12.3.1 Risks arising from the sovereign debt crisis
Even though the markets performed very well overall in 2011, risk management continued to examine the possible impact of the financial crisis and of the performance of the real economy on the KION Group's financial position and financial performance. In addition to ongoing screening and monitoring, the risk reports therefore included a separate assessment of the risks arising from the sovereign debt crisis. The economic problems in Greece, Italy, Spain, Portugal and Ireland, the EU rescue packages and the undercapitalisation of European banks that has become apparent were all signs that the financial crisis – and in particular the economic crisis in southern Europe – has not yet ended. Furthermore, it may flare up again at any time and spread to other regions.
Government action to support economies and the financial system resulted in a rise in government indebtedness worldwide. In Greece, Italy, 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 that this may have for the material-handling market and therefore also for the KION Group.
12.3.2 Market risks
Cyclical fluctuations in macroeconomic activity have always affected the market for industrial trucks. A downturn or stagnation in the industries and regions relevant to the KION Group represents a risk. Customers' decisions on whether to invest, particularly in new trucks, depend to a large degree on the economic situation. The KION Group mitigates this risk with its multi-brand strategy, comprehensive product portfolio and a diverse customer base consisting of companies of different sizes in different industries and regions. Market risk is also 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 further expand less cyclical business activities such as services in order to counteract economic downturns.
Global economic prospects have been very varied in recent times, and the markets therefore remain fragile. The International Monetary Fund (IMF) believes the global economic situation is still at risk due to the decline in the pace of growth in all regions of the world and owing to uncertainties regarding the funding position of public finances and financial institutions. In addition to a high level of uncertainty in the euro zone, there is also a continuing risk of a slowdown in growth in the United States. Current developments, above all in Europe, are making it increasingly difficult to gauge demand patterns reliably. The precise timing and even the extent of any change in the markets remains uncertain. 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 cost advantages in production due to the currency situation and also because Asian labour costs are lower. Providers from Asia can create additional competitive pressures in Europe, especially in this market environment. However, customers' high quality expectations and performance needs form a barrier to growth for many of these manufacturers. Their lack of an established distribution and service network in Europe makes it more difficult for them to gain a foothold in this market.
Alliances, partnerships and acquisitions are playing an increasing role in improving competitiveness in terms of resources, market access and product range. The KION Group continually evaluates its options for strengthening and consolidating its market position. An example of this in 2011 was the establishment of Voltas Material Handling in India.
12.3.4 Procurement and sales risks
The KION Group is exposed to risks in its procurement and sales activities. In 2011, 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 of parts and components and the rising cost of raw materials, energy, base products and intermediate products. As in 2010, the supply of components was a source of risk last year due to the surge in demand. Whereas there had still been isolated problems in the supply of electronic components at the start of the year, supplies of industrial tyres proved difficult as the year progressed. During the second half of 2011, the KION Group experienced sometimes considerable delays in the supply of plastic and electronic parts from individual suppliers. The shortage of parts had improved significantly by the end of the year due to the intensive efforts on the part of the Company's logistics staff and the new supplier development department, which works with suppliers on the ground to improve processes.
The earthquake and tsunami in Japan in spring 2011 did not lead to any major supply problems for the KION Group because it obtains just a small volume of goods directly from there. Only the supply of internal combustion engines was interrupted for a few weeks in May and June 2011. However, the Japanese suppliers had caught up with the delivery backlog by July.
Prices had been rising quickly from the second quarter of 2010 onwards as a result of the aforementioned increase in demand in the supplier markets. This trend continued into the first six months of 2011, but the second half of the year saw a much calmer price situation in the commodity markets.
As far as its sales are concerned, the KION Group is exposed to stiffer competition and therefore downward pressure on prices as a result of increasing globalisation and greater market transparency. Nevertheless, the KION Group was again able to maintain appropriate pricing for its customers in a competitive environment in 2011. At the same time, it is also optimising its cost structures and business processes. For example, the KION Group continued to systematically implement its KIARA performance enhancement programme, thereby significantly lowering its costs. The successful programme finished at the end of 2011. The brand companies in the KION Group are also steadily improving their services. Key factors for success here are the expansion of the distribution network, better logistics processes for spare parts and 24/7 availability of the service team.
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 line of trucks with which to meet demand for basic products, particularly in developing markets. In addition, the KION Group has strengthened its position in the Indian market by establishing Voltas Material Handling.
12.3.5 Production risks
The KION Group's closely integrated manufacturing network presents a potential risk to its ability to deliver goods on time in the event of operational disruptions or lengthy periods of production downtime at individual sites. 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. Quality assurance is a high priority throughout the value chain and reduces possible quality-related risks arising from the products and services provided. The KION Group mitigates its quality-related risks significantly by applying rigorous quality standards to its development activities, conducting stringent controls throughout the process chain and maintaining close contact with 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. Credit risk consists solely of counterparty risks attaching to financial institutions. Risk management procedures issued by Group Treasury stipulate how to deal with the aforementioned risks. In contrast, the individual Group companies directly 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 lending covenants. Accordingly, the KION Group has secured acquisition finance in the form of committed credit lines. The individual tranches have varying maturities, the longest bank liability extending until the end of 2016. Apart from that, €483 million of the original acquisition financing have already been repaid through the corporate bond of €500 million with maturity in 2018. The revolving credit facility has the shortest maturity expiring end of 2013 (cf. table credit terms, section 5.2 Financial position). The Company expects that it will be able to agree an extension with the banks before this date or that alternative refinancing schemes can be implemented. Further measures to ensure long-term financing are actively and continuously pursued by the company. As contractually agreed, the capex facility was reduced by approximately €54 million over the course of 2011.
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. On 7 November 2011, the KION Group drew down €133 million from the revolving credit facility. Although sufficient liquidity was available for operational business, capital expenditure and debt servicing, a stronger cash position is considered sensible in view of the current volatility of the financial markets. The KION Group also established a further diverse group of creditors that is independent of the banks by issuing a corporate bond of €500 million in April 2011.
The KION Group only uses derivatives to hedge underlying operational transactions; they are not used for speculative purposes. 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 of 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. Approximately 50 per cent of the currency risk arising from the US dollar tranche is hedged by currency forwards with an average €-US$ exchange rate of around 1.38. These derivative contracts expire in November 2012. When the currency hedges expire, there may be a material outflow of funds, depending on the US dollar exchange rate. At the end of 2011, around 60 per cent of the interest-rate risk was hedged by interest-rate swaps or was subject to a fixed rate of interest. The need to add new hedging instruments or replace ones that expire is reviewed on an ongoing basis.
The funds raised for acquisitions also give rise to risks for the KION Group in terms of compliance with certain financial covenants specified in the loan agreement. This risk continues to apply in view of the current uncertain economic and financial market environment. However, the Company is mitigating it by continuing steadfastly with steps to boost efficiency and by ensuring sufficient flexibility when defining new lending agreements. The KION Group complied with all the lending covenants in the reporting year.
12.3.7 Accounting risks arising from goodwill and the brands
In 2011, goodwill and the brands represented 35 per cent of total assets (2010: 36 per cent). Pursuant to IFRS, these assets are not amortised and their measurement depends, above all, on future expectations. If these future expectations are not fulfilled, there is a risk that impairment losses will have to be recognised on these assets.
12.3.8 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. Residual values in the markets for used trucks are therefore constantly monitored and forecast.
KION regularly assesses its overall risk position arising from financial services. The risks identified are immediately taken into account by the Company in the costing of new leases by recognising writedowns or valuation allowances and adjusting the residual values.
Risk-mitigating factors are the development and refinement of the KION Group's international used-truck marketing, the ongoing expansion of used-truck marketing to end customers, and the increase in demand accompanied by the optimisation of its profitability, which all stabilise the residual values of its industrial trucks. The majority of the residual values have underlying remarketing agreements that transfer any residual-value risk to the leasing company. This had a positive impact on the 2011 financial results. Group-wide standards to ensure that residual values are calculated conservatively, combined with an IT system for residual-value risk management, reduce risk and provide the basis on which to create the transparency required.
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. Moreover, the KION Group offers the majority of financial services via selected financing partners that bear the risks of the finance transaction.
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 2010 and 2011. KION also mitigates any losses from defaults by its receipt of the proceeds from the sale of repossessed trucks. It also primarily offers financial services indirectly via selected financing partners, and KION bears the counterparty risk in under 5 per cent of cases. The credit risk management system was updated during 2011 in preparation for the planned transfer of financial services activities to a separate segment. In particular, this involved revising the regulations concerning the process organisation as well as processes for risk management and control.
12.3.9 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 the critical challenges is to identify and develop young professionals with high potential who already work for the Company and to retain them over the long term, thereby enabling succession planning for key roles across the Group. The KION Group must also position itself in the external market as an employer of choice so that it can identify and recruit suitable talented candidates. This will enable it to make strategic additions to its portfolio of existing staff and, in this way, avert the risk of possibly losing expertise and thereby becoming less competitive.
In the year under review, the KION Group introduced plans to consolidate its European production facilities. These may have a negative impact on the Company's business and thus its financial position and financial performance if they lead to strikes or reactions of other kinds by the workforce, employee representatives or third parties. The planned consolidation will see the current production of warehouse technology at the site in Montataire (France) transferred to Luzzara (Italy), while the manufacture of STILL and OM counterbalance trucks will move from Bari (Italy) to the production site in Hamburg.
These plans are aimed at increasing capacity utilisation and improving flexibility in order to permanently safeguard the future of the European production sites. Even after these plans have been implemented, the KION Group will continue to have by far the highest number of European production facilities within the industry, with factories in all major markets in which demand is high. In 2011, the KION Group initiated the procedures necessary for such restructuring projects in conjunction with the employee representatives in France and Italy. The Company aims to implement the planned measures smoothly and in a socially compatible way as quickly as possible and in accordance with legal requirements.
In order to process and manage its business transactions, the Group needs a reliable IT 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, the KION Group 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. The Group 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.
12.3.11 Legal risks
The legal risks arising from the KION Group's 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 allegedly faulty or the Company allegedly 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.
Although legal disputes with third parties have been insignificant both currently and in the past, the Company has a centralised reporting system to record and assist pending lawsuits.
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 also taken out the usual types of insurance to cover any third-party claims. These issues are also tackled 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 compliance with mandatory laws, regulations and contractual arrangements at all times.
12.3.12 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.