Risk Analysis

The risk of a company is an important issue for shareholders and a risk analysis is conducted on Carlsberg in order to clarify the uncertainty of future cash flows. We evaluate (like scholars and practitioners along) on the likelihood of appearance and severity of impact (see appendix 7 for model) and distinguish between business risk and the financial risk (Jorion 2006).

4.5.1 Business Risk

The underlying operations of Carlsberg determine the business risk and are best valued by the term “operating income before interests”. This only factors in operational drivers and not debt. In turn it makes sense to divide the business risk into three parts being i) Strategic Risk, ii) Operational Risk and iii) External Risk (Jorion 2006 and Plenborg et al, 2007, p. 215).

Strategic Risk

The strategic risks were discussed in the strategic analysis in paragraph 3.2. The beer industry is identified predominately as a differentiated oligopoly and relatively consolidated. The threat of new entrants is small, and the suppliers have little bargaining power, but on the contrary buyers have increasing power because of reconciliation amongst supermarkets as mentioned in paragraph 3.2.

The beer market represents a steady demand and beer is a durable product – an indication of low strategic risk (Frank 2009, p. 466).

When combining the factors above and assessing them on their probability and impact, the overall strategic risk is seen as medium and the main driver being the increasing buyer power.

Operating Risk

Operating risks were also discussed in paragraph 3.2.3. The markets where Carlsberg have the biggest revenues are at the stage of maturity or growth, and this means that Carlsberg is a sustainable company with low operational risk.

Furthermore in the “Value Chain Analysis” the operations and associated risks in production-security and “talent-attraction” were found conducted by best practise. Since cost efficiency is in focus through the Excellence program, the aggregated indication is that the operating risk is considered as low.

External Risk

We already discussed the external risks in the strategic analysis, in the section about macro environment. The indications are that behind Carlsberg’s earnings, the main macro-drivers are GDP growth, political factors and commodity prices. The conclusion found is that the Russian currency had a critical influence on the Eastern European earnings and in addition the

financial crisis has had a big effect on revenues as well as the debt and equity markets (Gordy

& Howells 2004). Lastly we found that in Asia another critical factor is the purchasing power caused by changes in inflation and commodity prices.

Valued on probability and impact, the conclusion must be is that Carlsberg’s external risk is seen as medium to high (medium being relative and high being absolute).

4.5.2 Financial Risk

Two main components build the financial risk. The components are i) Debt related risk and ii) Currency risk.

Debt related risk concerns the financial gearing of Carlsberg and its borrowings. Currency risk concerns the effect of currency fluctuations in earnings contra cost-base.

These two risks are interrelated, because hedging possibilities exist by borrowing in the earnings currency. By hedging, the fluctuations between the DKK and the currency of Carlsberg’s operations are protected.

Debt related risk

Deb related risk comes from FGEAR, which is the financial gearing as mentioned in paragraph 4.2)

The FGEAR of Carlsberg and the peer group is shown in Figure 4.10 (also shown paragraph 4.2 above).

As seen historically Carlsberg has had the highest financial gearing. But in 2008 and

2009 Carlsberg has the lowest gearing. As mentioned before all companies made acquisitions in 2008-09. Carlsberg issued new shares (making EQ increase), Heineken financed the acquisition by issuing new debt, and AB-InBev has combined a stock issue and new debt.

When issuing new debt FGEAR increases (because of an increase NIBD), and this is the main driver of the increase in the AB-InBev and Heineken FGEAR. The decrease in Carlsberg’s FGEAR is caused by the issuance of new shares, and thereby and increase of EQ.

A high FGEAR increases the financial risk in the aspect of financial distress and the debt-owners plus equity debt-owners required rate of return increases (Koller et al 2010 and Jorion 2006). If we also take into account the fact of the restructuring 10bDKK current debt into 7-year bonds in Q2 2010 (7-7-year bonds) into account (Carlberg.com 2010, press release Q2), the overall picture allow us to determine the debt related risk as low.

Currency Risks

Since the acquisition of S&N Carlsberg has increased their exposure to the Eastern European market. This means exposure to the Russian economy and the ruble.

In paragraph 3.1.2, it is mentioned that the Russian economy has been severely affected by the global financial crisis. The devaluation of the ruble, also mentioned in Chapter III has had a significant impact on the profitability of Carlsberg’s operations in Russia in two ways. The borrowings made to finance the acquisitions of S&N are denoted in DKK and EUR. Carlsberg has not utilized the earlier mentioned natural hedge, and the reason is because of interest rates traditionally being higher in Russia than in the Euro zone.

Figure 4.10 - Development in FGEAR

0 0,5 1 1,5 2

2006 2007 2008 2009

AB-Inbev Heineken Carlsberg

Source: Ow n creation based on reformulated figures from Carlsberg, Heineken, AB- InBev AR 2009

Carlsberg has not secured cash flows from operations in Russia, since the costs associated with doing so outweigh the benefits (Børsen 2009a). The only risk-mitigating action Carlsberg has made towards the Russian ruble, is to allocate the cost of raw materials in a pool of EUR and USD (Carlsberg AR 2009). This ensures that the costs and revenues are affected evenly by fluctuations in the Russian ruble.

Concluding remark on financial risk is:

The large share of revenue coming from the more unstable Eastern European economies, Russia in particular and the large amount of tied-up capital also in this region (see appendix 6) makes the risk higher, but the declining exposure in FGEAR makes it lower, which ultimately makes the financial risk moderate.