Question

. Associated British Foods PLC is a leader in grocery, agriculture and retail products in the UK and the Company is facing risks and opportunities arising from the UK’s decision to leave the EU. Identify and explain FIVE principal risks for the Company.

Answer 1

In June, 2016, the UK voted to leave the EU, a pan-European political union and economic union with a single market (in which the EU is one territory without any internal borders or regulatory obstacles to free movement of goods and services & businesses). This event has been termed as Brexit.
Associated British Foods PLC is a major producer of Grocery products, Ingredients (e.g., yeast), Sugar, and Agricultural products, and owns fashion retailer Primark. As an international business, it operates in 50 countries. Although the UK is ABF’s primary market, operating factories across the EU and internationally and importing goods to the UK to supply retail customers, the company also exports goods across the EU and internationally with 2/3 of its sales and profit made outside the UK. Given its high dependence on trade, ABF is vulnerable to uncertainty around Brexit.

As per the Annual Report of ABF PLC, 2017, following the Brexit decision in 2016, the ABF group has established an EU Exit Steering Committee which consists of a small dedicated team which worked with all the businesses to assess the risks and opportunities arising from the UK’s decision to leave the EU.
Its being reported in the annual report, 2017 that there is a particular group’s business model, under which Primark (a fashion retail chain of ABF), operates largely discrete supply chains for its stores in each of the UK, US and EU. Also the food production business is, wherever possible, aligned with the end market. Hence, the group actually undertakes relatively little cross-border trading between the UK and the rest of the EU. The ABF, therefore, assured its investors that the overall impact of Brexit on the group has been relatively minor.
However, the group, all through these 4-5 years, has identified the key risks and uncertainties faced by it, in the backdrop of uncertain political circumstances resulting from Brexit. Since, the referendum of 2016, the group and the individual businesses have taken reasonable steps to mitigate wherever possible the impacts of leaving the EU. The company has continued to prepare for changes in legislation, trade agreements and working practices in order to take advantage of the changing commercial environment and to mitigate risk.

Principal risks and uncertainties

Movement in Exchange Rates & inflation - Since, AFB is an MNC operating & transcating in multiple currencies, changes in exchange rates give rise to transactional exposures within the businesses and to translation exposures when the assets, liabilities and results of overseas entities are translated into sterling upon consolidation. Although, over the last few years, sterling has weakend against some of its other trading currencies, it has resulted in a gain on translation of 9 million pounds.
On the other hand, since in the short-term, as the value of pound sterling to euro has decreased, input costs have substantially increased for ABF.  Thinking about long term business when Brexit was not there, ABF’s supply chain has been designed to work within the EU context, a borderless trade regime with little paperwork and no tariffs. However, now depending on how Brexit unfolds, ABF may incur additional costs in navigating complex customs processes as well as possible hike in import/ export duties, impacting profit margins.

Imports to the UK - After, the referendum, the UK government has indicated the tariffs that will be applied to the imports of the country in the absence of a transitional agreement of Brexit and hence the group has calculated the net positive impact on its business. In its annual report 2019. the co. reported that all necessary registrations, regarding this situation, have been completed. Where goods are imported into the UK by third parties on behalf of the businesses, assurances have been sought by the co. from these 3rd party vendors that supplies will be available as & when required.

To offset increased raw material costs, ABF is re-examining its supplier contracts to understand their viability post-Brexit, consequently sourcing more from the UK. For instance, it is expecting to buy more British wheat, switching away from German suppliers.

Possible disruptions to the UK-EU logistics - The speed and flexibility of ABF’s supply chain will likely decrease due to Brexit, as customs between borders becomes a bottleneck. Increased lead times reduces ABF’s responsiveness to customers (key part of its customer value proposition), reduces its ability to accurately forecast demand, and may lead to requirement for additional costly inventory across its supply chain. The ability to do this is again constrained by warehouse availability and the shelf life of the goods.|
To offset increased raw material costs, ABF is re-examining its supplier contracts to understand their viability post-Brexit, consequently sourcing more from the UK. For instance, it is expecting to buy more British wheat, switching away from German suppliers.
Like many other packaged goods companies, ABF is also exploring how to increase prices of its products, & selectively pass on cost inflation to retail customers, by asking the retailers to share the burden of higher costs.
At the moment ABF is bearing the burden of much of the cost inflation, causing unsustainable losses in categories such as ‘bread’; in the future, it is likely that more of this burden will be shared with retailers.

Data & People - The company has noted in its annual report, 2019, that wherever necessary, the businesses have agreed to the Standard Contractual Terms of the UK govt., in order to enable certain personal business data to be transferred from the EU to the UK.
The company is also facing problems regarding the residency status of its non - UK employees due to brexit. Hence, as per the corporate annual report, the businesses have publicised the UK government’s Settled Status Scheme and where appropriate the company has assisted employees with the application process.

Reducing manufacturing costs & Move to a ‘direct to consumer’ model
With slimmer profit margins due to Brexit, ABF is in the midst of deploying long-term cost reduction programs across its manufacturing facilities. While many of these programs were initiated before Brexit, their implementation has become all the more important in a post-Brexit environment.
To remain competitive in the post Brexit market, ABF needs to deliver products to end-users at low prices. By circumventing retailers and offering products directly to consumers (e.g., via an ecommerce model), ABF can offer low prices to consumers (avoiding the proft margin taken by retailers) while also increasing their own margins.