Pick n Pay Annual Report 2010

Pick n Pay Stores Limited and its subsidiaries

Notes to the annual financial statements

for the year ended 28 February 2010

29.

Financial instruments
Overview
The Company and Pick n Pay Holdings Limited have no significant exposure to risk in respect of financial instruments, as their only financial asset is a loan to a subsidiary company. There is minimal credit risk relating to this as it is payable by the main operating company within the Group. Liquidity risk is also minimalised as the only financial liability is an insignificant trade and other payable which will be funded by unlimited access to Group funds. Market risk is effectively negated as the financial asset and financial liability have no exposure to changes in exchange rates and very limited exposure to changes in interest rates.

The Group has exposure to the following risks arising from its financial instruments:

Credit risk
Liquidity risk
Market risk

This note presents information about the Group’s exposure to each of the above risks, the Group’s objectives, policies and processes for measuring and managing risk, and the Group’s management of capital. Further quantitative disclosures are included throughout these consolidated ﬁnancial statements.

The Group’s objective is to effectively manage each of the above risks associated with its ﬁnancial instruments, in order to limit the Group’s exposure as far as possible to any ﬁnancial loss associated with these risks.

The Board is ultimately responsible and accountable for ensuring that adequate procedures and processes are in place to identify, assess, manage and monitor key business risks. The Board has established the Audit, Risk and Compliance committee, which is responsible for developing and monitoring the Group’s risk management policies. The committee reports regularly to the Board on its activities.

The Group’s risk management policies are established to identify and analyse the risks faced by the Group, to set appropriate risk limits and controls, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reﬂect changes in market conditions and the Group’s activities. The Group, through its training and management standards and procedures, aims to develop a disciplined and constructive control environment in which all employees understand their roles and obligations.

The Audit, Risk and Compliance committee oversees how management monitors compliance with the Group’s risk management policies and procedures and reviews the adequacy of the risk management framework in relation to the risks faced by the Group. The committee is assisted in this regard by Group Risk and Assurance Services (internal audit). Internal audit undertakes both regular and ad hoc reviews of risk management controls and procedures, the results of which are reported to the Audit, Risk and Compliance committee.

29.1

Credit risk
Credit risk is the risk of financial loss to the Group if a customer or counterparty to a financial instrument fails to meet its contractual obligations.

Financial assets, which potentially subject the Group to concentrations of credit risk, consist principally of investments, loans, participation in export partnerships, trade receivables and cash balances.

The carrying amount of financial assets represents the maximum credit exposure. The maximum exposure to credit risk at 28 February was:

	GROUP

	2010 Rm	2009 Rm
Investments (note 10)	0.2	0.2
Loans (note 12)	124.7	128.6
Participation in export partnerships (note 13)	50.6	57.9
Trade receivables (note 16)	1 828.6	1 559.4
Cash balances (note 17)	1 428.1	1 221.9
	3 432.2	2 968.0

Investments
The Group has no material investments and therefore there is currently no significant credit risk from these instruments.

Loans
Loans to employees are granted and managed in accordance with strict regulations laid down by the Human Resources division, governing the size of the loan which may be granted and the associated interest rate and repayment terms. Before a loan is granted, it is first established that the employee is able to afford the monthly repayment terms. Where appropriate, the Group obtains suitable forms of security when granting loans. Repayments are deducted directly from the employee’s monthly salary. There are no loan balances which exceed repayment terms. The Group considers all loan balances to be recoverable and therefore no impairment provision is required.

Participation in export partnerships
A company listed on the JSE Limited has warranted certain important cash flow aspects of the Group’s participation in export partnerships. The Group’s directors have considered the credit risk relating to these aspects warranted and have satisfied themselves as to the creditworthiness of the warrantor company.

Trade receivables
Trade receivables are amounts owing by franchisees and are presented net of impairment losses.

The Group obtains various forms of security from its franchise debtors, including bank guarantees, notarial bonds over inventory and moveable assets and suretyships from shareholders. The total credit risk with respect to receivables from franchise debtors is further limited as a result of the dispersion amongst the individual franchisees and across different geographic areas. Accordingly, the Group has no significant concentration of credit risk.

	GROUP

	2010 Rm	2009 Rm
The ageing of trade receivables at 28 February was:
Trade receivables not impaired
Within payment terms	1 584.6	1 441.9
Exceeding payment terms by less than 14 days	64.9	25.1
Exceeding payment terms by more than 14 days	20.5	7.5
	1 670.0	1 474.5
Trade receivables with impairments
Within payment terms	150.5	72.2
Exceeding payment terms by less than 14 days	83.1	10.8
Exceeding payment terms by more than 14 days	74.5	52.6
	308.1	135.6
Total trade receivables	1 978.1	1 610.1
Allowance for impairment losses	(149.5)	(50.7)
Total trade receivables net of allowance for impairment losses	1 828.6	1 559.4
The movement in the allowance for impairment of trade receivables during the year was as follows:
At 1 March	50.7	7.6
Irrecoverable debts written off	—	—
Additional impairment losses recognised	106.8	45.1
Prior allowances for impairment reversed	(8.0)	(2.0)
At 28 February	149.5	50.7

The Group makes allowance for specific trade debtors which have clearly indicated financial difficulty and the likelihood of repayment has become impaired. More than 80% of the balance relates to customers that have an excellent credit history with the Group.

Impairment losses are recorded in the allowance account 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 directly. There is currently no allowance for impairment against any other class of financial asset.

Cash balances
The Group’s cash is placed with major South African and international financial institutions of high credit standing and within specific guidelines laid down by the Group’s Treasury committee and approved by the Board. The Treasury committee is appointed by the Board and comprises executive directors and senior executives. Consequently, the Group does not consider there to be any significant exposure to credit risk.

29.2

Liquidity risk
Liquidity risk is the risk that the Group will not be able to meet its financial obligations as they fall due. The Group’s approach to managing liquidity is to ensure, as far as possible, that it will always have sufficient liquidity to meet its liabilities when due, without incurring unacceptable losses or risking damage to the Group’s reputation.

One of the core founding principles of the Group is to maintain strong cash balances, not only to meet current financial obligations, but in order to be able to buy inventory forward on a rising market.

Adequate liquidity is further managed through the use of cash flow forecasts and by the maintenance of adequate borrowing facilities. In terms of its articles of association, the Company’s borrowing powers are unlimited. However, the Treasury committee maintains strict control over the acceptance and draw-down of any loan facility.
At 28 February the Group’s loan facilities comprised:

	GROUP

	2010 Rm	2009 Rm
Total borrowing facilities granted by financial institutions	4 988.2	4 471.2
Total actual borrowings and utilisation of facilities	(1 386.1)	(1 013.0)
Unutilised borrowing facilities	3 602.1	3 458.2

On average, trade receivables and inventory are realised within 30 days and trade payables are settled within 60 days. To the extent that the Group requires short-term funds, it utilises available banking facilities.

The following are the contractual maturities of financial liabilities, including estimated interest payments:


GROUP – 2010	Carrying amount Rm	Contractual cash flows Rm	Within 1 year Rm	2 to 5 years Rm	Over 5 years Rm
Non-derivative financial liabilities
Secured bank loans (note 22)	326.4	411.9	36.1	324.9	50.9
Unsecured bank loans (note 22)	250.0	310.4	24.2	286.2	—
Finance lease liabilities (note 22)	133.1	160.0	45.2	114.8	—
Trade and other payables (note 25)	7 392.5	7 392.5	7 392.5	—	—
Bank overdraft (note 17)	372.8	372.8	372.8	—	—
Derivative financial liabilities
Forward exchange contracts (note 25)	1.1	1.1	1.1	—	—

Total financial liabilities	8 475.9	8 648.7	7 871.9	725.9	50.9
To be settled through the management of:
Inventory (note 15)	3 298.6	3 298.6	3 298.6
Trade receivables (note 16)	1 978.1	1 978.1	1 978.1
Cash balances (note 17)	1 428.1	1 428.1	1 428.1
Net liabilities*	1 771.1	1 943.9	1 167.1	725.9	50.9

GROUP – 2009
Non-derivative financial liabilities
Secured bank loans (note 22)	331.3	461.6	35.8	360.9	64.9
Unsecured bank loans (note 22)	250.0	334.5	24.0	310.5	—
Finance lease liabilities (note 22)	135.1	167.2	54.0	113.2	—
Trade and other payables (note 25)	7 313.2	7 313.2	7 313.2	—	—
Bank overdraft (note 17)	149.1	149.1	149.1	—	—
Derivative financial liabilities
Forward exchange contracts (note 25)	2.6	2.6	2.6	—	—

Total financial liabilities	8 181.3	8 428.2	7 578.7	784.6	64.9
To be settled through the management of:
Inventory (note 15)	3 308.2	3 308.2	3 308.2
Trade receivables (note 16)	1 610.1	1 610.1	1 610.1
Cash balances (note 17)	1 221.9	1 221.9	1 221.9
Net liabilities	2 041.1	2 288.0	1 438.5	784.6	64.9

As disclosed above, the Group has adequate borrowing facilities to meet these current financial obligations.

29.3

Market risk

Market risk is the risk that changes in market prices, such as foreign exchange rates, interest rates and equity prices will affect the Group’s income or the value of its holdings of ﬁnancial instruments. The objective of market risk management is to manage and control market risk exposures within acceptable parameters, while optimising the return on the risk.

Currency risk

The Group is exposed to foreign currency risk through the importation of merchandise. This risk is covered by entering into forward exchange contracts (FECs). These contracts are matched with anticipated future cash outflows in foreign currencies. FECs are taken out when an order is placed with a foreign supplier. The Group does not use FECs for speculative purposes and does not apply cash flow hedge accounting.

The fair value of forward exchange derivative contracts was R1.1 million. This has been recognised as an expense in the statement of comprehensive income and is reflected as a part of trade and other payables.

As all foreign purchases are covered by FECs, ﬂuctuations in foreign exchange rates will have no signiﬁcant impact on the Group.

In relation to the participation in export partnerships, a fixed rate of exchange was set for the purposes of converting the foreign currency receipts in respect of the partnership’s sales into SA rands. Any exchange differences are for the account of the managing partner of the partnerships and will have no impact on the earnings of the Group.

The exchange rate sensitivity below, reflects the sensitivity of the assets, liabilities and profit of foreign operations to changes in exchange rates. There is very little exchange rate risk with regard to the import of goods to South Africa as FECs are in place which hedge the risk. The Group uses a 1% change in foreign currency exchange rates as a measure of sensitivity. The financial effect of a change in exchange rates in the case of a foreign operation will affect the carrying value of the foreign currency translation reserve which is a component of equity.

		Exchange rate sensitivity

GROUP	2010 1% increase Rm	2010 1% decrease Rm	2009 1% increase Rm	2009 1% decrease Rm
Assets
Inventory	5.3	(5.3)	4.9	(4.9)
Trade and other receivables	0.5	(0.5)	0.6	(0.6)
Cash and cash equivalents	2.5	(2.5)	1.5	(1.5)
Property, equipment and vehicles	4.9	(4.9)	3.8	(3.8)
Intangible assets	0.4	(0.4)	0.4	(0.4)
Goodwill	6.8	(6.8)	6.7	(6.7)
Total effect on assets	20.4	(20.4)	17.9	(17.9)
Liabilities
Trade and other payables	(5.8)	5.8	(5.6)	5.6
Leave pay obligation	(1.1)	1.1	(1.0)	1.0
Long term debt	(6.9)	6.9	(6.4)	6.4
Total effect on liabilities	(13.8)	13.8	(13.0)	13.0
Effect on foreign currency translation reserve	6.6	(6.6)	5.0	(5.0)

Interest rate risk

The Group manages the interest rate risk on long-term borrowings by fixing the interest rate with the relevant financial institution, wherever possible. We disclose below the information relating to variable interest financial instruments.

The effective rates on ﬁnancial instruments at 28 February 2010 are:

	Maturity of interest-bearing assets/liabilities

GROUP – 2010	Weighted average interest rate %	1 year or less Rm	2 to 5 years Rm	Over 5 years Rm	Total Rm
Financial assets
Cash and cash equivalents (note 17)	8.0	1 055.3	—	—	1 055.3
Loans (note 12)	2.6	17.3	69.0	38.4	124.7
Total financial assets		1 072.6	69.0	38.4	1 180.0
Financial liabilities
Variable-rate interest-bearing debt
Finance leases (note 22)	9.2	33.2	99.9	—	133.1
Total financial liabilities		33.2	99.9	—	133.1


GROUP – 2009
Financial assets
Cash and cash equivalents (note 17)	9.0	1 072.8	—	—	1 072.8
Loans (note 12)	2.3	17.8	71.2	39.6	128.6
Total financial assets		1 090.6	71.2	39.6	1 201.4
Financial liabilities
Variable-rate interest-bearing debt
Finance leases (note 22)	12.4	39.7	95.4	—	135.1
Total financial liabilities		39.7	95.4	—	135.1

Market price risk

The Group has no investment in equity securities and therefore has no exposure to market price risk.

Sensitivity analysis

The analysis below reflects the sensitivity of profit for the year and headline earnings per share to variations in the interest rate. Such variations affect the carrying values of financial assets and liabilities as well as the profit for the year and headline earnings per share. The variation is reflected in rand terms and represents the increase or decrease in the value of the assets, liabilities and profit/equity. The Group uses a 1% change in interest rates as a measure of interest rate sensitivity.

		Interest rate sensitivity

GROUP	2010 1% increase Rm	2010 1% decrease Rm	2009 1% increase Rm	2009 1% decrease Rm
Financial assets
Cash and cash equivalents	10.6	(10.6)	10.7	(10.7)
Loans	1.2	(1.2)	1.3	(1.3)
Total effect on financial assets	11.8	(11.8)	12.0	(12.0)
Financial liabilities
Bank loans	(3.7)	3.7	(4.4)	4.4
Finance leases	(1.3)	1.3	(1.4)	1.4
Total effect on financial liabilities	(5.0)	5.0	(5.8)	5.8
Effect on profit for the year, after tax	4.9	(4.9)	4.5	(4.5)
Effect on headline earnings per share	1.0c	(1.0c)	0.9c	(0.9c)

Fair value

At 28 February 2010 the carrying amounts of cash and cash equivalents, trade receivables and trade and other payables approximate their fair values due to their short-term maturities. Trade receivables and payables will mature within 30 to 60 days. The fair value of loans, investments and interest-bearing debt approximate their carrying value as disclosed on the balance sheet.

Basis for determining fair values
Financial liabilities

Fair value is determined by calculating the present value of future cash outflows discounted at a market interest rate at the reporting date. With regard to retirement benefit obligations, fair value is determined by a qualified actuary using actuarial assumptions.

Trade and other receivables

The fair value of trade and other receivables is estimated as the present value of future cash inflows discounted at a market-related interest rate.

Other financial assets (including cash and cash equivalents and loans)

Fair value is estimated as the present value of future cash inflows discounted at a market interest rate at the reporting date.

Participation in export partnerships – refer to note 13.

29.4

Capital management

The Board considers working capital management critical to the business and, in doing so, manages the balance between current assets and current liabilities. One of the core principles of the Group is to maintain strong cash balances in order to buy inventory forward on a rising market.

From time to time the Group purchases its own shares on the market. All share purchases are intended to cover the issue of shares under the Group’s share option schemes.

There were no changes in the Group’s approach to capital management during the year. Neither the Company nor any of its subsidiaries are subject to externally imposed capital requirements.

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