HSE EMBA Intellectual Capital Report

1. HSE Executive MBA 2006 Taiwan
策略財務及風險管理
課後研習報告
Strategic Finance and Risk Management
29th ~ 30th March 2008
Take-Home Examination
06TCEMBA0119
Student ID #
Name Jimmy Hua
Email Jimmyhua0420@yahoo.com
Professor Prof. Vesa Puttonen
Deadline 2008/04/22
Due Date: 23:59, 2008/04/22 (二)
Mail report to:hseee@neo‐emba.com
Please select a company with its English Annual Report available on the Internet.
1. Describe its financial risks
2. Describe its risk management policy
3. Basing on the analysis of the following factors to see if that company can benefit
from hedging against risks:
Equity ratio
Gearing ratio
P/E ratio
P/B ratio
Riskiness of its business
Ownership structure (family‐owned vs. diversified).
4. Compare this company’s risk management policy with you analysis.
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2.
I have the opportunity to have a factory tour to one of Autoliv’s manufacturing
facilities few weeks back. Autoliv is one of leading automobile safety device
manufactures in the world where headquarters is at Sweden and listed in NASDAQ
exchange (NYSE: ALV). Products such as air bags, seat belts, steering wheels, and
etc. are some of major safety products they are making.
The idea triggers me to evaluate this company’s financial risks is that this
company herself is making the most important safety part for vehicle – air bag.
There is nothing more important than giving the driver the peace of mind that
people in the car are protected with quality air bags and safety seat belts in vehicle
while driving. I only learn how rigorous and complicated these safety devices are
made after I visited the factory; otherwise, I feel it is just another typical little piece
of parts made of from the factory.
Having minimizing the risks to protect the drivers through making air bags and
seat belts, I begin to wonder if Autoliv would make these products as solid and
secure, how about its company risk management particularly in finance to protect
shareholders and stockholders value. Will Autoliv be as meticulous in managing
financial risks as in managing reducing risks in making air bags? Will Autoliv be as
thorough in calculating financial risks as in having meticulous processes making air
bags?
Autoliv’s Financial Risks
Autoliv’s primary financial risks are mainly from her international operations
and debt‐financed activities. Because Autoliv is an international company with 80
facilities doing business in 32 different countries worldwide, she has exposed and
needed to perform various currencies exchange activities. Moreover, strategic
alliance and expansion in facilities in China also cause risks in debt‐financed activities
are also a major risk category for Autoliv. From these two main activities, we can
further dissect them into Currency risks, Interest Rate risks, Refinancing risk, and
Credit risk.
Currency exchange is at risk when products are manufactured in one country,
but sells to another country and at risk when translating income statement and
balance sheet. The estimate risk amount in manufacturing exposes from currency
exchange is about $ 0.2 billion ($ 1.7 billion is the gross transaction in 2008, and $ 1.5
billion is the counter‐flow in the same currency pair). The top three paired
countries currencies are U.S. dollars to Mexican Peso for $202 millions, Euros to
Swedish Krona for $161 millions, and Euros to British Pounds for $117 millions. 12%
($0.2/$1.7 billion) is considered a major risk item and needed to evaluate for hedging.
Another currency risk is within the translation in income statement and balance
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3. sheet for non‐U.S. subsidiaries to U.S. dollars. If in any case (e.g. political impact,
major natural disaster, economic depression, and etc) one country’s currency
suddenly fluctuates, the currency rates would not be balance against the other.
This could be a major impact in the yearly budget planning and profit share at end of
year! Close to 55% of company sales is in Euros, and 21% is in U.S. dollars. From
2007 Sales, 1% increase of U.S. dollar against Euros is equivalent $ 37 million or
equivalent to 0.6% approximately. The operating income would also decline by
0.6% or by $ 3 million. The other minor impact is the financing major subsidiaries in
local currency. Since the company policy for financing has already using U.S. dollars,
the impact of such currency risk is minimal.
Interest rate risk comes when interest rate changes affecting company’s
borrowing cost. Autoliv is at financial risk when trying to financing subsidiaries’
operations and new expansion. Interest rates and conditions are varies depending
by countries. Interest rates are always dynamic and change according the current
country’s economic condition. With global operations, it is sometimes difficult for
Autoliv to forecast the interest expenses.
Refinancing risk will occur when Autoliv tries to borrow the money but could
not! Autoliv is constantly in a lookout for reducing cost in material, improving
manufacturing efficiency, developing better safety technologies, and better servicing
local customers by expanding local manufacturing sites. Autoliv currently does have
some outstanding debt. If financial institutions believe that Autoliv has already
reached her top to borrow more money, all activities list above might be either
postponed, suspended, or ceased resulting slow growth for the company and less
shareholders values.
Credit risk arises when counterparties unable to fulfill an agreed financial
obligation or cash deposits with banks. Financial obligation could come in different
forms such as forward exchange agreements, swap contracts, or other financial
instruments. When economy is slow, customers tend to be conservative in
purchasing additional safety equipment in the new car. If this is case, automobile
companies would tend to hold off purchasing from Autoliv resulting unable to fulfill
the cash deposits. Credit risk in financial obligation would occur when
counterparty makes the opposite decision from the market trend, resulting unable to
come out sufficient money to pay off the forward exchange agreement or swap
contracts. These types of occurrence appear often when buyers miscalculate the
loss could be appearing in such short time.
The coming table will summarize Autoliv’s position these financial risks. Some
of financial risks will benefit from heading, thus Autoliv does not take action to
prepare heading, and some risks do have some preventive measures by either
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4. amended policies or offering hedging. Below is the table summarizing the risk
policies:
Autoliv Financial Risk Policies Management Summary
Type of Risk Risk Management Policy
Currency Risk – Transaction ‐ Does not hedge.
‐ Income statement ‐ Does not hedge.
‐ Balance Sheet ‐ Finance major subsidiaries in the country’s
local currency.
Interest Rate Risk Amended policy in 2007: increase in floating
interest rates of 1% point should not increase
the annual net interest expense by more than $
10 million (previously $ 5 million) in the
following year and not by more than $ 15
million (previously $ 10 million) in the second
year.
Refinancing Risk Issuance of the $ 400 million U.S. private
placement in November 2007 without financial
covenants thus reducing risks in any given year
spreading out between 2021 and 2019.
Credit Risk Works with banks that have a high credit
rating and that participate in the Autoliv’s
financing.
Entering with limited number of banks up to
a calculated risk amount of $ 75 million per
bank.
After understanding what Autoliv’s financial risks are and how Autoliv’s do to manage
their risks through various methods and policies, the next thing to do is to use few
key risk evaluation factors to further exam if they line up with Autoliv’s risk
management policies. These key indicators are:
Equity ratio
Gearing ratio
P/E ratio
P/B ratio
Riskiness of its business
Ownership structure (family‐owned vs. diversified)
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5. Equity Ratio
The equity ratio is the shareholder’s equity
relative to total assets. Base on Autoliv’s
2007 Annual Report (page 69), the 2007
equity ratio is 44. The graph on the right
illustrates the Autoliv’s last five years Equity
Ratio. Although the Equity Ratio is
considerate high at 44 comparing with other
companies, the five years historical figures
show a sign of decreasing where back in year 2003, the equity ratio is higher at 49.
If we look the year 2007 along, Autoliv is less beneficial to do hedging. But if we
look at the 4 years trend from 2007 Annual’s Report, there is a potential that Autoliv
is in more risk from relying more on creditors rather than stockholders. However,
this could be a good sign also, because in recent years, Autoliv is in heavy expansion
in Asia, in particular in China for manufacturing operation trying to lowering the cost
and close to customers. So the Equity Ratio has begun to decrease base on this
reason. Thus performing hedging or not performing hedging from equity ratio
point of view is about neutral.
Gearing Ratio
The Gearing Ratio is the net
debt‐to‐equity ratio (Net debt/
(Shareholders’ equity +minority
interest). Base on Autoliv’s 2007
Annual Report (page 69), the 2007
Gearing ratio is 33. This number may
be fair for the manufacturing operation
and automobile industry, because it
requires continuous expansion from
bank borrowing to meet market demand. However, if we compare the ratio over
the last 4 year s from 2007 Annual’s Report, the trend is moving to an upward
direction meaning the financial risk is increasing each year. Thus the riskiness in this
business from P/E point of view is somewhat greater than before. It is suggested it
would be somewhat beneficial performing hedging than not performing hedging.
P/E ratio
The P/E ratio is the share at end of year divides by annual earnings per share (EPS).
The 2007 EPS is $ 3.7, and the last trade stock in 2007 was $ 47.32. Thus the Ratio
is taking $47.32 divides by $ 3.7 (EPS) equaling 12.79. Putting another way, the
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6. purchaser of Autoliv stock is paying $12.27 for every dollar of earnings. The graph
from right is taken from NASDAQ forecasting Autoliv’s future EPS by listing the actual
2007 EPS first. From the forecast
point of view, by year 2011, purchaser
only spends half of money in 2007 for
every dollar of earnings. It seems like a
good stock to keep. Thus the riskiness
in this business from P/E point of view is
considered minimum.
Autoliv 2007 P/E Ratio and Forecast
Source: http://www.nasdaq.com/earnings/peratio.asp?symbol=ALV&selected=ALV%60
P/B ratio
The P/B ratio is the stock share price divides the total assets and intangible assets
and liabilities. Thus, the Autoliv P/B ration is taking stock price of US $ 47.32 divides
the result of total asset, 5,305 minus 1,760 and minus 1,552. Then the P/B ratio
equals to 47.32 / (5305‐1760‐1552) = 47.32/1993 = 2.37. The P/B is just about in the
middle, thus the riskiness in this business from P/B point of view is considered
neutral to minimum.
Riskiness of its business
The riskiness of its business may come in several factors. These factors may come
from ability to manufacture, research
and development, cost, source of
material, competition, financial
leverage, automobile industry trend,
and alternative products. Autoliv is
the leader in market share of air bags,
with 40% of air bag market share from
year 2005 as shown the pie chart on
the right. Airbag market share % in 2005
Beside Autoliv already has built up the market leader advantage, the other
advantage is from market demand. More and more countries are requiring air bags
as the standard equipment for every new car being sold. The global demands are
expected to grow to 91.9 million units by 2011. In addition, key automobile market
and the safety laws setters, the U.S., the U.S. government agency, NHTSA (National
Highway Traffic Safety Administration) is requiring all new cars sold in U.S. by 2009
needed to pass the side crash tests. The entrant barrier, the dependency of
automobile brands, rivalry, and development of more safety devices are all part of
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7. threats. Moreover, since Autoliv has been in the market for over 20 years, she has
already possessed in depth experience, knowledge, and skills to succeed in this
market. Well diversified customer base around the world with no more than 12%
for the largest customer (graph shown on the left) and balanced facilities in major
regions (chart below) makes Autoliv the leader in the automobile safety device
industry. With 80 manufacturing facilities to meet speedy delivery and services,
and more than 20 crash test sites in 29
different countries, these make Autoliv
one of its kind stand out from the
competition. Thus the riskiness in this
business is considered minimum.
Ownership structure (family‐owned vs.
diversified)
The ownership of stocks is quite
diversified. There are over 70,000 Autoliv shareholders including 275 institutions
that have Autoliv’s stocks. The top 5 shareholder institutions count 31.7% of total.
They are: Alliance Bernstein owns 8,681,476 which accountable for 11.8%; LSV Asset
Management owns 4,183,953 which accountable for 5.7%, Iridian Asset,
Management LLC. owns 3,755,236 which accountable for 5.1%, Renaissance
Technologies Corp owns 3,200,400 shares which accountable for 4.4%, Blavin &
Company Inc. owns 2,760,885 which accountable for 3.8%, Management/Directors
owns 665,270 shares which accountable for 0.9%. This represents a well balanced
shareholders mix. The largest single shareholder holds no more than 12%.
Institutions, which have over $ 100 million dollars assets, have more than 270s
providing the individual stockholders and Autoliv’s management the confidence that
Autoliv is a sound and well reputable stock for financial institutions to keep and
invest. Thus it does not benefit much from hedging.
From above six different indicators’ findings and explanation, below chart is the
summary for Autoliv’s Financial Risk Evaluation Assessment. The down‐arrows
represent whether Autoliv is more or less benefit from hedging. Whether it is less
or more benefit from hedging, it is basing on the above analysis and findings.
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8. Key Financial Risk Evaluation Factors
for Autoliv
More Benefit from Hedging Less Benefit from Hedging
1. Equity Ratio : 44 High | Low
2. Gearing Ratio: 33 High | Low
3. P/E Ratio: 12.79 High | Low
4. P/B Ratio : 2.37 High | Low
5. Risk Business: Low High | Low
6. Ownership diversity: High Private | Public
: indicating the risk stand of that particular risk factor
Autoliv’s risk management policy is based on several already known risks to
apply strategies, amended policies, and introduced control and reporting systems to
reduce and minimize those risks. Risks include financial and non‐financial
circumstances. From financial risk management point of view, the way that Autoliv
manages they are working closely with selective banks to secure credit and ensure
substantial credit line is available. Moreover, Autoliv amends her floating interest
rate and issue placement to reduce its risk in refinancing processes. Let’s look
closely further and compare with the six risk evaluation factors that I have evaluated
from above.
Autoliv’s asset/equity ratio is a good indicator to look for if Autoliv is under
expansion or being conservative. In fact, Autoliv in recent years is undergoing
either for improvements to existing operations, or expansion of the company
overseas (few expansions and partnerships in China). Over the last five years,
Autoliv begins to drop her asset/equity ratio from 49 (year 2003) to 44 (year 2007)
indicating the company is in fact suitable for the extension of credit, especially the
amount of debt carried by the company is somewhat low. This is aligning with
Autoliv’s Risk Management policy: to increase floating interest with increasing in
total interest cap from $ 5 million to 10 million, and to work with selected banks to
have a high credit.
The higher degree of leverage or gearing, the more the company is considered
risky. This is what Autoliv seems to be moving in the recent five years. If economy is
not in Autoliv’s favor, having high gearing (high leverage) is more vulnerable to
downturns in the business cycle because Autoliv must continue to service its debt
regardless of how bad sales are. However, in this case, the automobile industry in
air bag in particular does looking good in the long run. A greater proportion of
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9. equity provides a cushion and is seen in Autoliv’s case as a measure of strong
financial strength in the last few years. And now Autoliv would like to take this
advantage trying to expand by issuing $ 400 million private placement without
financial covenants. Although the P/E ratio has been dropped over the years, I
believe it is well taken care with cautious and meticulously calculated.
Although the gearing ratio is increasing each year in the last few years for
Autoliv, there are few indicators for Autoliv to allow it to happen:
In the recent years, Autoliv keeps expansion in low cost countries,
acquisitions in joint venture in Korea, China, and in India. If these
countries in the long run can reduce the cost and bring higher return than
not doing so, it is wiser for Autoliv to borrow the money to gain more
businesses in the future.
Autoliv is still going through a decent profitable phase and profits which are
well able to cover all fixed interest capital obligations and still leave a
surplus available to the ordinary shareholders.
Autoliv is able to take advantage in currency exchange by borrowing the
lowest interest rate from countries who could offer. If interest rates are
low, it may be wiser for a business to borrow funds rather than issue shares.
Autoliv has been in the automobile safety device manufacturing business for
over 20 years with majority of market share, tier 1 customers, solid global presence
and profitable future ahead of her making sure the P/B ratio is solid and won’t
change significantly over times.
It is apparent that safety device in automobile will be a must in every single
vehicle. Even 2‐wheels motorcycle is trying adopt air bag in its safety system. The
riskiness of business in this industry would be minimum from industry point of view.
In addition, Autoliv has been in the safety device business for over 20 years.
Although there have always been new competitors, it seems like Autoliv does not
slow down in expansion and develop new products and technologies including
protecting over 4,500 patents now.
It is also apparent that Autoliv is a sound and well diversified company with over
70,000 shareholders including 275 institutions making sure Autoliv has substantial
investors watching over her operations. Even internally, Autoliv has been quite
diversified also. Her research and development strategy is that no single
development project accounts for more than 1% of Autoliv’s total R,D&E spending.
With all of above in mind, Autoliv believes to be a well established and sound
company with solid financial planning and risk management policy in place.
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10. Source:
1. NASDAQ:
http://www.nasdaq.com/asp/extendfund.asp?symbol=ALV&selected=ALV&page=full
2. Autoliv web site at www.autoliv.com.
3. Autoliv Financial information including 2007 Annual report:
http://www.autoliv.com/alv/connect/Home or
http://www.autoliv.com/alv/resources/file/ebfe5401933ecf4/AutolivAR_LOW.pdf
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