12.3.1 Risks arising from the economic crisis
Even though the markets recovered considerably in 2010, risk management continued to examine the impact of risks resulting from the financial and economic crisis on the KION Group's financial position and financial performance. In addition to ongoing screening and monitoring, the risk report therefore includes a separate assessment of the risks arising from the receding crisis in financial and product markets. The economic problems in Greece, Spain, Portugal and Ireland, plus the EU rescue packages, highlight the fact that the financial and economic crisis has not yet ended. Risk management is also focusing once more on the risks associated with market recovery (e.g. potential supply bottlenecks). However, demand for industrial trucks remains significantly below its pre-crisis level. The KION Group has continued to systematically implement its KIARA performance enhancement programme and has significantly lowered costs.
Government action to support economies and the financial system resulted in a rise in government indebtedness worldwide. In Greece, Spain, Portugal and Ireland, debt repayments and the consolidation of national budgets restrict future flexibility and increase the pressure on governments to take appropriate action in terms of both income and expenditure. It is impossible to predict the implications for the material handling market and therefore also for the KION Group.
12.3.2 Market risks
Fluctuations in the business cycle in the relevant markets result in a risk to the KION Group's performance. In particular, sales of new trucks depend to a large degree on economic growth. The KION Group's distribution of sales over a variety of industries and regions as well as its limited dependency on big-ticket customers serve to mitigate the risk. Market risk is reduced by close monitoring of markets and competitors as well as any resulting necessary adjustments to production capacities. The KION Group takes measures to boost its sales and expand less cyclical businesses such as services to counteract economic downturns.
Times of crisis allow premium manufacturers, such as the KION Group, that have their own sales and service networks to benefit from the tendency of customers to opt for high-quality products. With its current brand and product portfolio, the KION Group is in an outstanding market position.
Market risk persists despite the positive outlook for all the major economies. The weak economic performance of Greece, Ireland and Portugal is a sign that the market environment remains susceptible to exogenous shocks. An escalation of the euro crisis and an associated adverse impact on the industrial trucks markets of the countries affected cannot be ruled out. Outside the euro zone, the UK and US economies are also affected by measures to consolidate their budget deficits. Depending on the scope of these measures and/or the ability of these countries to raise funds in the capital markets, negative effects could also be felt in their industrial trucks markets. The KION Group is also monitoring the political situation in North African and Middle Eastern countries as well as the impact on their industrial trucks markets, although these markets only play a minor role in a global context. The oil price and any consequences for global trade are also being closely observed. The KION Group therefore closely monitors macroeconomic and market conditions so that it is ready to promptly step up action already implemented or initiate additional measures if required.
12.3.3 Competition risks
Manufacturers from Asia, especially those from China and Korea, have an advantage in the production of lower-priced equipment due to the weakness of the euro and also because Asian labour costs are low. Providers from Asia can create competitive pressures for the KION Group, especially in the low-price segment. However, customers' high quality expectations and performance needs form a barrier to growth for many of these manufacturers, and their lack of an established distribution and service network in Europe makes it more difficult for them to gain a foothold in this market.
12.3.4 Procurement and sales risks
The KION Group is exposed to risks in its procurement and sales activities. In 2010, the Group rigorously maintained its more intensive management of receivables and procurement as a result of the economic crisis.
Procurement activities constitute a potential risk for the KION Group in terms of the lack of availability and rising cost of raw materials, energy, base products and intermediate products. While the financial situation of suppliers was a significant source of risk during the general financial and economic crisis, availability of components came to the fore as a risk in 2010 because our suppliers experienced a surge in demand. The KION Group was directly affected by supply problems and also indirectly via its suppliers, particularly in the case of electronic components. Supplier-related processes have since improved again. At the same time, the KION Group has taken additional steps to further increase the availability of production parts.
While the KION Group benefited from stable, relatively low prices in the commodity markets at the beginning of 2010, prices shot up from the second quarter onwards as a result of the aforementioned rise in demand in the supplier markets. However, there is still a risk of significant volatility in procurement prices in the future owing to the economic situation remaining benign.
The ongoing screening of suppliers from a risk perspective is proving to be highly effective. Only one of the selected suppliers initiated insolvency proceedings during 2010, but this did not lead to any significant interruption to supplies or to the ability of the KION Group to deliver its own products.
As far as its sales are concerned, the KION Group is now exposed to stiffer competition and downward pressure on prices as a result of increasing globalisation and greater market transparency. The KION Group ensures that it sustains a profitable level of pricing, and in 2010 it was able to withstand pricing pressures in a competitive environment, particularly in western Europe, while at the same time improving its market share. At the same time it is optimising its cost structures and business processes. The measures initiated in 2009 have made a major contribution to reducing costs. The KION Group's brand companies are also continually enhancing the services they provide. Important aspects of this work include expanding the sales force, improving spare-parts logistics processes and ensuring 24/7 availability.
The Baoli brand enables the KION Group to supply customers in low-price market segments who were previously difficult to reach. Baoli also provides the KION Group with a platform on which to meet demand for basic products, particularly in developing markets.
12.3.5 Production risks
Because the Company has a closely integrated manufacturing network, operational disruptions or lengthy periods of production downtime at individual sites present a potential risk to its ability to deliver goods on time. To mitigate these risks, the KION Group carries out preventive maintenance, implements fire protection measures, trains its staff and builds a pool of external suppliers.
The Company has taken out a commercially appropriate level of insurance cover against loss. So that it can manage quality-related risks arising from the products and services it provides, the KION Group attaches considerable importance to quality assurance right from the start of the value chain. It mitigates its quality-related risks significantly by applying rigorous quality standards to its development activities, conducting stringent controls throughout the entire process chain and maintaining close contact with its customers and suppliers.
12.3.6 Financial risks
The main types of financial risk managed by Group Treasury, including risks from funding instruments, are liquidity, exchange-rate, interest-rate and counterparty risk. Risk management procedures issued by Group Treasury stipulate how to deal with these risks. Counterparty risk consists only of risks related to financial institutions. The individual Group companies manage counterparty risks involving customers.
The restructuring of the existing acquisition finance during 2009 continued to provide the Group with the flexibility needed to meet the requirements of the financial covenants. Accordingly, the KION Group has secured acquisition finance in the form of committed credit lines (with maturities up to 2016). At the end of 2010, the capex facility (approximately €29 million) was reduced as agreed and the drawn portion of the RCF facility (€125.4 million) was also repaid. However, this credit line can be re-drawn if required. The Company generally refers to credit ratings to manage counterparty risk when depositing funds with a financial institution. Deposits are also restricted to the limits covered by the deposit protection fund run by the Federal Association of German Banks (Einlagensicherungsfonds des Bundesverbandes deutscher Banken).
The KION Group only uses derivatives to hedge underlying operational transactions. It does not use them for speculation. Records are kept of the type of financial instruments used, the limits governing their use and the group of banks acting as counterparties. Group Treasury rigorously complies with and monitors the strict separation of functions between the front, middle and back offices.
Each Group company's liquidity planning is broken down by currency and incorporated into the KION Group's financial planning and reporting process. Group Treasury checks the liquidity planning and uses it to determine the funding requirements for each company. Normally, at least 50 per cent of the exchange-rate risk related to the planned operating cash flows based on liquidity planning is hedged by currency forwards in accordance with the relevant guideline.
The KION Group uses interest-rate and currency-related derivatives – primarily interest-rate swaps and currency swaps, but also interest-rate and currency options – to hedge the interest-rate and currency risks arising in connection with the acquisition finance. The currency risk arising from the US dollar tranche (excluding PIK interest) is fully hedged by a combination of forwards and options within a USD/EUR exchange-rate range of 1.5139 to 1.1825 (the USD/EUR rate to be hedged within this range is around 1.375). These derivative contracts expire in September 2011. When the hedges expire, there may be a material outflow of funds, depending on the US dollar exchange rate. At the end of 2010, approximately 40 per cent of the Group's interest-rate exposure was hedged by interest-rate swaps; a further 44 per cent of its interest-rate exposure was hedged against one-month Euribor rising above 1.75 per cent per annum by means of interest-rate caps. The need to replace hedging instruments that expire is reviewed on an ongoing basis.
The funds raised for the acquisition of the KION Group also give rise to risks in terms of compliance with certain financial covenants specified in the loan agreement. However, these covenants were restructured in 2009 and the Company complied with them comfortably at the end of 2010. Despite the abatement of the economic crisis, there is still a risk of non-compliance with the covenants, although KION mitigates this risk with its comprehensive action plan instigated in 2009 and by including sufficient headroom in the revised covenants. The KION Group complied with all the financial covenants in the past financial year.
12.3.7 Risks from financial services
The funding terms and conditions faced by the lenders themselves (manifested, for example, in the payment of liquidity premiums on interbank lending) may result in a future shortage of lines of credit and/or increased financing costs for companies. However, the Group currently does not expect any further changes in its lines of credit or any excessive increases in margins.
The KION Group's leasing activities mean that it may be exposed to residual value risks from the marketing of trucks that are returned by the lessee at the end of a long-term lease and subsequently sold or re-leased. The brand companies therefore constantly monitor and forecast residual values in the markets for used trucks.
KION regularly assesses its overall risk position arising from financial services, recognising write-downs, valuation allowances or provisions to cover the risks it identifies. Any change in residual values is immediately taken into account when calculating new leases.
The risk-mitigating measures taken by the KION Group include managing used trucks on an international basis, steadily increasing the number of used trucks remarketed to end customers and extending lease terms more frequently, which stabilises the residual values of its industrial trucks. It has also increased the proportion of leases with an underlying remarketing agreement because these leases transfer any residual-value risk to the leasing company. Group-wide standards to ensure that residual values are calculated conservatively reduce risk and provide the basis on which to create the transparency required. KION has also refined its management of residual values and implemented an IT system for residual-value risk management.
The KION Group mitigates its liquidity risk and interest-rate risk by ensuring that most of its transactions and funding loans have matching maturities. Long-term leases are primarily based on fixed-interest agreements. The credit facilities provided by various banks ensure that the Group has sufficient liquidity. These risks do not exist in cases where the KION Group offers financial services indirectly via selected funding partners.
In order to exclude exchange-rate risk, KION generally funds its leasing business in the local currency used in each market.
Because of low default rates, counterparty risk has not been significant to date in the KION Group. The Group has not identified any material changes between 2009 and 2010. KION's losses from defaults are also mitigated by its receipt of the proceeds from the sale of repossessed trucks. The Company is not generally exposed to counterparty risk in cases where the KION Group offers financial services indirectly via selected financing partners. The KION Group's credit risk management system takes into account the current economic conditions. KION has tightened the requirements that need to be satisfied prior to the signing of new leases as part of a more restrictive authorisation process for avoiding potential future risks.
12.3.8 Human resources
For KION to secure its long-term success, it is vital that managerial staff and young professionals of sufficient quality and quantity to meet its future challenges are retained within the Company for a long period, particularly in key functions.
One of its critical challenges is to promote suitable staff who already work for the Company and retain them over the long term, whilst also identifying talented young professionals, developing them as managers and drawing up succession plans for key roles across the entire Group. KION must also identify and recruit suitable candidates in the external market as strategic additions to the portfolio of existing staff. In this way, the risk of possibly losing expertise and staff to competitors is countered in advance.
Neither the KION Group nor any of its brand companies is currently ranked as an 'employer of choice' by graduates, so increasing the Company's appeal as an employer is crucial, alongside targeted succession planning and strategic management of new talent.
In order to process and manage its business transactions, the Group needs a system landscape that is expandable and flexible enough to be adjusted in line with the requirements of the market. Complexity must be reduced so that differentiation is restricted only to those functions where it is absolutely required. This allows the KION Group to share existing expertise between the brands (on the basis of best practice) and strengthen its competitive position.
The rationalisation of the current brand-specific systems is being driven forward under the auspices of the 'KION ONE' project, which has three modules: 'KION ONE Factory', 'KION ONE Sales & Service' and 'KION ONE Infrastructure Consolidation'. Internal and external specialists with the necessary skills are implementing these action plans without impairing the day-to-day running of the business.
For this project, KION is using its internal IT service provider KION Information Management Services (KIM), which was established in 2007 as a private limited company in Germany (GmbH). KIM pools internal IT resources and makes them available throughout the Group. It is also gradually bringing contracts that had previously been outsourced back into the Group, thereby securing inhouse expertise. The Group was and remains able to monitor risk via the Group-wide portfolio management and project planning & control system. Independent external audits are conducted to provide additional quality assurance.
Various technical and organisational measures protect the Company's data against unauthorised access, misuse and loss. The technical protection measures include virus scanners, firewall systems and access controls. Access to the Group's infrastructure is also validated and recorded.
12.3.10 Legal risks
The legal risks for the KION Group arising from its business are typical of those faced by any company operating in this sector. The Company is a party in a number of pending lawsuits in various countries. It cannot assume with any degree of certainty that it will win any of the lawsuits or that the existing risk provision in the form of insurance or provisions will be sufficient in each individual case. However, the Company is not expecting any of these existing legal proceedings to have a material impact on its financial position or financial performance. These lawsuits relate, among other things, to liability risks, especially as a result of legal action brought by third parties because, for example, the Company's products were faulty or the Company failed to comply with contractual obligations. The KION Group has taken measures to prevent it from incurring financial losses as a result of these risks.
In addition to the high quality and safety standards applicable to all users of the Company's products, with which it complies when it develops and manufactures the products, it has alsotaken out the usual types of insurance to cover any third-party claims. Within the KION Group, these issues are also monitored by teams whose members come from a variety of functions. The aim of the teams is to identify and minimise risks, for example the risks arising from inadequate contractual arrangements. A further objective of this cooperation across functions is to ensure that the various departments comply with mandatory laws, regulations and contractual arrangements.
Although legal disputes with third parties have been insignificant both currently and in the past, the Company is in the process of establishing a centralised reporting system to record and assist pending lawsuits.
12.3.11 External risks
External risks arise as a result of constant changes in the Company's political, legal and social environment. Because it operates in countries in which the political or legal situation is uncertain, the KION Group is exposed to the consequent risk of government regulation, capital controls and expropriations. Although fairly unlikely, natural disasters and terrorist attacks constitute a further risk to the KION Group's financial position and financial performance.