liabilities in foreign currencies. Holding assets and liabilities in Sterling pound, US dollars and other currencies, yet the company’s functional currency is the SA Rand, has seen Lonmin Plc exposed to the risk of fluctuations in the values of its assets and liabilities (Butler, 2012). Therefore, through holding its assets and liabilities in SA Rand, the company can mitigate these risks. Strategies for mitigating company and political risks for Lonmin Plc Company and political risk sare another type risk that highly affects Lonmin Plc, yet it is a risk that is also partially beyond the control of the company. The strategies through which Lonmin Plc can mitigate the country and political risk is improving the pay for its mining workforce to reasonable standards that manifest the global outlook of pay rates. This would in turn help the company to avoid suffering from the risk of consistent riots and strikes that have been affecting the company’s business performance in the last few years (Hickel, 2014). The second way in which Lonmin Plc can mitigate the country and political risk is enhancing its community relations and social development for the community in which the company operates (Brink, 2004). This can result in goodwill amongst the community, and thus help in mitigating the risk of destruction and vandalizing of the company’s assets by the surrounding community during politically turbulent times. Finally, Lonmin Plc can mitigate the country and political risk of loss of quality employees and also against the lack of capacity to attract professionals to work in its business in South Africa. This can be achieved by providing good pay, allowances and enhanced and adequate security for its expatriates and other high-level foreign staff, who are always the target of the xenophobic attacks in South Africa (Hickel, 2014). This way, the company can mitigate the risk of inability to sustain professional and quality workforce while also becoming attractive to more quality professionals. Bibliography Bartram, M., Brown, W. & Minton, B. (2010). Resolving the Exposure Puzzle: The Many Facets of Exchange Rate Exposure. Journal of Financial Economics 95 (2): 148–173. Brink, C. H. (2004). Measuring political risk. Aldershot: Ashgate. Butler, K. C. (2012). Multinational finance: Evaluating opportunities, costs, and risks of operations. Hoboken, NJ: Wiley. Coplin, W. D., & OLeary, M. K. (1994). The handbook of country and political risk analysis. New York: Political Risk Services. Fatehi, K. (2008). Managing internationally: Succeeding in a culturally diverse world. Los Angeles: Sage Publications. Hickel, J. (2014). "Xenophobia" in South Africa: Order, Chaos, and the Moral Economy of Witchcraft. The Journal of Cultural Anthropology. Lonmin Plc. (2007). Annual Report and Accounts For the year ended 30 September 2014: Market Review and Outlook. Lonmin Plc. Lonmin Plc. (2012). Annual Report and Accounts For the year ended 30 September 2014: Market Review and Outlook. Lonmin Plc. Lonmin Plc. (2013). Annual Report and Accounts For the year ended 30 September 2014: Market Review and Outlook. Lonmin Plc. https://www.lonmin.com/online_annual_report_2013/governance/audit_and_risk_committee_report_03.html Lonmin Plc. (2014). Annual Report and Accounts For the year ended 30 September 2014: Market Review and Outlook. Lonmin Plc. https://www.lonmin.com/Online_Annual_report_20141/notes/note_20.html Marios, K. & Spyros, H. (2007). International business: a global perspective. Publisher: Boston, Mass. Moffett, Michael et al. (2012). Fundamentals of Multinational Finance. London: Pearson. Yahoo! Inc Finance. (2015). Lonmin PLC (LMI.L): Historical Stock Prices. April 29, 2015. 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