Davide Campari-Milano S.p.A. and Campari Group are exposed to external risks and uncertainties arising from general or specific conditions in the industries in which they work, as well as to risks arising from strategic decisions and internal operational risks.
Business and Specific Risks
Risks relating to international trade and operations in emerging markets
In line with its international growth strategy, the Group currently operates in numerous markets, and plans to expand in certain emerging countries, especially in Eastern Europe, Asia, Latin America and Africa. Operating in emerging markets means that the Group is vulnerable to various risks inherent in international business, including exposure to an often unstable local political and economic environment, exchange rate fluctuations (and related hedging difficulties), export and import quotas, and limits or restrictions on investment, advertising or the repatriation of dividends.
Risks relating to the Company’s dependence on licences for the use of third-party brands and licences granted to third parties for use of the Group's brands
At 31 December 2017, 7.9% of the Group’s consolidated net sales came from production and/or distribution under licence of third-party products. Should any of these licensing agreements be terminated or not renewed for any reason, this could have a negative effect on the Group’s activities and operating results.
Risks relating to market competition
The Group is part of the alcoholic and non-alcoholic beverage sector, where there is a high level of competition and a huge number of operators. The main competitors are large international groups involved in the current wave of mergers and acquisitions, which are operating aggressive competitive strategies at global level. The Group’s competitive position vis-à-vis the major global players, which often have greater financial resources and benefit from a more highly diversified portfolio of brands and geographic locations, means that its exposure to market competition risks is particularly significant.
Risks relating to the Company’s dependence on consumer preference and propensity to spend
An important success factor in the beverage industry is the ability to interpret consumer preferences and tastes – particularly those of young people – and to continually adapt sales strategies to anticipate market trends and strengthen and consolidate the product image. If the Group’s ability to understand and anticipate consumer tastes and expectations and to manage its own brands were to cease or decline significantly, this could considerably affect its activities and operating results. Moreover, the unfavourable economic situation in certain markets is dampening the confidence of consumers, making them less likely to buy drinks.
Risks relating to the Company’s dependence on key customers
In some markets where the Group operates, sales are concentrated on a limited number of key customers: therefore, a possible change in the priorities or deterioration of the financial conditions of these customers could have significant adverse effects on the Group’s business and outlook. Furthermore, if such key customers see the terms and conditions set forth in contracts as no longer acceptable, they may require them to be renegotiated, resulting in less favourable terms and conditions.
Risks relating to legislation in the beverage industry
Activities relating to the alcoholic beverages and soft drinks industry – production, distribution, export, import, sales and marketing – are governed by complex national and international legislation, often drafted with somewhat restrictive aims. The requirement to make the legislation governing the health of consumers, particularly young people, ever more stringent could, in the future, lead to the adoption of new laws and regulations aimed at discouraging or reducing the consumption of alcoholic drinks. Such measures could include restrictions on advertising or tax increases for certain product categories. Any tightening of regulations in the main countries in which the Group operates could lead to a fall in demand for its products.
The Group operates in many countries with different tax regulations. In many jurisdictions, distillates and wines are subject to import and excise duties, some of which could rise and negatively affect demand for Campari Group products. Such changes could have a negative impact on profit margins or sales, reducing overall consumption or encouraging consumers to move to categories of alcoholic beverages that are less heavily taxed. Moreover, significant changes in the international tax environment could suddenly increase overall business costs if there is a rise in the Group’s effective tax rate, and lead to uncertain and/or unexpected exposure to tax. The Group regularly reviews its business strategy and tax policy in light of regulatory changes, and assesses the likelihood of any negative results of potential inspections in order to determine the adequacy of its tax provisions.
Risks relating to environmental policy
With regard to the risks associated with environmental policy, the Group’s industrial management has implemented dedicated procedures relating to safety and qualitative controls in the area of environmental pollution and the disposal of solid waste and waste water. The objective of this structure is to continuously monitor and update the Group’s industrial activities based on the legislation in force in the individual countries in which it operates.
Risks relating to product compliance and safety
The Group is exposed to risks relating to its responsibility to ensure that its products are safe for consumption. It has therefore put in place procedures to ensure that products manufactured in Group plants are compliant and safe in terms of quality and hygiene, in accordance with the laws and regulations in force, and voluntary certification standards. In addition, the Group has defined guidelines to be implemented if quality is accidentally compromised, such as withdrawing and recalling products from the market.
Risks relating to employees
In the various countries where the Group has subsidiaries, its dealings with employees are regulated and protected by collective labour agreements and the regulations in force locally. Any reorganisation or restructuring undertaken, where this becomes essential for strategic reasons, is defined on the basis of plans agreed with employee representatives. Moreover, the Group has implemented specific procedures to monitor safety in the workplace, and it is worth noting that the accident rate at Group plants is very low and that any accidents that do occur tend to be minor.
Environmental and geopolitical risks
The Group operates in around 190 countries. Production activities and the implementation of the Group’s strategies are subject to the effects of natural events and geopolitical risks. Environmental changes, some of which could have a significant impact, could interfere with the local supply chain, as well as harm some customers. These events are generally unpredictable and may affect the seasonality of sales, just as natural disasters (such as hurricanes) may damage products and disrupt production at some plants. Some weather conditions might also have a positive effect on some geographical regions, but a negative effect in other segments. The Group monitors environmental and geopolitical risks, has emergency plans in place and continuously develops plans to deal with such crises. The Group counts compliance with regulations and with local and international standards among its priorities, together with business continuity assessment, back-up scenarios and global insurance policies.
Risk of failure to comply with laws and regulations
As the Group is exposed and subject to numerous different regulations, there is a risk that failure to comply with laws and regulations, as well as with the Group’s policies, could harm its reputation and/or lead to potentially substantial fines. To mitigate this risk, the Group has created a Code of Ethics and defined Rules of Business Conduct. It also provides its employees with regular training on its global policies. Internal assurance activities are continuously monitored and assessed with local management in order to improve the internal control system.
Cyber-security risks have a potential global impact for Campari Group, due to both the strong interconnectedness within the Group and the ever-increasing pervasiveness of technology (and the internet) on the performance of company activities. The major risks associated with cyber-security include reputational damage caused by breaches/theft of sensitive data, the malfunctioning or disruption of IT systems, the unavailability of online services due to a cyber attack and the increased cost of resolving these problems.
Exchange rate and other financial risks
Around 58.4% of the Group’s consolidated net sales in 2017 came from outside the European Union. With the growth in the Group’s international operations in areas outside the Eurozone, a significant fluctuation in exchange rates could hit the Group’s activities and operating results. However, the establishment of Group entities in countries such as the United States, Australia, Jamaica, Brazil, Canada, Russia and Argentina allows this risk to be partly covered, given that both costs and income are denominated in the same currency. Therefore, exposure to foreign exchange transactions generated by sales and purchases in currencies other than the Group’s functional currencies represented an insignificant proportion of consolidated sales and consolidated margins in 2017. For a more detailed analysis of the Group’s risks, see note 39 – ‘Provisions for risks’, and for financial risks, note 46 – ‘Nature and extent of risks arising from financial instruments’ in this report.
The Group’s main financial instruments include current accounts, short-term deposits, short and long-term bank loans, finance leases and bonds. The purpose of these is to finance the Group’s operating activities. In addition, the Group has trade receivables and payables resulting from its operations. The main financial risks to which the Group is exposed are market (currency and interest rate risk), credit and liquidity risk. These risks are described below, together with an explanation of how they are managed. To cover these risks, the Group makes use of derivatives, primarily interest rate swaps, cross currency swaps and forward contracts, to hedge interest rate and exchange rate risks.
With regard to trade transactions, the Group works with medium-sized and large customers (mass retailers, domestic and international distributors) on which credit checks are performed in advance. Each company carries out an assessment and control procedure for its customer portfolio, partly by constantly monitoring amounts received. In the event of excessive or repeated delays, supplies are suspended. Historical losses on receivables recorded represent a very low percentage of revenues and annual outstanding receivables, and significant coverage and/or insurance. The maximum risk at the reporting date is equivalent to the carrying amount of trade receivables. Financial transactions are carried out with leading domestic and international institutions, whose ratings are monitored, in order to minimise counterparty insolvency risk. The maximum risk at the reporting date is equivalent to the carrying amount of these assets.
The Group’s ability to generate substantial cash flow through its operations allows it to reduce liquidity risk to a minimum. This risk is defined as the difficulty of raising funds to cover the payment of the Group’s financial obligations.
The table below summarises financial liabilities at 31 December 2017 by maturity based on the contractual repayment obligations, including non-discounted interest.
31 December 2017 On demand Within 1 year Due in 1 to 2 years Due in 3 to 5 years Due after 5 years Total € million € million € millioni € million € million € millioni Payables and loans due to banks - 19.6 3.6 303.6 326.9 Bonds - 30.0 249.5 659.3 156.5 1,094.8 Property leases - 0.1 0.1 0.3 0.9 1.4 Other financial payables - 0.8 0.8 Total financial liabilities - 50.6 252.7 963.2 157.4 1,423.9
The Group’s financial payables, with the exception of non-current payables with a fixed maturity, consist of short-term bank debt. Thanks to its liquidity and close management of cash flow from operations, the Group has sufficient resources to meet its financial commitments at maturity. In addition, there are unused credit lines that could cover any liquidity requirements.
Market risk consists of the possibility that changes in exchange rates, interest rates or the prices of raw materials or commodities (alcohol, aromatic herbs, sugar) could negatively affect the value of assets, liabilities or expected cash flows.
The price of raw materials depends on a wide variety of factors, which are difficult to forecast and are largely beyond the Group’s control. Although historically the Group has not encountered particular difficulties in purchasing sufficient high-quality raw materials, we cannot rule out the possibility that the emergence of any tensions in this area could lead to difficulties in obtaining supplies, causing costs to rise, which would have negative consequences on the Group’s financial results.
Interest rate risk
The Group is exposed to the risk of fluctuating interest rates in respect of its financial assets, payables to banks and lease agreements. The Parent Company’s 2012, 2015 and 2017 bond issues pay interest at a fixed rate. Overall, at 31 December 2017, 65% of the Group’s total financial debt was fixed-rate debt.
The following table shows the effects on the Group’s income statement of a possible change in interest rates, if all other variables remain constant.
A negative value in the table indicates a potential net reduction in profit and equity, while a positive value indicates a potential net increase in these items.
The assumptions used with regard to a potential change in rates are based on an analysis of the trend at the reporting date. The table illustrates the full-year effects on the income statement in the event of a change in rates, calculated for the Group’s variable-rate financial assets and liabilities. As regards the fixed-rate financial liabilities hedged by interest rate swaps, the change in the hedging instrument offsets the change in the underlying liability, with practically no effect on the income statement. Net of tax, the effects are as follows:
Increase/decrease in interest rates in basis points Income statement 31 December 2017 Increase in interest rates
Decrease in interest rates
Euro +/- 5 basis points (0.6) 0.6 Dollar +30/-10 basis points 0.3 (0.1) Other currencies 0.8 (1.0) Total effect 0.5 (0.5)
Exchange rate risk
The Group develops its business activities on an international scale, and sales achieved in non-EU markets are progressively increasing. However, the establishment of Group entities in countries such as the United States, Brazil, Australia, Argentina, Russia and Switzerland allows the exchange rate risk to be partly hedged, given that both costs and income are denominated in the same currency.
Therefore, exposure to foreign exchange transactions generated by sales and purchases in currencies other than the Group’s functional currencies represented an insignificant proportion of consolidated sales in 2017. For these transactions, Group policy is to mitigate the risk by using forward sales or purchases.
The analysis was performed on the economic effects of a possible change in the exchange rates against the euro, keeping all the other variables constant.
This analysis does not include the effect on the consolidated financial statements of the conversion of the financial statements of subsidiaries denominated in a foreign currency following a possible change in exchange rates.
The assumptions adopted regarding a potential change in rates are based on an analysis of forecasts provided by financial information agencies at the reporting date.
The types of transaction included in this analysis are sales and purchase transactions in a currency other than the Group’s functional currency.
The effects on shareholders’ equity are determined by changes in the fair value of forward contracts on future transactions, which are used as cash flow hedges.
The results of this analysis showed that the effects would not be significant.