Annual Report 2017

3. Financial Risk Management

3.1 Financial Risk Factors

The Group’s activities expose it to a variety of financial risks: market risks such as currency risk, fair value interest rate risk, cash flow interest rate risk and price risk, credit risk and liquidity risk. The Group’s overall risk management program focuses on the unpredictability of financial markets and seeks to minimize potential adverse effects on the financial performance of the Group. The Group uses derivative financial instruments to hedge certain risk exposures.

The Group’s management provides principles for overall risk management, as well as policies covering specific areas, such as foreign exchange risk, interest rate risk, credit risk and the use of derivative and non-derivative financial instruments.

3.1.1 Market Risk


(i) Foreign exchange risk

Foreign exchange risk arises when future commercial transactions or recognized assets or liabilities are denominated in a currency that is not the entity’s functional currency. The Group treasury’s risk management policy is to hedge the expected cash flows in most currencies, mainly by making use of derivative financial instruments as described in note 2.16.

The majority of the Group operations takes place in the ‘eurozone’, which comprises 59.71% (2016: 60.95%) of total revenue. Translation exposure to foreign exchange risk relates to those activities outside the eurozone, whose net assets are exposed to foreign currency translation risk. The currency translation risk is not hedged.

If the currencies of these operations had been 5% weaker against the euro with all other variables held constant, the Group’s result for the year would have been 0.5% higher (2016: 0.8% lower) of which 0.3% lower impact of GBP offset by 1.6% higher impact of USD (2016: 0.5% lower impact of GBP) and equity would have been 3.8% lower (2016: 3.2% lower), of which 1.1% lower impact of GBP (2016: 0.9% lower impact of GBP).

Foreign exchange risks with respect to commercial transactions other than in the functional currency are mainly related to US dollar denominated purchases of goods in Asia, certain rental payments and indirect exposure on goods and services invoiced in the functional currency but of which the underlying exposure is in a non-functional currency. Based on the treasury policy the foreign currency risk relating to commercial transactions denominated in a currency other than the euro is hedged between 25% and 80% of the transactional cash flows based on a rolling 12-month forecast, resulting in a relatively limited foreign exchange risk for non-hedged commercial transactions. Cash flow hedge accounting is applied when the transaction is highly probable. Fair value hedge accounting is applied when the invoice is received.

(ii) Interest rate risk

The Group’s income and operating cash flows are substantially independent of changes in market interest rates. The Group generally borrows at variable rates and uses interest rate swaps as cash flow hedges of future interest payments, which have the economic effect of converting interest rates from floating rates to fixed rates. Under the interest rate swaps, the Group agrees with other parties to exchange, at specified intervals, the difference between fixed contract rates and floating interest rate amounts calculated by reference to the agreed notional principal amounts and benchmarks.

The table below shows sensitivity analysis considering changes in the EURIBOR:

2017

2016

Impact on result before tax

Impact on Other Comprehensive Income

Impact on result before tax

Impact on Other Comprehensive Income

EURIBOR rate - increase 50 basis points

-1,913

8,235

- 1,600

5,870

EURIBOR rate - decrease 50 basis points

888

-5,985

498

- 3,942

Note 32 describes the financial derivatives the Group uses to hedge the cash flow interest rate risk.

(iii) Price risk

Management believes that the price risk is limited, because there are no listed securities held by the Group and the Group is not directly exposed to commodity price risk.

3.1.2 Credit Risk

Credit risk is managed both locally and on a Group basis, where applicable. Credit risk arises from cash and cash equivalents, derivative financial instruments and deposits with banks and financial institutions, as well as credit exposures to wholesale, retail customers and health insurance institutions, including outstanding receivables and committed transactions. Derivative transactions are concluded and cash and bank deposits are held only with financial institutions with strong credit ratings. The Group also diversifies its bank deposits and apply credit limits to each approved counterparty for its derivatives. The Group has no significant concentrations of credit risk as a result of the nature of its retail operations. In addition, in some countries all or part of the credit risk is transferred to credit card companies. The Group has receivables from its franchisees. Management believes that the credit risk in this respect is limited, because the franchisee receivables are in certain instances secured by pledges on the inventories of the franchisees. The utilization of credit limits is regularly monitored. Sales to retail customers are settled in cash or using major debit and credit cards.

3.1.3 Liquidity Risk

Prudent liquidity risk management implies maintaining sufficient cash, the availability of funding through an adequate amount of bilateral credit facilities (immediately available funds), a commercial paper program and committed medium-term facilities (available at 4 days' notice). Due to the dynamic nature of the underlying business, the Group aims at maintaining flexibility in funding by maintaining headroom of at least €200 million as a combination of cash at hand plus available committed credit facilities minus any overdraft balances and/ or debt maturities with a term of less than one year. Group management monitors its liquidity periodically on the basis of expected cash flows, and local management of the operating companies in general monitors the liquidity even more frequently.

The Group has a revolving credit facility of €1,200 million. In July 2016 the facility was extended for a second time and now has a final maturity date of 17 September 2021. The interest rate on the drawings consists of the margin and the applicable rate (i.e. for a loan in euros, the EURIBOR), however the applicable rate can never be below zero percent.

The facility requires GrandVision to comply with the following financial covenants: maintenance of a maximum total leverage ratio (net debt/adjusted EBITDA) of less than or equal to 3.25 and a minimum interest coverage ratio (adjusted EBITDA/net interest expense) of 5. Compliance with the bank covenants is tested and reported on twice a year. As of the balance sheet date, the Group is in compliance with the bank covenants and has been so for the duration of the facility.

In 2016 GrandVision began a commercial paper program under which it can issue commercial paper up to the value of €500 million (2016: €400 million). As of 31 December 2017 the amount outstanding under the commercial paper program was €398.8 million (2016: €342 million).

The table below analyses the Group’s financial liabilities and derivative financial liabilities into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. The amounts disclosed are the contractual undiscounted cash flows.

in thousands of EUR

Within 1 year

1-2 years

2-5 years

After 5 years

Total

31 December 2017

Borrowings

217,501

1,904

381,737

-

601,142

Commercial paper

398,242

-

-

-

398,242

Derivative financial instruments

3,119

2,654

6,974

4,208

16,955

Contingent consideration

27,680

19,838

1,787

-

49,305

Financial leases

508

340

280

-

1,128

Trade, other payables and accrued expenses

467,516

-

-

-

467,516

31 December 2016

Borrowings

202,493

1,015

392,080

-

595,588

Commercial paper

342,000

-

-

-

342,000

Derivative financial instruments

1,823

2,036

5,647

4,499

14,005

Contingent consideration

3,756

-

1,130

-

4,886

Financial leases

980

524

553

12

2,069

Trade, other payables and accrued expenses

443,901

-

-

-

443,901

3.2 Capital Risk Management

The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital. There are no externally imposed capital requirements.

In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debts. The Group monitors capital on the basis of leverage ratio (defined as net debt/adjusted EBITDA).

Management believes the current capital structure, operational cash flows and profitability of the Group will safeguard the Group’s ability to continue as a going concern. GrandVision aims to maintain a maximum leverage ratio of 2.0 (net debt/adjusted EBITDA) excluding the impact of any borrowings associated with, and any EBITDA amounts attributable to major acquisitions. Net debt consists of the Group's borrowings, derivative financial instruments and cash and cash equivalents.

in thousands of EUR

31 December 2017

31 December 2016

Equity attributable to equity holders

1,039,074

946,906

Net debt

831,563

750,153

Adjusted EBITDA

551,512

537,148

Leverage ratio

1.5

1.4

3.3 Fair Value Estimation

The financial instruments carried at fair value can be valued using different levels of valuation methods. The different levels have been defined as follows:

  • Quoted prices (unadjusted) in active markets for identical assets or liabilities (level 1). A market is regarded as active if quoted prices are readily and regularly available from an exchange, dealer, broker, industry group, pricing service, or regulatory agency, and those prices represent actual and regularly occurring market transactions on an arm’s length basis.
  • Inputs other than quoted prices included in level 1 that are observable for the asset or liability, either directly (prices) or indirectly (derived from prices) (level 2). Valuation techniques are used to determine the value. These valuation techniques maximize the use of observable market data where it is available and rely as little as possible on entity-specific estimates. All significant inputs required to fair value an instrument have to be observable.
  • Inputs for asset or liability that are not based on observable market data (unobservable inputs) (level 3).

The assets and liabilities for the Group measured at fair value qualify for the level 3 category except for the derivative financial instruments (note 32) which qualify for the level 2 category. The Group does not have any assets and liabilities that qualify for the level 1 category. If multiple levels of valuation methods are available for an asset or liability, the Group will use a method that maximizes the use of observable inputs and minimizes the use of unobservable inputs.

The table below shows the level 2 and level 3 categories:

in thousands of EUR

Level 2

Level 3

At 31 December 2017

Assets

Derivatives used for hedging

1,427

-

Non-current assets

-

1,486

Total

1,427

1,486

Liabilities

Contingent consideration - Other current and non-current liabilities

-

45,761

Derivatives used for hedging

7,524

-

Total

7,524

45,761

At 31 December 2016

Assets

Derivatives used for hedging

5,223

-

Non-current assets

-

1,748

Total

5,223

1,748

Liabilities

Contingent consideration - Other current and non-current liabilities

-

3,653

Derivatives used for hedging

5,034

-

Total

5,034

3,653

There were no transfers between levels 1, 2 and 3 during the periods.

Level 2 category

An instrument is included in level 2 if the financial instrument is not traded in an active market and if the fair value is determined by using valuation techniques based on the maximum use of observable market data for all significant inputs. For the derivatives, the Group uses the estimated fair value of financial instruments determined by using available market information and appropriate valuation methods, including relevant credit risks. The estimated fair value approximates to the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Specific valuation techniques used to value financial instruments include:

  • quoted market prices or dealer quotes for similar instruments;
  • the fair value of interest rate swaps is calculated as the present value of the estimated future cash flows based on observable yield curves;
  • the fair value of forward foreign exchange contracts is determined using forward exchange rates at the balance sheet date, with the resulting value discounted back to present value.
Level 3 category

The level 3 category refers to investments held in buildings and contingent considerations. For the investments held in buildings, an external expert performs a valuation periodically. The valuation technique is consistent compared to prior years. The contingent considerations are remeasured based on the agreed business targets. Refer to note 6 for more details on the valuation methodologies and key inputs in the determination of fair value of the contingent considerations related to Visilab and Tesco Opticians.