Notes to the annual financial statements

Pick n Pay Stores Limited

29.	Financial instruments
	Overview
	The Company and Pick n Pay Holdings Limited have limited 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 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 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). Group Risk and Assurance Services undertakes both regular and ad hoc reviews of risk management controls and procedures, the results of which are reported to the Audit 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
		2011 Rm	2010 Rm
	Investments (note 10)	0.2	0.2
	Loans (note 12)	90.2	124.7
	Participation in export partnerships (note 13)	48.2	50.6
	Trade receivables (note 16)	1 649.4	1 828.6
	Cash balances (note 17)	715.2	1 428.1
		2 503.2	3 432.2
	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
		2011 Rm	2010 Rm
	The ageing of trade receivables at 28 February was:
	Trade receivables not impaired
	Within payment terms	1 302.7	1 584.6
	Exceeding payment terms by less than 14 days	79.5	64.9
	Exceeding payment terms by more than 14 days	4.6	20.5
		1 386.8	1 670.0
	Trade receivables with impairments
	Within payment terms	215.3	150.5
	Exceeding payment terms by less than 14 days	97.8	83.1
	Exceeding payment terms by more than 14 days	132.7	74.5
		445.8	308.1
	Total trade receivables	1 832.6	1 978.1
	Allowance for impairment losses	(183.2)	(149.5)
	Total trade receivables net of allowance for impairment losses	1 649.4	1 828.6
	The movement in the allowance for impairment of trade receivables during the year was as follows:
	At 1 March	149.5	50.7
	Irrecoverable debts written off	(62.6)	—
	Additional impairment losses recognised	108.3	106.8
	Prior allowances for impairment reversed	(12.0)	(8.0)
	At 28 February	183.2	149.5

	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 Group’s borrowing powers are limited to its total share capital and accumulated profits. 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
		2011 Rm	2010 Rm
	Total borrowing facilities granted by financial institutions	5 799.3	4 988.2
	Total actual borrowings and utilisation of facilities	(2 321.2)	(1 386.1)
	Unutilised borrowing facilities	3 478.1	3 602.1

	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 – 2011

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)

321.0

375.9

36.0

302.8

37.1

Unsecured bank loans (note 22)

250.0

286.2

24.1

262.1

—

Finance lease liabilities (note 22)

106.1

117.1

50.6

66.5

—

Trade and other payables (note 25)

5 980.4

—

Bank overdraft (note 17)

362.6

—

Overnight bank borrowings (note 17)

900.0

—

Derivative financial liabilities

Forward exchange contracts (note 25)

57.4

—

Total financial obligations

7 977.5

8 079.6

7 411.1

631.4

37.1

To be settled through the management of:

Inventory (note 15)

3 143.8

Trade receivables (note 16)

1 832.6

Cash balances (note 17)

715.2

Net liabilities*

2 285.9

2 388.0

1 719.5

631.4

37.1

GROUP – 2010

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

—

Bank overdraft (note 17)

372.8

—

Derivative financial liabilities

Forward exchange contracts (note 25)

1.1

—

Total financial obligations

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

Trade receivables (note 16)

1 978.1

Cash balances (note 17)

1 428.1

Net liabilities*

1 771.1

1 943.9

1 167.1

725.9

50.9

*	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
	Derivatives held for risk management
	Net investment hedge
	The Group has used forward exchange contracts (FECs) to hedge the foreign currency translation risk on its net investment in its foreign subsidiary InterFrank Group Holdings Pty Limited (Franklins).
	The fair value of derivatives designated as a net investment hedge is a liability of R72.5 million (R52.2 million net of tax) (2010: nil), which has been recognised directly in the foreign currency translation reserve through other comprehensive income and in fair value of outstanding forward exchange contracts in trade and other payables.
	Other derivatives held for risk management
	The Group is exposed to foreign currency risk through the importation of merchandise. This risk is covered by entering into 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 is an asset of R15.1 million. This has been recognised as income in the statement of comprehensive income and is reflected as a part of fair value of outstanding forward exchange contracts in 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 South African 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
	2011	2011	2010	2010
GROUP	1% increase Rm	1% decrease Rm	1% increase Rm	1% decrease Rm
Assets
Inventory	5.3	(5.3)	5.3	(5.3)
Trade and other receivables	0.3	(0.3)	0.5	(0.5)
Cash and cash equivalents	1.2	(1.2)	2.5	(2.5)
Property, equipment and vehicles	5.6	(5.6)	4.9	(4.9)
Intangible assets	0.3	(0.3)	0.4	(0.4)
Goodwill	7.0	(7.0)	6.8	(6.8)
Total effect on assets	19.7	(19.7)	20.4	(20.4)
Liabilities
Trade and other payables	(7.0)	7.0	(5.8)	5.8
Leave pay obligation	(1.1)	1.1	(1.1)	1.1
Long-term debt	(7.1)	7.1	(6.9)	6.9
Total effect on liabilities	(15.2)	15.2	(13.8)	13.8
Effect on foreign currency translation reserve	4.5	(4.5)	6.6	(6.6)

*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 2011 are:
	Maturity of interest-bearing assets/liabilities
GROUP – 2011	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)	4.4	352.6	—	—	352.6
Loans (note 12)	4.7	12.5	49.9	27.8	90.2
Total financial assets		365.1	49.9	27.8	442.8
Financial liabilities
Variable-rate interest-bearing debt
Finance leases (note 22.1)	10.4	44.0	62.1	—	106.1
Overnight bank borrowings (note 17)	5.8	900.0	—	—	900.0
Total financial liabilities		944.0	62.1	—	1 006.1

GROUP – 2010

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 22.1)	9.2	33.2	99.9	—	133.1
Total financial liabilities		33.2	99.9	—	133.1

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

Sensitivity analysis
The analysis overleaf 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
	2011	2011	2010	2010
GROUP	1% increase Rm	1% decrease Rm	1% increase Rm	1% decrease Rm
Financial assets
Cash and cash equivalents	7.2	(7.2)	14.3	(14.3)
Loans	0.9	(0.9)	1.2	(1.2)
Total effect on financial assets	8.1	(8.1)	15.5	(15.5)
Financial liabilities
Bank overdraft	(3.6)	3.6	(3.7)	3.7
Overnight bank borrowings	(9.0)	9.0	—	—
Finance leases	(1.1)	1.1	(1.3)	1.3
Short-term borrowings	(0.5)	0.5	(0.4)	0.4
Total effect on financial liabilities	(14.2)	14.2	(5.4)	5.4
Effect on profit after tax	(4.4)	4.4	7.3	(7.3)
Effect on headline earnings per share	(0.9c)	0.9c	1.5c	(1.5c)

	Fair value
	At 28 February 2011 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 statement of financial position.

	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.