The Group enters into derivative transactions, including, principally, interest rate swaps and forward currency contracts. The purpose is to manage the interest rate and currency risks arising from the Group’s operations and its sources of finance. It is the Group’s policy that no speculative trading in financial instruments shall be undertaken. The main risks arising from the Group’s financial instruments are cash flow interest rate risk, liquidity risk, foreign currency risk and credit risk. The Board reviews and agrees policies for managing each of these risks and they are summarised below.
Wesfarmers maintains a flexible financing structure so as to be able to take advantage of new investment opportunities that may arise. The Group’s objective is to maintain a balance between continuity of funding and flexibility through the use of bank loans, bank accepted bills, commercial paper, corporate bonds and the overnight money market across a range of maturities. Although the bank debt facilities have fixed maturity dates, from time to time they are reviewed and extended, thus deferring the repayment of principal. Wesfarmers aims to spread maturities evenly to avoid excessive refinancing in any period. Liquidity risk is managed centrally by Group Treasury using the operating cash flows of the underlying businesses and accessing the debt and equity capital markets.
The Group regularly forecasts future cash flows, in addition to the annual budgeting process, to gauge future funding requirements and ensure sufficient capacity to meet those requirements. Wesfarmers continues to maintain investment grade credit ratings from Moody’s and Standard and Poor’s. These ratings assist in accessing global debt capital markets. Wesfarmers aims to maintain flexibility in funding by keeping committed credit lines available with a variety of counterparties. The Group also maintains backup liquidity for its commercial paper programme.
The Group’s policy is to protect the Group from currency fluctuations together with maintaining the integrity of business decisions and protecting the competitive position of the Group’s activities. The Group’s primary currency exposures are in US Dollars and arise from sales or purchases by an operating unit in currencies other than the unit’s functional currency.
The Group requires all of its operating units to hedge foreign exchange exposures for firm commitments relating to sales or purchases or when highly probable forecast transactions have been identified. Before hedging, the operating units are also required to take into account their competitive position. Operating units are not permitted to speculate on future currency movements.
The Group aims to hedge approximately 70 per cent to 100 per cent (up to 24 months) of its foreign currency purchases for which firm commitments or highly probable forecast transactions exist. Such foreign currency purchases arise predominantly in the retail, Chemicals, Energy and Fertilisers and Industrial and Safety divisions.
The parent company transacts all hedges of currency sales and purchases on a back-to-back basis with forward currency contracts with banks and these are exactly offset by internal contracts with the relevant subsidiaries. From a Group perspective, the internal contracts are eliminated as part of the consolidation process, leaving only the external contracts in the name of Wesfarmers Limited.
The parent has EUR debt which is converted to Australian dollars using cross currency interest rate swaps.
As a result of operations in New Zealand, the Group’s balance sheet can be affected by movements in the AUD/NZD exchange rate. The Group mitigates the effect of its structural currency exposure by borrowing in NZD in New Zealand.
The Group’s exposure to the risk of changes in market interest rates relates primarily to the Group’s debt obligations with a floating interest rate. The Group’s policy is to limit the Group’s exposure to adverse fluctuations in interest rates which could erode Group profitability and adversely affect shareholder value.
To manage the interest rate exposure, the Group generally enters into interest rate swaps or issues fixed rate debt. An interest rate swap is an agreement to exchange, at specified intervals, the difference between fixed and variable rate interest amounts calculated by reference to an agreed-upon notional principal amount. These swaps are designated to hedge interest costs associated with underlying debt obligations.
Although Wesfarmers has issued Euro bonds, cross currency swaps are in place to mitigate any risk related to European interest rates. These cross currency swaps ensure that the effective interest rate to Wesfarmers is referenced to Australian interest rates.