Aspen Annual Report 2009 - Notes to the Group annual financial statements

Annual Report for the year ended 30 June 2009

Notes to the Group annual financial statements

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36.	FINANCIAL RISK MANAGEMENT
	36.1	Introduction
		The Group is exposed to liquidity, credit, foreign currency and interest rate risk, arising from its financial instruments. The Audit & Risk Committee has the overall responsibility for the establishment and oversight of the Group’s risk management framework. The Group’s overall risk management programme focuses on the unpredictability of financial markets and seeks to minimise potential adverse effects on the financial performance of the Group.
		Financial risk management is carried out by the Group Treasury Management Department in close co-operation with operational units, using guidance provided by the Audit & Risk Committee. A formal treasury policy setting out the role and responsibility of the Group Treasury Management Department and the management of risk was adopted by the Audit & Risk Committee during the prior year. A significant part of administration of foreign exchange risk management is outsourced. Group Treasury Management Department identifies, evaluates and hedges financial risks. The Audit & Risk Committee provides principles for overall risk management, as well as policies covering specific areas, such as foreign currency risk, interest rate risk, credit risk, use of derivative financial instruments and investing excess liquidity.
	36.2	Risk profile
		Risk management and measurement relating to each of these risks is discussed under the headings below. The Group’s objective in using derivative instruments is for hedging purposes to reduce the uncertainty over future cash flows arising from foreign currency and interest rate exposures.
	36.3	Foreign currency risk
		The Group’s transactions are concluded in the respective functional currencies of the individual operations. However, the Group’s operations utilise various foreign currencies (i.e. currencies other than the operations’ functional currencies) in respect of sales, purchases and borrowings, and consequently the Group is exposed to exchange rate fluctuations that have an impact on cash flows. The translation of foreign operations to the presentation currency of the Group (translation risk), as well as economic risk, is not taken into account when considering foreign currency risk. Economic risk refers to the effect of exchange rate movements on the international competitiveness of the company. Economic risk is not handled by the Group Treasury Management Department, as it is a strategic matter managed directly by the Aspen Board of Directors.
		Foreign currency risks are managed through the Group’s financing policies and selective use of forward exchange contracts.
		Forward exchange contracts
		Forward exchange contracts are utilised primarily to reduce foreign currency exposure arising from imports and exports.
		All forward exchange contracts are supported by underlying commitments or transactions which have already occurred.
		At 30 June 2009 and 30 June 2008 the Group had forward exchange contracts denominated in various currencies in respect of firm commitments.
		As hedge accounting was not applied fair value adjustments were recognised directly in the income statement.
		The table below reflects the fair values of outstanding forward exchange contracts at year-end

	Foreign amount Million	Forward cover value R’million	Marked to market value R’million	Cumulative fair value in income statement: (loss)/gain R’million
June 2009
Imports*
Swiss Franc	0,6	5,5	4,7	(0,8)
Euro	7,9	94,9	87,8	(7,1)
Pound Sterling	1,8	26,4	23,3	(3,1)
Japanese Yen	20,4	1,8	1,7	(0,1)
US Dollar	46,9	417,6	369,6	(48,0)
Swedish Krone	0,3	0,5	0,4	(0,1)
		546,7	487,5	(59,2)
Exports*
Euro	0,1	0,6	0,5	0,1
US Dollar	1,5	12,4	11,7	0,7
		13,0	12,2	0,8
June 2008
Imports*
Swiss Franc	0,8	5,9	6,0	0,1
Euro	11,5	141,6	143,4	1,8
Pound Sterling	1,6	24,6	24,4	(0,2)
Japanese Yen	26,3	2,1	2,0	(0,1)
US Dollar	24,6	200,8	198,5	(2,3)
Danish Krone	0,3	0,4	0,4	—
		375,4	374,7	(0,7)

		*Includes forward exchange contracts that represent imports and exports being managed on a net basis.

	Foreign amount Million	Forward cover value R’million	Marked to market value R’million	Recoginsed fair value in income statement: (loss)/gain R’million
June 2008
Exports*
Euro	0,1	1,1	1,1	—
US Dollar	1,1	8,9	8,9	—
		10,0	10,0	—

		* Includes forward exchange contracts that represent imports and exports being managed on a net basis.
		Definitions
		Marked to market value: Foreign notional amount translated at the market forward rate at 30 June.
		Forward cover value: Foreign notional amount translated at the contracted rate.
		The maturity profiles of the foreign exchange contracts at year-end (including those contracts for which the underlying transactions were recorded but payment not reflected by year-end) are summarised as follows

	2009	2008
	Marked to market value R’million	Marked to market value R’million
July	229,4	155,0
August	119,5	43,1
September	54,4	50,0
October	22,9	27,5
November	16,9	40,4
December	16,0	25,8
January	8,9	11,8
February	4,8	5,0
March	0,9	4,4
April	1,6	—
May	0,2	—
June	—	1,7
	475,5	364,7


		Hedge accounting in 2008
		The Group entered into forward exchange contracts to hedge the foreign currency risk arising from changes in the USD/South African Rand spot exchange rate associated with the settlement of a portion of the purchase price of the acquisition of certain joint ventures.
		The forward exchange contracts were designated as cash flow hedges. None of these forward exchange contracts was outstanding at 30 June 2008.
		The hedged cash flows took place prior to 30 June 2008. The fair value movement of the forward exchange contracts of R146,5 million was deferred in equity in accordance with the application of cash flow hedge accounting. The portion of the fair value movement relating to the purchase of shares in the respective entities from external parties of R59,0 million was transferred from equity and recognised as part of the initial cost of the investment.
		The portion of the fair value movement relating to the subscription of new shares will remain in equity until the investment is disposed of or the net investment is impaired, at which time it will affect profit or loss.
		Exposure to currency risk
		Sensitivity analysis
		The Group has used a sensitivity analysis technique that measures the estimated change to the income statement of an instantaneous 10% strengthening or weakening in the South African Rand against all other currencies, from the rate applicable at 30 June, for each class of financial instrument with all other variables remaining constant. This analysis is for illustrative purposes only, as, in practice, market rates rarely change in isolation.
		The Group is mainly exposed to fluctuations in foreign exchange rates in respect of South African Rand, US Dollar, Euro, Brazilian Real, Mexican Peso, Kenyan Shilling, Pound Sterling, Australian Dollar and Tanzanian Shilling. The analysis considers the impact of changes in foreign exchange rates on profit or loss, excluding foreign exchange translation differences resulting from the translation of Group entities that have a functional currency different from the presentation currency, into the Group’s presentation currency (and recognised in the foreign currency translation reserve), which amounted to a direct debit to equity of R399,9 million at 30 June 2009 (2008: credit of R117,3 million).
		A change in the foreign exchange rates to which the Group is exposed at the reporting date would have increased/(decreased) profit before tax by the amounts shown below.
		The analysis has been performed on the basis of the change occurring at the start of the reporting period and assumes that all other variables, in particular interest rates, remain constant and was performed on the same basis for 2008.

		(Decrease)/increase in profit before tax
	Change in exchange rate %	Weakening in functional currency R’million	Strengthening in functional currency R’million
30 June 2009
Denominated : Functional currency
South African Rand : US Dollar	10	(35,2)	35,2
Brazilian Real : US Dollar	10	(16,3)	16,3
US Dollar : Pound Sterling	10	14,0	(14,0)
South African Rand : Euro	10	(12,0)	12,0
US Dollar : Australian Dollar	10	6,5	(6,5)
Tanzanian Shilling : US Dollar	10	(3,7)	3,7
South African Rand : Pound Sterling	10	(3,0)	3,0
Tanzanian Shilling : Kenyan Shilling	10	(2,4)	2,4
Mexican Peso : US Dollar	10	(2,0)	2,0
Other exposures	10	(10,4)	10,4
		(64,5)	64,5
30 June 2008
South African Rand : Euro	10	(16,0)	16,0
South African Rand : US Dollar	10	(17,0)	17,0
Brazilian Real : US Dollar	10	(8,8)	8,8
Australian Dollar : US Dollar	10	(1,1)	1,1
Mexican Peso : US Dollar	10	(1,6)	1,6
Indian Rupee : US Dollar	10	(4,6)	4,6
Other exposures	10	(4,1)	4,1
		(53,2)	53,2


The following significant exchange rates against the South African Rand applied at year-end
	Spot rate		Average rate
	2009	2008	2009	2008
Australian Dollar	6,25	7,55	6,52	6,63
Brazilian Real	3,99	4,93	4,30	4,68
Euro	10,92	12,35	12,09	10,90
Kenyan Shilling (Inverse)	9,86	8,42	8,65	8,43
Pound Sterling	12,76	15,61	14,11	14,70
Indian Rupee	0,16	0,18	0,18	0,18
Mexican Peso	0,59	0,76	0,69	0,75
Tanzanian Shilling (Inverse)	168,42	152,79	142,87	157,00
US Dollar	7,78	7,84	8,90	7,32


	36.4	Interest rate risk
		Exposure to interest rate risk on financial assets and liabilities is monitored on a continuous and proactive basis. The debt of the Group is structured on a combination of floating and fixed interest rates. The benefits of fixing or capping interest rates on the Group’s various financing activities are considered on a case-by-case and project-by-project basis, taking the specific and overall risk profile into consideration.
		At the reporting date, the interest rate profile of the Group’s interest-bearing financial instruments was as follows

	Carrying value
	2009 R’million	2008 R’million
Variable rate instruments
Financial assets	(1 402,5)	(1 499,0)
Financial liabilities	2 928,5	3 331,3
Net variable rate exposure	1 526,0	1 832,3
Fixed rate instruments
Financial assets	(325,8)	—
Financial liabilities	3 567,8	262,0
Net fixed rate exposure	3 242,0	262,0

		The following interest rate derivative contracts were in place at 30 June 2009

		Interest rate swaps
		The Group has entered into interest rate swaps to hedge the cash flow interest rate risk of certain non-current borrowing amounts. Details of the swaps are:
		Pay fixed rate receive floating rate swaps:

	Contract amount R’million	Fixed interest rate%	Expiry date	Fair value losses R’million
US Dollar – Loan A	1 984,9	6,11 3-month US Dollar LIBOR	10 October 2013	75,3
US Dollar – Loan B	1 011,9	6,11 3-month US Dollar LIBOR	10 April 2012	39,2
South African Rand	525,0	8,33 3-month JIBAR	23 December 2010	5,5
	3 521,8			120,0

		The above interest rate swaps were designated in cash flow hedge relationships. The nature of the risk being hedged (interest rate risk) is the variability of the quarterly interest payment on the hedged loans, attributable to movements in the 3-month US Dollar LIBOR rate and the 3-month JIBAR rate respectively. Gains or losses recognised in the hedging reserve in equity as of 30 June 2009 will be continuously released to the income statement (finance costs) as the interest on the hedged loans is recognised in the income statement.
		The Group had no interest rate swaps in the 2008 year:
		The maturity profile of gross contract amounts of interest rate swaps at 30 June were all between 1 and 5 years.
		Interest rate sensitivity
		The Group is exposed mainly to fluctuations in the following market interest rates: US Dollar LIBOR, JIBAR and T-Bill rates. Changes in market interest rates affect the interest income and expense of floating rate financial instruments. Changes in market interest rates affect profit or loss only in relation to financial instruments with fixed interest rates if these financial instruments are recognised at their fair value.
		An increase of a 100 basis points in interest rates at 30 June would have decreased profit before tax by R15,3 million in 2009 and R18,3 million in 2008. A decrease of a 100 basis points will have an equal and opposite effect on profit before tax. Changes in market interest rates also affect equity (hedging reserve) through the impact of such changes on the fair values of the interest rate swaps designated in effective hedge relationships, and the extent of the hedge effectiveness. An increase of 1% in the yield curve at 30 June 2009 would result in a decrease of R60,6 million in the fair value of the derivative liability in the statement of comprehensive income. A decrease of 1% in the yield curve would result in an increase in the derivative liability of R60,7 million. The analysis assumes that all other variables, in particular foreign currency rates, remain constant.

	36.5	Liquidity risk
		Liquidity risk is the risk that an entity in the Group will not be able to meet its obligations as they become due. The Group manages liquidity risk by effectively managing its working capital, capital expenditure and cash flows. The Group finances its operations through a mixture of retained earnings, short-term and long-term bank funding. Adequate banking facilities and reserve borrowing capacities are maintained. The Group is in compliance with all of the financial covenants in its loan documents. The Group has sufficient undrawn borrowing facilities, which could be utilised to settle obligations. Refer to note 17.
		The Group manages liquidity risk through forecasting and monitoring cash flow requirements on a daily basis.
		The following are the undiscounted contractual maturities of financial assets and liabilities

	Undiscounted cash flows
	On demand R’million	< 1 year R’million	1 – 5 years R’million	Total R’million
30 June 2009
Financial assets
Other non-current financial receivables	—	1,5	4,6	6,1
Trade and other receivables (financial instruments only)	—	1 776,1	—	1 776,1
Cash and cash equivalents	1 461,9	603,4	—	2 065,3
Total financial assets	1 461,9	2 381,0	4,6	3 847,5
Financial liabilities
Preference shares – liability component	—	29,8	436,5	466,3
Secured loans	—	303,3	3 223,0	3 526,3
Unsecured loans	1 606,1	—	729,1	2 335,2
Finance lease and instalment credit liabilities	—	18,5	13,0	31,5
Bank overdrafts	742,4	—	—	742,4
Deferred payables – deferred earn-out consideration	—	0,7	—	0,7
Trade and other payables (financial instruments only)	—	1 084,1	—	1 084,1
Forward exchange contracts (gross settled)*	—	58,4	—	58,4
Gross cash inflows	—	(475,3)	—	(475,3)
Gross cash outflows	—	533,7	—	533,7
Interest rate swaps (net settled)	—	—	120,0	120,0
Total financial liabilities	2 348,5	1 494,8	4 521,6	8 364,9
Net financial liabilities/(assets)	886,6	(886,2)	4 517,0	4 517,4
30 June 2008
Financial assets
Other non-current financial receivables	—	—	7,0	7,0
Trade and other receivables (financial instruments only)	—	1 152,4	—	1 152,4
Forward exchange contracts (gross settled)*	—	0,7	—	0,7
Gross cash inflows	—	(364,7)	—	(364,7)
Gross cash outflows	—	365,4	—	365,4
Cash and cash equivalents	930,0	592,2	—	1 522,2
Total financial assets	930,0	1 745,3	7,0	2 682,3
Financial liabilities
Preference shares – liability component	—	—	545,0	545,0
Secured loans	—	112,3	80,9	193,2
Unsecured loans	2 400,3	—	—	2 400,3
Finance lease and instalment credit liabilities	—	13,7	17,5	31,2
Bank overdrafts	577,3	—	—	577,3
Deferred payables – deferred earn-out consideration	—	11,0	0,8	11,8
Trade and other payables (financial instruments only)	—	873,9	—	873,9
Financial liability at amortised cost	—	255,3	2 952,5	3 207,8
Derivative financial instruments	—	1,2	—	1,2
Total financial liabilities	2 977,6	1 267,4	3 596,7	7 841,7
Net financial liabilities/(assets)	2 047,6	(477,9)	3 589,7	5 159,4

		*For the purpose of the above table foreign currency cash (in)/outflows were translated into South African Rand using the relevant forward rates.

	36.6	Credit risk
		Credit risk, or the risk of financial loss due to counterparties to financial instruments not meeting their contractual obligations, is managed by the application of credit approvals, limits and monitoring procedures. Counterparty credit limits are reviewed and approved by the respective subsidiary boards.
		Credit risk primarily arises from trade and other receivables, other non-current financial receivables, derivative financial instruments and cash and cash equivalents. The Group’s maximum exposure to credit risk is represented by the carrying amount of these financial assets, with the exception of financial guarantees granted by the Group for which the maximum exposure to credit risk is the maximum amount the Group would have to pay if the guarantees were called on.
		Trade and other receivables
		The Group has policies in place to ensure that sales of products are made to customers with a solid credit history. Ongoing credit evaluations on the financial condition of customers are performed and where appropriate credit guarantee insurance cover is purchased. Trade receivables consist primarily of a large, widespread customer base. The granting of credit is controlled by application and account limits. Trade and other receivables are carefully monitored for impairment. No single customer represents more than 14% of total trade receivables for the years ended 30 June 2009 and 30 June 2008. In the year ended 30 June 2009, sales of the GSK brands made up 16% of the Group’s total revenue. During the transition period the business is being managed by GSK and comprises sales to approximately 100 territories. This risk profile will change once the distribution arrangements for the global brands are transitioned to the Aspen network in the 2010 financial year.
		The Group has made allowance for specific trade debtors which have clearly indicated financial difficulty and the likelihood of repayment has become impaired. More than 95% of the trade receivables balance relates to customers that have a long-standing insurable history with the Group and there has been no default on payments.
		Impairment losses are recorded in the allowance account for losses until the Group is satisfied that no recovery of the amount owing is possible, at which point the amount is considered irrecoverable and is written off against the financial asset.
		The risk profiles listed below reflect the different markets that the Group services. These markets all have different payment patterns, risk profiles and insurance risks.

	2009 R’million	2008 R’million
Risk profile of gross trade receivables
Pharmaceutical private debtors	992,6	666,3
Consumer private debtors	152,6	148,1
Tender debtors	252,6	110,2
Export debtors	170,7	71,1
Sundry debtors	2,7	0,9
	1 511,2	996,6

		Cash and cash equivalents and derivative financial instruments
		Treasury counterparties consist of a diversified group of prime financial institutions. Cash balances are placed and derivatives are entered into with different financial institutions to minimise risk. The Group does not expect any treasury counterparties to fail to meet their obligations, given their high credit ratings. All cash balances are held with highly reputable banks having been rated by Fitch at AA+ or higher on a long-term basis.
		Other financial assets
		The recoverability of other non-current financial receivables are monitored as appropriate.

36.7

Capital risk disclosures

The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide sustainable returns for shareholders, benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital.

The capital structure of the Group consists of borrowings, more specifically non-current and current borrowings and equity attributable to holders of the parent, comprising share capital, share premium, non-distributable reserves, preference shares and retained income.

The Board’s policy is to maintain a strong capital base so as to maintain investor, creditor and market confidence, and to sustain future development of business. The Board reviews the capital structure on a quarterly basis. As part of the review, the Board considers the cost of capital and the risks associated with each class of capital. Based on recommendations of the Board, the Group will balance overall capital structure through payments of dividends (including capital distributions and capitalisation shares), new shares issued as well as the issue of new borrowings or the redemption of existing borrowings.

There were no changes to the Group’s approach to capital management during the year. The gearing ratio has improved since the prior year. This was mainly due to an increase in profitability in the current year following a significant expansion of business activities in the prior year.

In terms of the Group’s funding arrangements with its bankers, the Group is subject to the following financial covenants

(a) Group covenants

	–	The capacity to increase interest-bearing debt is restricted to 3 times Group earnings before interest, tax, depreciation and amortisation.
	–	Group net finance charges need to be covered by Group earnings before interest, tax, depreciation and amortisation by at least 3 times.
	–	Total shareholders’ equity may not be less than R3 billion.

(b) Aspen Global covenants

	–	The capacity to increase interest-bearing debt is restricted to 4,5 times earnings before interest, tax, depreciation and amortisation.
	–	Aspen Global net finance charges need to be covered by earnings before interest, tax, depreciation and amortisation by at least 3 times.
	–	On an annual basis the cumulative debt service cover ratio may not be less than 1,4 times. Cumulative debt service cover ratio is defined as free cash flows plus opening cash divided by the aggregate payment of capital plus interest.

(c) Latin American covenants

–

The net indebtedness of the Latin American businesses may not exceed earnings before interest, tax, depreciation and amortisation by 3 times, subject to such indebtedness being limited to USD100 million.

The Group is entitled to make distributions to their shareholders provided that the lenders of the USD term loan are satisfied, acting reasonably, that specified covenants will be met for a period of 12 months after such a distribution.

At 30 June 2009 all the above covenants were complied with.

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