Global Running and Risk Management Analysis of Carpetright Plc - Case Study Example

Global running and risk management analysis of Carpetright plc Contents Introduction 3 Discussion 4 Main Market and Competitive Situation 4 FinancialPerformance 4 Profitability Performance 4 Returns on Investment 6 Liquidity Performance 7 Financial Gearing 8 Corporate and Financial Actions 9 Risk Management 10 Exchange Rate Risk 10 Country and Political Risk 13 Conclusion and Recommendation 16 References 17 Introduction Exchange rate risk, Political risks and Country risks are major risks which a multinational company can face during its term of operation. A company must employ various strategies to reduce or counteract such risk. Carpetright is a multinational retailer floor Coverings Company situated in UK which is exposed to above risks. The company is listed on London Stock Exchange. Carpetright was founded in 1988 by Lord Harris of Peckham. He opened the first store in Canning Town. The company acquired Sleepright stores of UK in 2008. Carpetright has a total of 620 stores all over the world and employs around 3200 individual. The group mainly operates in two geographical locations namely UK and Rest of Europe, which comprises of Republic of Ireland, Belgium and Netherlands. The company has about 478 stores in UK alone, 21 stores in Republic of Ireland, 26 stores in Belgium and 95 stores in Netherlands. According to industry estimates their market share is around 24% of the total floor coverings market in UK. It has recently undergone expansion in Republic of Ireland, Netherlands and Belgium. It has a wide range of products like mattresses, rugs, carpets, beds, vinyl floorings and laminate flooring. Presently it is a leading specialist in floor covering and carpet in Europe. The primary objective and strategies of the group is delivering long-term sustainable growth in cash flow and earnings per share. Their main vision is to continually improve and develop their product ranges and provide the consumers with many market leading product choices at lowest possible cost with an unbeatable customer service. The company faces a lot of risk in the process of their operation, which includes country, political, exchange rate etc. This report will discuss about the various risks management strategies of Carpetright. Carpetright faces exchange rate risks, political and country risk. This report discusses different strategies which Carpetright takes to mitigate all these risks. Discussion Main Market and Competitive Situation The management of Carpetright feels that the market condition is tough and recent euro zone crisis and global economic meltdown in 2008 still has lingering effects on the company. The company mainly operates in European countries (Carpetright plc, 2014, p. 1). These include Rest of Europe and UK. These include countries like Republic of Ireland, Belgium and Netherlands. Among these countries the company mainly has their store locations in UK. The sales figure of the company fell disappointedly (Farrell, 2013, p. 1). The company is considered by many for being the economic bell weather. The main competitors of Carpetright are B&Q plc, Wickes Ltd. And Floor My Home Limited. Relative to the tough market conditions in UK, the company had continued to perform robustly (BBC, 2014, p. 1). Though the sales figure of the company has taken a beating recently due to weak economic condition, its retail mix and aggressive store opening program has helped it remain in top position in the business (Datamonitor, 2006, p. 1). It has benefitted itself from recent growth in carpet sales due to increase in cold weather conditions and tough market conditions proved unattractive to the new entrants. Its closest competitors Allied Carpets has given little to fight for in the market condition (Parker, 2007, p. 131). Financial Performance Profitability Performance Period Ending 2013 2012 2011 2010 2009 Gross Profit Margin -0.01 0.04 0.02 0.05 0.05 Gross profit of a company indicates the operational efficieny of a company (Bragg, 2006, p. 81). The gross profit of the company is fluctuating from 2009 to 2013. It can be seen that the operating profit of the company has decreased by 81% in 2012 and by 115% in 2013 as compared to 2009. Gross profit margin of the company is decreasing. The main reason for this is high inflation in the European region which resulted in increasing cost for raw materials (Carpetright, 2013, p. 11). This made the gross profit of the company suffer loss in 2013. The total cost base of UK increased in 2013 by 0.9% as compared to 2012 (Carpetright, 2013, p. 11). The Store payroll cost of the company was managed closely by the volume of sales and it increased by 0.2% in 2013 (Ruddick, 2014, p.1). But Store occupancy costs fell by 0.9% because of net reduction in the number of stores, reduced depreciation and successful rent negotiation. But all the above essentially offset by business and utility rates inflation. Along the same time, the rent in like-for-like stores increased by 0.3%. This indicates the current economic environment that the company faces. During the same period the central support cost and marketing cost wet by 5.7% due to increased sales-driven advertising activity (Carpetright, 2013, p. 11). Period Ending 2013 2012 2011 2010 2009 Net Profit Margin -0.01 0.02 0.01 0.03 0.02 It can be seen that the net profit margin of the company is fluctuating from 2009 to 2013. The company is going through a difficult time. The main reason for this is that economic and political uncertainties in Europe which resulted in fall in consumer demand especially in Netherlands. It was found that overall floor covering market declined in 2013 (Carpetright, 2013, p. 4). They have made a positive impact through self-help group which was reflected by increase in profits in 2012. Returns on Investment Period Ending 2013 2012 2011 2010 2009 Return on Equity -0.10 0.16 0.07 0.22 0.18 The return on Equity of the company is fluctuating in nature. In 2011 the ROE declined while it increased in 2012 and again declined in 2013. This shows that the company is suffering due to heavy losses in 2013 and consecutively the shareholders are suffering losses. Though the equity base of the company is constant from 2009 to 2012, it decreased by 3% in 2013. But the main reason was losses suffered by Carpetright during the period resulted in shareholder not getting the dividend (Analysed from Attached Excel). Carpetright has reduced their debt, but the underlying economic environment continues to be uncertain and thus during 2012 and 2013, the company has not paid any dividend (Carpetright, 2013, p. 4). Liquidity Performance Period Ending 2013 2012 2011 2010 2009 Current Ratio 0.57 0.60 0.62 0.62 0.71 The current ratio of the company is decreasing over the period of years. The group has been trying to reduce their debt over a period of years and has been successful in doing that. It is seen that the current assets of the company is decreasing over the period of years. It has decreased by 7% in 2013 as compared to 2012. During the same time the current liability of the company has decreased by 3% in 2013 with respect to 2012 (Analysed from Attached Excel). Thus the current ratio has decreased in 2013. This indicates that it is hard for the company to maintain profitability in such difficult economic scenario (Kieso, Weygandt and Warfield, 2007, p. 175). Financial Gearing Period Ending 2013 2012 2011 2010 2009 Debt Equity Ratio 2.96 2.92 3.82 3.70 4.37 Clearly debt equity ratio of Carpetright is fluctuating, with this ratio being decreasing from 2011 to 2013. The Group has been reducing their debt though sale and leaseback of freehold properties during the later part of the financial year 2013. They have used combination of cash flow from profitability and level of net capital expenditure has helped the company in reducing the net debt for the company. During the entire period the equity remained constant though it decreased slightly in 2013 (Analysed from Attached Excel). Corporate and Financial Actions Lord Harris of Peckham, the Chairman of Carpetright understood the importance of quality product for them to be right. The company made a positive impact of self-help action which they were taking. The like-for-like sales grew in UK by 2.2% mainly due to their self help group actions (Carpetright, 2013, p. 11). In Europe, economic and political uncertainty continued to depress the consumer demand and the entire group suffered particularly in Netherlands. Their main focus was on reduction of net debt of the group which got nearly halved to £ 10.2 million as compared to £ 19.1 million in 2012 (Neville, 2013, p. 1). Risk Management Exchange rate risks indicate the risk of receiving fewer amounts in domestic currency when a company invests into other countries. Carpetright operates in many countries like Netherlands, Belgium, etc. where it uses varieties of techniques to protect itself from other this type of risk. Exchange rate risk is a major risk included within the financial risk (Jain, 2007). Similarly Political risk means the risk faced by the company due to uncertain political situation which exists in a country (Seidman, 2004). Such kinds of risk are faced regularly by due to exposure to such kind of risks in normal course of the business operations the group has to use appropriate risk management strategies (Livingstone and Grossman 2001). Exchange Rate Risk The foreign exchange market is a complex network of over the counter market. It facilitates exchange of one currency into another. It is the largest and least regulated market in the world. There are many operations which a company can do to protect itself from risk faced while doing operations in multiple countries (Rush, 2013). The main risk is the currency risk faced by a company where any fluctuations in exchange rate can severely impact the earnings of the company. This kind of risk can be mitigated by hedging or entering into a swap with other companies so that the company can mitigate any adverse fluctuations in the future (Leadley and Forsyth, 2004). (Source: Carpetright plc, 2013, p. 40) Form the above figure it is found that Carpetright suffered a loss of £7.5 million in 2012 with respect to hedged equity investments while the group suffered a gain of £1.9 million in 2013. Carpetright is a UK based company and thus it earns mainly in pounds Sterling. But it has its bases in foreign countries where they earn other than pounds. Such kind of transactions is recorded at the opening exchange rate for the month in which transactions occur. Liabilities and Monetary assets of the company are dominated in foreign currencies which are converted into local currency as per the exchange rates at the balance sheet date (Mourdoukoutas and Siomkos, 2009). Any exchange gains or losses are at first recognized in the income statement for the period under consideration except in case where they are a part of net foreign investment hedge. In those circumstances they are considered to be part of equity. Outside the UK, the group operates in a number of countries outside UK. These include the Netherlands, Republic of Ireland, Poland and Belgium. The currency from operations of expenses and revenues are mainly dominated by Zlotys or Euros. The investment in Poland by the group is not significant and thus the company does not need the risk to be hedged. Carpetright tires to mitigate currency risk for the investments in European operations by adopting many techniques (Annual report, 2013, p. 67). (Source: Carpetright plc, 2013, p. 67) The financial statements of Carpetright are reported in pounds Sterling which is the functional and presentational currency of the company. The transactions of the company are recorded in foreign currencies at the opening rate for every month whenever a transaction occurs. At the balance sheet date, the monetary assets and liabilities are denominated in the foreign currency. Any exchange gains or losses are recognised in the income statement for that period except in cases where they are a part of net foreign investment hedge at the time they are recognised in equity. During preparation of consolidated financial statement, the foreign earnings of the group are translated at the exchange rate ruling at the balance sheet date. Income and expenses of the foreign operations are further translated at the average exchange rate during the same period. The differences on translation are recognised as a separate component of equity. After disposal of the foreign operation the cumulative exchange differences of Carpetright for that operation are included in the income statement as part of the profit or loss on disposal. At the same time Goodwill and fair value adjustments which arise from the acquisition of a foreign operation are treated like assets and liabilities and are later translated at the exchange rate ruling during the balance sheet date (Carpetright, 2013, p. 45). Exchange rate risks management technique of Carpetright: Hedging Exchange rate risk can be managed by hedge including natural hedge and financial hedge. It also can be managed by forward contracts and other financial derivatives. The major method used by the company is hedge. Carpetright has entered into hedging for minimizing the losses that their group can suffer due to Foreign Exchange rate movement The Group enters into a hedge of net investments in foreign entities through currency borrowings, the gains or losses on the retranslation of the borrowings are recognised in equity. They discontinue their hedge accounting when their hedging instrument is sold or expires or it is no longer qualified under hedge accounting (Rheinlander, 2011, p. 152). During the same period any gain or loss suffered by the group on the hedging instrument which is recognized as part of equity is retained in equity until the hedged transaction happens. In case when the hedged transaction is no longer expected to happen, the cumulative gain or loss in equity is transferred to the income statement of the group (Carpetright, 2013, p. 48). The Euro dominated borrowings of the company is designated as natural hedging instruments of Euro dominated investments in foreign operations in order to protect the Group from currency risk in respect of the Group’s Euro-dominated foreign operations. Borrowing balances are carried at amortised cost which approximates fair value since borrowings bear interest at the prevailing floating rate. The carrying value of borrowings amounted to €1.8 million in 2013 (Carpetright, 2013, p. 69). Country and Political Risk Global crises such as debt ceiling controversies in USA and Arab Spring which protests the whole Middle East and North Africa (MENA) region and spread rapidly with no advance warning. The Euro-zone negotiation is another major global political risk for the large MNCs operates in UK and European countries. In Europe, economic and political uncertainty results in decline of consumer demands. This has impacted the group particularly in Netherlands. In countries like Netherlands and Belgium the austerity measures adopted by the government results in weak consumer demand in flooring market. The same thing happened in Republic of Ireland. In current economic and political scenario the group is using many measures to mitigate the risk (Bouchet, Clark and Groslambert, 2003, p. 162). In countries like Belgium, Netherlands the group is trying to buy stores at lower cost. Thus the company is trying to enter into long term agreement with the country so that they can get lower store cost. Carpetright looks to do FDI in countries after looking the political stability of the company (Wagner, 2012, p. 94). Carpetright try to reduce the inflation cost by trying to source their raw materials from local place so that they don’t have to import them from outside. This reduces the cost significantly (Williams, Haka, Bettner and Carcello, 2008, p. 281). Carpetright must enter into investment agreements with central governments so that they can get the required resources available from the governments at cheap rates like land, water, manpower etc. The group can go for investment guarantees which are essentially a contract that guarantees repayment of principal and interest rate. Carpetright will be able to avoid political uncertainties in case of change of governments of a country. In either case they will be guaranteed of the return which they expect out of their investment. Local sourcing is yet another way of avoiding political risk where by sourcing the resources naturally the group can cut down the cost. If they outsource the resources then they can face many trade restrictions or rise in import duty etc. which depends on the political relations between two countries. The issue of Facility location can help in mitigation of political risk. The group can move its important facilities, supply chain, R&D in a country where the political risk is low. They can move their facilities in locations like Free Trade Zones where there is no normal customers’ requirement for entry of foreign goods. The group can use imported components in the final product and delay payments of customs duties until the product is shipped into the host country. The Group can use multiple sources borrowing so that they can avoid sourcing all of the raw materials from one single country and thus face low political risk. By doing that they can stop sourcing the resource from a country where the political risk is high and source it from other country where political risk is low. Similarly by control of transportation from politically stable country can reduce their political risk. Carpetright may be impacted negatively by the economic downturn on consumer spending or the ability of their customers to service their debts. The group’ performance may be adversely affected by regulatory, legal and other developments in countries in which it operates. Carpetright is subject to a range of regulatory and legal requirements originating from UK (particularly Consumer Data protection and Credit Act), other countries which in which it operates and in the European Union, particularly in areas of product safety, consumer protection, competition, provision of credit, levies, taxation, labour and employment practices and environment. But the main problem is that the legal system in Netherlands, Ireland and Belgium is not as developed as legal system in UK. In those countries foreign company rarely wins cases against the host country. Another technique which Carpetright can take is purchasing a political risk insurance from organisations which specializes in selling the political risk insurance. Such a policy would compensate the group in cases any adverse event occurs. Buying political risk insurance has its disadvantage as the premium rates would depend on the country, industry and other factors. Carpetright can make some political donations to keep the political parties at bay (Reuters, 2013, p. 1). Political and country risks management technique of Carpetright Conclusion and Recommendation Carpetright plc has achieved a good performance in a number of years except in 2013. In 2013 the profitability of the company has decreased due to uncertain conditions in Europe. The management of the company is experienced in handling the retail business. They have a winning attitude towards implementation of the plan. The group is looking to expand despite economic recession. The company has faced inflation is many countries like Belgium, Netherlands etc (Carpetright, 2013, p. 12). To overcome this management should try to expand in emerging economies where the consumer sentiment has remained fairly constant as compared to those in Europe. This will boost up their sales and their profit margins will improve. Also this would help the company in paying dividends to the shareholders which they are not paying. This will improve the investor sentiment and more number of people will invest into the company in hope of higher returns. In such competitive world they should try to reduce as much debt as possible so that they can remove the burden of paying interest rate and it will constrain their expansion policy. Hence they should try to look for more equity based funding. References BBC. 2014. Carpetright in profits warning after poor Dutch sales. Available at: http://www.bbc.co.uk/news/business-25923861. [Accessed on: 22 Feb. 2014] Bouchet, M.H., Clark, E. and Groslambert, B. 2003. Country Risk Assessment: A Guide to Global Investment Strategy. New Jersey: John Wiley & Sons Bragg, S. 2006. Business ratios and formulas: a comprehensive guide, New Jersey: John Wiley and Sons. Carpetright plc. 2014. Company Overview. 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