Annual report and financial statements 2009

Notes to the Group financial statements

18 Financial instruments

a) Financial risk management

The Group’s treasury operations are controlled centrally by the Treasury Committee in accordance with clearly defined policies and procedures that have been authorised by the Board. There is an amount of delegated authority to the Treasury Committee, but all activities are summarised in half yearly treasury reports which are presented to the Audit Committee.

The Group’s principal financial liabilities, other than derivatives, comprise bank loans and overdrafts, other borrowings, finance leases and trade and other creditors. The main purpose of these financial liabilities is to raise finance for the Group’s operations. The Group has various financial assets such as trade debtors and cash and short term deposits which arise directly from its operations.

The Group enters into derivative transactions, in the form of forward currency contracts, cross-currency swaps and diesel and electricity price contracts. The purpose of these derivative instruments is to manage risks arising from the Group’s operations and its sources of finance. The financial derivatives relating to commitments entered into during the year are to manage the risks arising from its usage of diesel and electricity. It remains the Group’s policy not to engage in speculative trading of financial instruments.

The objectives, policies and processes for managing these risks, which remain unchanged from the prior year are stated below:

i) Foreign currency risk

The Group makes the majority of its purchases in Sterling. However, it incurs currency exposure in respect of overseas trade purchases made in currencies other than Sterling, primarily the Euro and US dollars. The Group’s objective is to reduce risk to short term profits from exchange rate fluctuations. It is Group policy that any transactional currency exposures recognised to have a material impact on short term profits will be hedged through the use of derivative financial instruments. As at the balance sheet date, the Group had entered into forward foreign exchange contracts to mitigate foreign currency exposure on up to 50% of its forecasted purchases within the next six months. Exposure on debt denominated in a foreign currency is fully hedged using cross-currency interest rate swaps.

The sensitivity to a reasonably possible change (+/–20%) in the US dollar / Euro exchange rate has been determined as being immaterial.

ii) Liquidity risk

The Group’s policy is to maintain a balance of funding with a range of maturities and a sufficient level of undrawn committed borrowing facilities to meet any unforeseen obligations and opportunities. Short term cash balances, together with undrawn committed facilities, enable the Group to manage its liquidity risk. The Group finances its operations with a combination of bank credit facilities and bonds.

The Treasury Committee monitors rolling forecasts of the Group’s liquidity reserve on a quarterly basis, which comprises committed and uncommitted borrowing facilities on the basis of expected cash flow. At the year end, the Group had undrawn committed facilities of £850m (note 17); these facilities remain available to the Group.

The table below summarises the maturity profile of the Group’s primary non-current financial liabilities based on contractual undiscounted payments, which includes interest payments. Balances due within 12 months equal their carrying balances as the impact of discounting is not significant.

As the amounts included in the table are the contractual undiscounted cash flows, these amounts do not agree to the amounts disclosed on the balance sheet for borrowings. Where borrowings are subject to a floating rate, an estimate for interest has been taken.

The table below analyses the Group’s derivative financial instruments which will be settled on a gross basis into relevant maturity groupings based on the remaining period at the balance sheet date to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows.

iii) Credit risk

Credit risk is managed on a Group basis. Credit risk arises from cash and cash equivalents, deposits with banking groups as well as credit exposures from tenants of investment properties.

The Group maintains deposits with banks and financial institutions with an acceptable credit rating for a period not exceeding six months. Further, the Group has specified limits that can be deposited with any banking group or financial institution at any point. The maximum exposure on cash and cash equivalents and deposits is equal to the carrying amount of these instruments. The Group does not expect any significant performance losses from counterparties.

The Group trades only with recognised, creditworthy third parties. It is the Group’s policy that tenants of investment properties who wish to trade on credit terms are subject to credit verification procedures. In addition, receivable balances are monitored on an ongoing basis with the result that the Group’s exposure to bad debts is not significant. The maximum exposure is the carrying amount as disclosed in note 14. There are no significant concentrations of credit risk within the Group.

iv) Other risk

Pricing risk: The Group manages the risks associated with the purchase of electricity, gas and diesel consumed by its activities. This does not include fuel purchased for resale to customers. The Treasury Committee reviews the Group’s market price exposure to these commodities on a quarterly basis and determines a strategy for utilising derivative financial products in order to mitigate the volatility of the commodity prices.

The Group intends to hold derivatives to maintain cover of its energy purchases of up to 75% over an appropriate timescale.

Cash flow interest rate risk: The Group’s long term policy is to protect itself against adverse movements in interest rates by maintaining up to 60% of its consolidated total net debt in fixed rate borrowings over a four year horizon. As at the balance sheet date, 74% of the Group’s borrowings are at fixed rate, thereby substantially mitigating the Group’s exposure to adverse movements in interest rate.

Cash and cash equivalents is a significant interest-bearing asset held by the Group. At year end, a 1% movement in interest rates would have had a £2m (2008: £5m) impact on the Group’s annual finance income. There are no other significant interest-bearing assets held by the Group.

b) Capital management

The Group’s objectives are to safeguard its ability to continue as a going concern providing returns to shareholders, through the optimisation of the debt and equity balance, and to maintain a strong credit rating and headroom. The Group manages its capital structure and makes appropriate decisions in light of the current economic conditions and strategic objectives of the Group. The Group has completed a share buyback programme in the period, see note 23.

A key objective of the Group’s capital management is to maintain compliance with the covenants set out in the revolving credit facility.

The Group’s policy is to maintain both a gearing ratio and interest cover, which represents headroom of at least 10% over and above the requirements laid down in the revolving credit facility. Throughout the year, the Group has comfortably complied with this policy.

There has been no change in the objectives, policies or processes with regards to capital management during the years ended 1 February 2009 and 3 February 2008.

c) Fair values

i) Financial assets

All financial derivatives are held at fair value which has been determined by reference to prices available from the markets on which the instruments are traded.

Cash and cash equivalents and Debtors are held at book value which equals the fair value. The values of the financial assets are disclosed within note 12.

ii) Financial liabilities

All financial liabilities are carried at amortised cost. The Euro bonds are retranslated at balance sheet date spot rates. The fair value of the Sterling and Euro bonds are measured using closing market prices. These compare to carrying values as follows:

The fair value of other items within current and non-current borrowing equals their carrying amount, as the impact of discounting is not significant.

d) Hedging activities

i) Cash flow hedge

At 1 February 2009, the Company held a cross-currency swap which has been designated as a cash flow hedge. This derivative financial instrument is used to minimise risk from potential movements in foreign exchange rates inherent in cash flow of certain liabilities. To minimise the risk from potential movements in commodity prices, the Group has fuel price contracts which are also designated as cash flow hedges.

The hedged forecast transactions denominated in foreign currency are expected to occur at various dates over the next two years. Gains and losses recognised in the hedging reserve in equity (note 23) on cross-currency swaps as at 1 February 2009 are recognised in the income statement in the period or periods during which the hedged forecast transaction affects the income statement, which is generally once every year over the course of the next two (2008: three) years.

ii) Forward contracts

The Group uses forward foreign exchange contracts to hedge the cost of future purchases of goods for resale, where those purchases are denominated in a currency other than the functional currency of the purchasing company. The hedging instruments are primarily used to hedge purchases in Euro and US dollars. The cash flows hedged will occur within one year of the balance sheet date.

At 1 February 2009, the total notional amount of outstanding forward foreign exchange contracts to which the Group has committed was £53m (2008: £45m). The fair value of these outstanding forward exchange contracts at the balance sheet date was £3.4m (2008: £0.2m).

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