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Performance review
Other financial matters
Financial risk managementThe Group is exposed to market risks arising from its international operations. The Group has well defined and consistently applied policies for the management of foreign exchange and interest rate exposures. There has been no change since the year end in the major financial risks faced by the Group. The main risks arising from the Group’s financial instruments are interest rate risk, liquidity risk and foreign currency risk.
The Treasury Committee of the Board reviews and agrees policies for managing each of these risks and they are summarised below. These policies are regularly reviewed. The Group’s financial instruments, other than derivatives, comprise borrowings, cash and liquid resources and various items, such as trade receivables and trade payables that arise directly from its operations. The Group also enters into derivative transactions (principally interest rate swaps and forward foreign currency contracts). The purpose of such transactions is to hedge certain interest rate and currency risks arising from the Group’s operations and its sources of finance.
Details of financial instruments are shown in note 20 to the accounts.
Derivatives are also used to a limited extent to hedge movements in the price paid for lumber. These options and futures hedging contracts mature within one year and all are with organised exchanges. The Group’s policy is to control credit risk by only entering into financial instruments with authorised counterparties after taking account of their credit rating.
It is, and has been throughout the period under review, the Group’s policy that no trading in financial instruments or speculative transactions be undertaken.
Capital structureThe Group monitors two principal measures of financial gearing, the ratio of net debt to shareholders’ funds and the ratio of net debt to EBITDA (earnings before interest, taxes, depreciation and amortisation). Over the longer term the Group aims to maintain the ratio of net debt to shareholders’ funds within the range of 50 to 75 per cent and as at 31 July 2007 the ratio was 71.5 per cent.
The Group’s main borrowing facilities all contain a financial covenant limiting the ratio of net debt to EBITDA. For all facilities agreed after 1 August 2005 this ratio has been set at 3.5. As at 31 July 2007 the ratio was 2.2:1 (2006: 1.9:1). The Group aims to maintain this ratio generally in the range of 1.5 to 2.3.
For the Group, these two ratios are highly correlated both historically and prospectively and the two ranges are closely aligned.
Interest rate riskThe Group finances its operations through a mixture of retained profits and bank and other borrowings. The Group borrows in the desired currencies principally at floating rates of interest and then uses interest rate swaps to generate the desired interest rate profile, thereby managing the Group’s exposure to interest rate fluctuations.
At the year end approximately £1,102 million of the Group’s net debt was at fixed rates for one year or more, after taking account of swaps.
The Group reviews deposits and borrowings by currency at both Treasury Committee and Board meetings. The Treasury Committee gives prior approval to any variations from floating rate arrangements.
Liquidity riskThe Group maintains a policy of ensuring sufficient borrowing headroom to finance all investment and bolt-on acquisitions for the following financial year with an additional contingent safety margin. Large acquisitions such as DT Group are funded shortly before the acquisition is made.
The Group currently has undrawn centrally managed facilities in excess of £1 billion.
On 25 September 2006 DT Group was acquired, funded by a syndicated bank facility for €1,500 million (£1,011 million) with a maturity of 18 months. Also on 25 September the Group placed approximately 10 per cent of Wolseley plc issued ordinary share capital raising £646 million. These net proceeds were used to repay €964 million (£646 million) of the 18 month facility. As at 31 July 2007, the outstanding drawings under the 18 month facility were €500 million (£338 million). This facility will mature during the year ending 31 July 2008 and will be refinanced from existing facilities. A further £250 million of short-term facilities with core banks are renewed on an annual basis.
Following its acquisition by Wolseley, DT Group renegotiated its local bank facilities consisting of a DKK3,000 million (£272 million) multi-currency revolving facility and DKK2,076 million (£188 million) of mortgage facilities. These facilities are now on the same commercial terms and financial covenants as the main Group facilities.
The year-end maturity profile of the Group’s centrally managed facilities was as follows:
| Maturity | 2007 Facility £m |
2006 Facility £m |
|---|---|---|
| Less than one year | 588 | 200 |
| 1–2 years | 155 | 34 |
| 2–3 years | 313 | 174 |
| 3–4 years | 103 | 343 |
| 4–5 years | 1,887 | 111 |
| Greater than 5 years | 367 | 2,282 |
| Total | 3,413 | 3,144 |
At 31 July 2007, the Group had committed undrawn loan facilities of £1,204 million available to fund working capital, investments and general corporate purposes, as follows:
| 2007 Facility £m |
2006 Facility £m |
|
|---|---|---|
| Less than one year | 250 | 200 |
| 1–2 years | – | – |
| Over two years | 954 | 580 |
Foreign currency riskThe Group has significant overseas businesses whose revenues are mainly denominated in the currencies of the countries in which the operations are located. Approximately 49.6 per cent of the Group’s revenue is in US dollars. The Group does not have significant transactional foreign currency cash flow exposure. However, those that do arise are generally hedged with either forward contracts or currency options. The Group does not normally hedge profit translation exposure since such hedges have only temporary effect. Most of the foreign currency earnings generated by the Group’s overseas operations are reinvested in the business to fund growth in those territories. The Group’s policy is to maintain the majority of its debt in the currencies of its operating companies as this hedges both the net assets and cash flows of the Group.
Details of average exchange rates used in the translation of overseas earnings and of year-end exchange rates used in the translation of overseas balance sheets, for the principal currencies used by the Group, are shown in the Five year summary. The net effect of currency translation was to decrease revenue by £776 million (5.5 per cent) and to decrease trading profit by £51 million (5.8 per cent).
These currency effects reflect a movement of the average sterling exchange rate against each of the major currencies with which the Group is involved as follows:
| 2007 (Strengthening)/ weakening of sterling |
2006 (Strengthening)/ weakening of sterling |
|
|---|---|---|
| US dollar | (8.2)% | 3.5% |
| Euro | (1.7)% | 0.1% |
Commodity riskThe Group’s operating performance is affected by price fluctuations in stainless steel, nickel alloy, copper, aluminium, plastic, lumber and other commodities. The Group seeks to minimise the effects of changing prices through economies of purchasing and inventory management, resulting in cost reductions and productivity improvements as well as price increases to maintain reasonable profit margins. With the exception of lumber futures held to hedge future sales commitments, no trading instruments are held in respect of these commodities. At 31 July 2007, the Group held no lumber futures contracts.
Market price riskThe Group regularly monitors its interest rate and currency risk by reviewing the effect on profit before tax over various periods of a range of possible changes in interest rates and exchange rates. On the basis of the Group’s analysis, it is estimated that the maximum effect of a rise of one percentage point in the principal interest rates on the Group’s continuing businesses would result in an increase in the interest charge of approximately £17 million. Similarly, it is estimated that a strengthening of sterling by 10 per cent against all the currencies in which the Group does business would reduce operating profit before amortisation and impairment of acquired intangibles by approximately £72 million (8.3 per cent) due to currency translation, with the US dollar reduction being £45 million and the Euro reduction being £12 million.
Financial reportingThese financial statements are the Group’s second prepared under IFRS. The Group's accounting policies set out in Group accounting policies of the accounts have remained unchanged from those disclosed last year.
InsuranceThe Group has a captive insurance company which is registered and operational in the Isle of Man. No policies are written for third parties. The administration is undertaken by a specialist management company. The Group’s insurance arrangements are reviewed annually.
Going concernThe Directors are confident, on the basis of current financial projections and facilities available, that the Company and the Group have adequate resources to continue in operation for the foreseeable future. Accordingly the Directors continue to adopt the going concern basis in preparing the financial statements.
Stephen P Webster
Chief Financial Officer
24 September 2007