Unilever 2004 Annual Report Download - page 54

Unilever Annual Report and Accounts 2004 51
Risk management
(continued)
Cash and borrowings
The Group generated an Ungeared Free Cash Flow of €4.9 billion
in 2004 (see page 22). Ungeared Free Cash Flow provides the
funds to service the financing of the business and enhance
shareholder return. A material and sustained shortfall in our cash
flow could undermine our credit rating and overall investor
confidence and could restrict the Group’s ability to raise funding.
The Group had gross borrowings totalling €12.0 billion at the end
of 2004. Market, interest rate and foreign exchange risks to
which the Group is exposed are described below.
Treasury risks
Unilever Treasury manages a variety of market risks, including the
effects of changes in foreign exchange rates, interest rates and
credit spreads. Other risks managed include liquidity, country and
counterparty risks.
Unilever has an interest rate management policy aimed at
optimising net interest cost and reducing volatility. This is
achieved by modifying the interest rate exposure of debt and cash
positions through the use of interest rate swaps. Further details
on the fixing levels of the projected net debt are given in note 16
on page 120.
Unilever’s foreign exchange policy requires that operating
companies manage trading and financial foreign exchange
exposures within prescribed limits. This is achieved primarily
through the use of forward foreign exchange contracts. Business
groups monitor compliance with this policy. At the end of 2004,
there was no material exposure from companies holding assets
and liabilities other than in their functional currency.
Unilever conducts business in many foreign currencies but
publishes its financial statements and measures its performance in
euros. As a result, it is subject to exchange risk due to the effects
that exchange rate movements have on the translation of the
results and underlying net assets of its foreign subsidiaries.
Unilever aims to reduce its foreign exchange exposure in
operating companies by borrowing in the local currency, except
where inhibited by local regulations, lack of local liquidity or local
market conditions. An exception may also be made where the
economic value of the net assets locally is considered substantially
to exceed their book value. From time to time, currency
revaluations will trigger exchange translation movements in our
balance sheet as a result of these exceptions. In 2004, the
significant weakening of the US dollar against the euro has had
a negative impact on our reported operating results, but has had
a positive impact on our debt and equity, when reported in euros.
Counterparty exposures are minimised by restricting dealing
counterparties to a limited number of financial institutions that
have secure credit ratings, by working within agreed counterparty
limits, by obtaining collateral for outstanding positions and by
setting limits on the maturity of exposures. Counterparty credit
ratings are closely monitored and concentration of credit risk
with any single counterparty is avoided. There was no significant
concentration of credit risks with any single counterparty as at
the year end.
As a result of the share option plans for employees, we are
exposed to movements in our own share price. In recent years
we have hedged this risk through buying Unilever shares in the
market when the share option is granted and holding these
shares until the share option is exercised or lapses. In 2001, we
also entered into a contract with a bank for the forward purchase
of Unilever shares, further details of which are given in note 16
on page 121. At the year end, 97% of all outstanding employee
share options were hedged; based on Unilever’s experience with
the exercise level of options we consider this position as being
fully hedged.
The analysis below presents the sensitivity of the fair value
of the financial and derivative instruments the Group held at
31 December 2004, to the hypothetical changes described below.
Interest rate sensitivity
The fair values of debt, investments and related hedging
instruments are affected by movements in interest rates. The
analysis shows the sensitivity of the fair value of interest rate
sensitive instruments to a hypothetical 10% change in the interest
rates (ie. 0.1% for each 1% of the interest rate) across all
maturities as at 31 December 2004.
Foreign exchange rate sensitivity
The values of debt, investments and hedging instruments,
denominated in currencies other than the functional currency
of the entities holding them, are subject to exchange rate
movements. The analysis shows the sensitivity of these values
to a hypothetical 10% change in foreign exchange rates as at
31 December 2004.
Fair value changes:
Sensitivity to a
hypothetical 10% change in
rates as at 31 December
€ million € million
2004 2003
Interest rate risk 160 175
Foreign exchange rate risk 75
The above-mentioned interest rate sensitivity relates to financial
and derivative instruments with fair values amounting to
€12 397 million at the end of 2004 (2003: €16 411 million).
For further information on fair values see note 16 on page 121.
The above-mentioned foreign exchange rate risk relates to a value
of financial instruments and derivatives of €68 million at the end
of 2004 (2003: €46 million).
Further details on derivatives, foreign exchange exposures and
other related information on financial instruments are given in
note 16 on pages 120 and 121.
In addition, as a multinational group, Unilever’s businesses are
exposed to varying degrees of risk and uncertainty related to
other factors including competitive pricing, commodity, raw and
packaging material pricing, consumption levels, physical risks,
legislative, fiscal, tax and regulatory developments, terrorism and
economic, political and social conditions in the environments
where we operate. All of these risks could materially affect the
Group’s business, our turnover, operating profit, net profit, net
assets and liquidity. There may also be risks which are unknown
to Unilever or which are currently believed to be immaterial.