Financial review
The main financial risks faced by the Group relate to the availability of funds to meet business needs, the risk of default by counterparties to financial transactions, fluctuations in interest and foreign exchange rates and credit rating risks. These risks are managed as described below. The Group Balance Sheet position at 28 February 2009 is representative of the position throughout the year.
Funding and liquidity The Group finances its operations by a combination of retained profits, long and medium-term debt, capital market issues, commercial paper, bank borrowings and leases. The objective is to ensure continuity of funding. The policy is to smooth the debt maturity profile, to arrange funding ahead of requirements and to maintain sufficient undrawn committed bank facilities, and a strong credit rating so that maturing debt may be refinanced as it falls due.
Tesco Group has a long-term rating of A3 by Moody’s and A- by Standard and Poor’s with a stable outlook. New funding of £5.6bn was arranged during the year, including a net £0.7bn from property transactions and £4.9bn from medium-term notes (MTNs). At the year end, net debt was £9.6bn (last year £6.2bn).
Interest rate risk management The objective is to limit our exposure to increases in interest rates while retaining the opportunity to benefit from interest rate reductions. Forward rate agreements, interest rate swaps, caps and collars are used to achieve the desired mix of fixed and floating rate debt.
The policy is to fix or cap a minimum of 40% of actual and projected debt interest costs of the Group excluding TPF. At the year end, £6.3bn of debt was in fixed rate form (last year £2.5bn) with a further £0.7bn of debt capped or collared, therefore 72% (2008 – 55%) of net debt is fixed, capped or collared. The remaining balance of our debt is in floating rate form. The average rate of interest paid on an historic cost basis excluding joint ventures and associates this year was 5.2% (last year 4.5%).
Foreign currency risk management Our principal objective is to reduce the effect of exchange rate volatility on short-term profits. Transactional currency exposures that could significantly impact the Group Income Statement are hedged, typically using forward purchases or sales of foreign currencies and currency options. At the year end, forward foreign currency transactions, designated as cash flow hedges, equivalent to £2,110m were outstanding (2008 – £1,198m) as detailed in financial instruments. We hedge the majority of our investments in our international subsidiaries via foreign exchange transactions in matching currencies. Our objective is to maintain a low cost of borrowing and hedge against material movements in our Group Balance Sheet value. During the year, currency movements increased the net value of the Group’s overseas assets by £480m (last year increase of £284m). We translate overseas profits at average foreign exchange rates which we do not currently seek to hedge.
Credit risk The objective is to reduce the risk of loss arising from default by parties to financial transactions across an approved list of counterparties of high credit quality. The Group’s positions with these counterparties and their credit ratings are routinely monitored.
Tesco Personal Finance (TPF) TPF became a wholly owned subsidiary of Tesco Group on 19 December 2008. In preparation for this change the risk management and treasury capabilities of TPF have been materially strengthened. All policies pertaining to risk within TPF are now subject to TPF governance procedures which are owned by the TPF Board.
TPF has a banking business, predominantly in the UK, with the three main products being credit cards, unsecured personal loans and savings. TPF has also developed a significant insurance business, with motor, home and pet insurance being the main products.
Credit risk, arising from its unsecured lending, is managed using all the normal reporting and collections and recoveries systems. In terms of liquidity risk TPF has implemented a conservative approach to the minimum amount of liquid assets its holds and to its core funding ratio of customer assets/customer liabilities. TPF has at this stage in its development an increased element of operational risk as it currently outsources most of its operations to Royal Bank of Scotland Group whilst at the same time it is in the process of building new banking and insurance systems. TPF retains profit and loss risk to its insurance activities of which a large weather related event would generate the largest adverse variance.
Insurance We purchased Assets, Earnings and Combined Liability protection from the open insurance market at ‘catastrophe’ level only. The risk not transferred to the insurance market is retained within the business by using our captive insurance companies, Tesco Insurance Limited in Guernsey and Valiant Insurance Company Limited in the Republic of Ireland. Tesco Insurance Limited covers Assets and Earnings, while Valiant Insurance Company Limited covers Combined Liability.
Statement of compliance
This Business Review has been prepared in accordance with the requirements for a business review under the Companies Acts 1985 and 2006.
The Business Review’s intent is to provide information to shareholders and should not be relied on by any other party or for any other purpose.
Cautionary statement regarding forward-looking information
Where this review contains forward-looking statements, these are made by the Directors in good faith based on the information available to them at the time of their approval of this report. These statements should be treated with caution due to the inherent risks and uncertainties underlying any such forward-looking information.
The Group cautions investors that a number of important factors, including those in this document, could cause actual results to differ materially from those contained in any forward-looking statement. Such factors include, but are not limited to, those discussed under ‘Risks and uncertainties’ .
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