Opportunities and Risks
Excerpts from Deutsche Post AG's 2014 Group Annual Report.
No foreseeable risk to the Group
Identifying opportunities and risks – and swiftly capitalising upon or counteracting them – is an important objective for our Group. This is why we already account for the anticipated impact of potential events and developments in our current business plan. The opportunities and risks reported here represent additional potential deviations from the Group’s projected earnings. In consideration of our current business plan, the Group’s overall opportunity and risk situation has not changed significantly compared with last year. No new risks have been identified that could have a potentially critical impact on the Group’s result. Based on the Group’s early warning system and in the estimation of its Board of Management, there were no identifiable risks for the Group in the current forecast period which, individually or collectively, cast doubt upon the Group’s ability to continue as a going concern. Nor are any such risks apparent in the foreseeable future. The assessment of a stable to positive outlook is moreover reflected in the Group’s credit ratings.
Uniform reporting standards for opportunity and risk management
As an internationally operating logistics company, we are faced with numerous changes. Our aim is to identify the resulting opportunities and risks at an early stage and take the necessary measures in the specific areas affected in due time to ensure that we achieve a sustained increase in enterprise value. Our Group-wide opportunity and risk management system facilitates this aim. Each quarter, managers estimate the impact of future scenarios, evaluate opportunities and risks in their departments and present planned measures as well as those already taken. Queries are made and approvals given on a hierarchical basis to ensure that different managerial levels are involved in the process. Opportunities and risks can also be reported at any time on an ad hoc basis.
Our early identification process links the Group’s opportunity and risk management with uniform reporting standards. We continuously improve the IT application used for this purpose. Furthermore, we use a Monte Carlo simulation for the purpose of aggregating opportunities and risks in standard evaluations.
This stochastic model takes the probability of occurrence of the underlying risks and opportunities into consideration and is based on the law of large numbers. From the distribution function of each individual opportunity and risk one million randomly selected scenarios – one for each opportunity and risk – are combined. The resulting totals are shown in a graph of frequency of occurrence. The following graph shows an example of such a simulation:
The most important steps in our opportunity and risk management process are:
- Identify and assess: Opportunities and risks are defined as potential deviations from projected earnings. Managers in all divisions and regions provide an estimate of our opportunities and risks on a quarterly basis and document respective actions. They use scenarios to assess best, expected and worst cases. Each identified risk is assigned to one or more managers, who assess it, monitor it, specify possible procedures for going forwards and then file a report. The same applies to opportunities. The results are compiled in a database.
- Aggregate and report: The controlling units responsible collect the results, evaluate them and review them for plausibility. If individual financial effects overlap, they are noted in our database and taken into account when compiling them. After being approved by the department head, all results are passed on to the next level in the hierarchy. The last step is complete when Corporate Controlling reports to the Group’s Board of Management on significant opportunities and risks as well as on the potential overall impact each division might experience. For this purpose, opportunities and risks are aggregated for key organisational levels. We use two methods for this. In the first method, we calculate a possible spectrum of results for the divisions and add the respective scenarios together. The totals for “worst case” and “best case” indicate the total spectrum of results for the respective division. Within these extremes, the total “expected cases” shows current expectations. The second method makes use of a Monte Carlo simulation, the divisional results of which are regularly included in the opportunity and risk reports to the Board of Management.
- Overall strategy: The Group Board of Management decides on the methodology that will be used to analyse and report on opportunities and risks. The reports created by Corporate Controlling provide an additional regular source of information to the Board of Management for the overall steering of the Group.
- Operating measures: The measures to be used to take advantage of opportunities and manage risks are determined within the individual organisational units. They use cost-benefit analyses to assess whether risks can be avoided, mitigated or transferred to third parties.
- Control: For key opportunities and risks, early warning indicators have been defined that are monitored constantly by those responsible. Corporate Internal Audit has the task of ensuring that the Board of Management’s specifications are adhered to. It also reviews the quality of the entire opportunity and risk management operation. The control units regularly analyse all parts of the process as well as the reports from Internal Audit and the independent auditors with the goal of identifying potential for improvement and making adjustments where necessary.
Internal accounting control and risk management system
(Disclosures required under section 315 (2), number 5 of the Handelsgesetzbuch (HGB – German Commercial Code) and explanatory report)
Deutsche Post DHL Group uses an internal accounting control system to ensure that Group accounting adheres to generally accepted accounting principles. This system is intended to make sure that statutory provisions are complied with and that both internal and external accounting provide a valid depiction of business processes in figures. All figures are to be entered and processed accurately and completely. Accounting mistakes are to be avoided in principle and significant assessment errors uncovered promptly.
The control system design comprises organisational and technical measures that extend to all companies in the Group. Centrally standardised accounting guidelines govern the reconciliation of the single-entity financial statements and ensure that international financial reporting standards (EU IFRSs) are applied in a uniform manner throughout the Group. All Group companies are required to use a standard chart of accounts. We immediately assess new developments in international accounting for relevance and announce their implementation in a timely manner, for example, in monthly newsletters. Often, accounting processes are pooled in a shared services centre in order to centralise and standardise them. The IFRS financial statements of the separate Group companies are recorded in a standard, SAP-based system and then processed at a central location where one-step consolidation is performed. Other components of our control system include automatic plausibility reviews and system validations of the accounting data. In addition, manual checks are carried out regularly at a decentralised level by those responsible locally (by a chief financial officer, for example) and at a central level by Corporate Accounting & Controlling, Taxes and Corporate Finance at the Corporate Center.
Over and above the aforementioned internal accounting control system and risk management structures, Corporate Internal Audit is an essential component of the Group’s controlling and monitoring system. Using risk-based auditing procedures, Corporate Internal Audit regularly examines the processes related to financial reporting and reports its results to the Board of Management. Upstream and downstream checks and analyses of the reported data are performed under chronological aspects. If necessary, we call in outside experts, for instance in the case of pension provisions. Finally, the Group’s standardised process for preparing financial statements using a centrally administered financial statements calendar guarantees a structured and efficient accounting process.
Reporting opportunities and risks
Identifying opportunities and risks – and swiftly capitalising upon or counteracting them – is a key objective for our Group. This is why we account for the anticipated impact of potential events and developments in our current business plan as well as in our revenue and earnings projection. In the following we primarily report those risks and opportunities which, from the current standpoint, could have an additional significant, potentially positive or negative, impact during the current forecast period.
We assess opportunities and risks based on their probability of occurrence and impact. Subsequently, we distinguish between opportunities and risks of low, medium and high relevance. We characterise opportunities and risks of medium and high relevance as significant.
The opportunities and risks described here are not necessarily the only ones the Group faces or is exposed to. Our business activities could also be influenced by additional factors of which we are currently unaware or which we do not yet consider to be material.
Opportunities and risks are identified and assessed decentrally at Deutsche Post DHL Group. Reporting on possible deviations from projections, including latent opportunities and risks, occurs primarily at the country or regional level. In view of the degree of detail provided in the internal reports, decentrally reported opportunities and risks are combined into categories below for the purposes of this report. It should be noted that the underlying individual reports – with the exception of those on the world economy and global economic output – usually exhibit a zero to minimal correlation. It is rather unlikely that a number of major opportunities or risks in a single category or across categories would occur systematically at the same time.
Unless otherwise specified, a low relevance is attached to individual opportunities and risks within the respective categories and in the forecast period under observation (2015). With respect to opportunities and risks arising from possible legal proceedings or those already underway, we generally refrain from making an assessment to avoid affecting our position in the proceedings. The opportunities and risks generally apply for all divisions, unless indicated otherwise.
Some risks arise primarily from the fact that the Group provides some of its services in a regulated market. A large number of postal services rendered by Deutsche Post AG and its subsidiaries (particularly the Post - eCommerce - Parcel division) are subject to sector-specific regulation by the Bundesnetzagentur (German federal network agency) pursuant to the Postgesetz (PostG – German Postal Act). The Bundesnetzagentur approves or reviews prices, formulates the terms of downstream access and has special supervisory powers to combat market abuse.
On 25 January 2012, the European Commission issued a ruling on the formal investigation regarding state aid that it had initiated on 12 September 2007. In its review, the European Commission determined that Deutsche Post AG was not overcompensated for providing universal services between 1989 and 2007 using state resources. It also did not find fault with the state guarantees for legacy liabilities. By contrast, in its review of funding for civil servants’ pensions, the European Commission concluded that illegal state aid had, in part, been received. It said that the pension relief granted to Deutsche Post AG by the Bundesnetzagentur during the price approval process led to Deutsche Post AG receiving a benefit, which it must repay to the Federal Republic of Germany; in addition, it must also be ensured that no benefits are received in the future which could be considered illegal state aid. The Commission furthermore stated that the precise amount to be repaid was to be calculated by the Federal Republic. In a press release, the European Commission had referred to an amount of between €500 million and €1 billion. Deutsche Post AG is of the opinion that the Commission’s state aid decision of 25 January 2012 cannot withstand legal review and has filed an appeal with the European Court of Justice in Luxembourg. The Federal Republic of Germany has similarly appealed the decision.
To implement the state aid ruling, the federal government called upon Deutsche Post AG on 29 May 2012 to make a payment of €298 million, including interest. Deutsche Post AG paid this amount to a trustee on 1 June 2012 and appealed the recovery order to the Administrative Court. The appeal, however, has been suspended pending a ruling from the European Court. The company made additional payments of €19.4 million, €15.6 million and €20.2 million to the trustee on 2 January 2013, 2 January 2014 and 2 January 2015, respectively. The payments made were reported in the balance sheet under non-current assets; the earnings position remained unaffected. The European Commission has not expressed its final acceptance of the calculation of the state aid to be repaid. On 17 December 2013, it initiated proceedings against the Federal Republic of Germany with the European Court of Justice to effect a higher repayment amount.
If the appeals issued by Deutsche Post AG or the federal government against the state aid ruling are successful, the opportunity exists that the payment of €298 million and the payments of €19.4 million, €15.6 million and €20.2 million made in addition – as well as the additional annual payments of around €19 million to be made in the future – will be returned. A repayment would only affect the liquidity of Deutsche Post AG; the earnings position would remain unaffected.
On the other hand, although Deutsche Post AG and the federal government are of the opinion that the state aid decision cannot withstand legal review, it cannot be ruled out that Deutsche Post AG will ultimately be required to make a potentially higher payment, which could have an adverse effect on earnings. More information about the state aid investigation is provided in the Notes.
On 14 November 2013, the Bundesnetzagentur determined the conditions for regulating certain mail prices requiring approval under the price-cap procedure from January 2014 to December 2018. The general rate of inflation less the productivity growth rate stipulated by the regulatory authority (X-factor) in the amount of 0.2% p.a. constitutes the key factor applicable to the price trend for these products. This would necessitate price reductions if the inflation rate in the reference period is lower than the productivity growth rate specified and permit price increases if the inflation rate in the reference period is higher than the productivity growth rate specified. On 15 October 2014, the Bundesnetzagentur approved a 1.0% increase in the average price of all price-capped products.
On 8 June 2013, the Bundesnetzagentur initiated market abuse proceedings against Deutsche Post InHaus Services GmbH, citing discriminatory access conditions for sorting and consolidation services following a complaint by one of the company’s competitors. The party filing the complaint accused the company in particular of offering other postal services providers better conditions for posting and collection than it itself had been offered. Deutsche Post InHaus Services GmbH considers the accusations to be unfounded. On 18 November 2014, the Bundesnetzagentur suspended the market abuse proceedings. It is currently unknown whether the complainant will appeal the suspension of the proceedings.
Since 1 July 2010, as a result of the revision of the relevant tax exemption provisions, the VAT exemption has only applied to those specific universal services in Germany that are not subject to individually negotiated agreements or provided on special terms (discounts etc.). Deutsche Post AG does not believe that the legislative amendment fully complies with the applicable provisions of European Community law. Due to the legal uncertainty resulting from the new legislation, Deutsche Post AG is endeavouring to clarify certain key issues with the tax authorities. Although Deutsche Post AG is implementing the required measures to a large extent, the differing legal opinions on the part of Deutsche Post AG and the tax authorities will be judicially clarified.
In light of the announced legal proceedings, we have not undertaken a risk classification.
In addition to the opportunities and risks arising from sector-specific regulation pursuant to the Postgesetz (PostG – German Postal Act), the company is subject to additional opportunities and risks arising from legal conditions.
On 5 November 2012, the Bundeskartellamt (German federal cartel office) initiated proceedings against Deutsche Post based on suspicion of abusive behaviour with respect to agreements on mail transport with major customers. Based upon information from Deutsche Post AG’s competitors and customer surveys, the authorities suspect that the company had violated the provisions of German and European antitrust law. Deutsche Post AG does not share this opinion. However, should the authorities find their suspicions confirmed, they may require Deutsche Post AG to refrain from certain practices or impose fines. Due to the on-going legal proceedings, we are not providing a risk assessment at present.
On 30 June 2014, DHL Express France received a Statement of Objections from the French Competition Authority alleging anti-competitive conduct in the domestic express business; a business which we had divested in June 2010. We are currently co-operating with the French authorities regarding the issues raised in the Statement of Objections. Due to the on-going legal proceedings, we are not providing a risk assessment.
Risks arising from macroeconomic and sector-specific conditions are a key factor in determining the success of our business. For this reason we pay close attention to economic trends in the individual regions. Despite the volatile economic climate, demand for logistics services rose in 2014, as did the related revenues.
A variety of external factors offer us numerous opportunities, indeed we believe that the global market will continue to grow. Advancing globalisation means that the logistics industry will continue to grow at least as fast as or faster than the world economy as a whole. This is especially true for Asia, where trade flows to other regions and in particular within the continent will continue to increase. As the market leader, our DHL divisions can generate above-average benefits from this. This also applies to regions such as South America and the Middle East, which continue to see robust growth. We are similarly well positioned in the emerging economies of Brazil, Russia, India, China and Mexico (BRIC+M) and will take advantage of opportunities arising in these markets.
Whether and to what extent the logistics market will grow is dependent on a number of factors. The trend towards outsourcing business processes continues. As a result, supply chains are becoming more complex and more international but are also more prone to disruption. For this reason, customers want stable, integrated logistics solutions, which is what we provide with our broad-based service portfolio. We continue to see growth opportunities in this area, in particular in the Supply Chain division and as a result of closer co-operation between all our divisions.
The booming online marketplace represents another opportunity for us in that it is creating demand for transporting documents and goods. The B2C market is experiencing double-digit growth, particularly due to the rapid rise in digital retail trade. This has created high growth potential for the national and international parcel business, which we intend to tap into by expanding our parcel network.
On the other hand, we are nonetheless unable to rule out the possibility of an economic downturn in specific regions and a stagnation or decrease in transport quantities. However, this would not reduce demand for our services in all business units. Indeed, the opposite effect could arise in the parcel business, for example, as a result of an increase in online purchasing amongst consumers. Companies might also be forced to outsource transport services in order to lower costs. Cyclical risks can affect our divisions differently with respect to magnitude as well as point in time, which may mitigate the total effect. Therefore, we consider these risks to be medium at best. Moreover, we have taken measures in recent years to make costs more flexible and to allow us to respond quickly to a change in market demand.
Deutsche Post and DHL are in competition with other providers. Such competition can significantly impact our customer base as well as the levels of prices and margins in our markets. In the mail and logistics business, the key factors for success are quality, customer confidence and competitive prices. Thanks to our high quality along with the cost savings we have generated in recent years, we believe that we shall be able to remain competitive and keep any negative effects at a low level.
As a global operator, Deutsche Post DHL Group is inevitably exposed to financial opportunities and risks. These are mainly opportunities or risks arising from fluctuating exchange rates, interest rates and commodity prices and the Group’s capital requirements. Using operational and financial measures, we try to reduce the volatility of our financial performance due to financial risk.
Opportunities and risks with respect to currencies may result from scheduled or planned future foreign currency transactions. Significant currency risks from planned transactions are quantified as a net position over a rolling 24-month period. Highly correlated currencies are consolidated in blocks. The identified risks are partly hedged using derivatives. The most important planned net surpluses at the Group level are in pound sterling, Japanese yen and Indian rupee, whilst the Czech crown is the only currency with a considerable net deficit. By offsetting the net deficit in US dollars with surpluses in other highly correlated currencies, the net risk in the “US dollar block” at the Group level is relatively balanced and thus not actively managed. The average hedging level for the year 2015 was approximately 55% as at the reporting date.
A potential general devaluation of the euro presents an opportunity for the Group’s earnings position. Based on current macroeconomic estimates, we consider this opportunity to be of low relevance.
The main risk to the Group’s earnings position would be a general appreciation of the euro. The significance of this is considered low when considering the individual risks arising from the performance of the respective currencies.
As a logistics group, our biggest commodity price risks result from changes in fuel prices (kerosene, diesel and marine diesel). In the DHL divisions, most of these risks are passed on to customers via operating measures (fuel surcharges). We only have noteworthy hedging instruments for the purchase of diesel in the Post - eCommerce - Parcel (PeP) division.
The key control parameters for liquidity management are the centrally available liquidity reserves. Deutsche Post DHL Group had central liquidity reserves of €3.8 billion as at the reporting date, consisting of central financial investments amounting to €1.8 billion plus a syndicated credit line of €2 billion. Therefore, the Group’s liquidity is sound in the short and medium term. Moreover, the Group enjoys open access to the capital markets on account of its good ratings within the industry, and is well positioned to secure long-term capital requirements.
The Group’s net debt amounted to €1.5 billion at the end of 2014. Given our existing interest rate hedging instruments, the share of financial liabilities with short-term interest lock-ins in total financial liabilities in the amount of €5.2 billion is approximately 35%. The fact that the European Central bank is likely to keep short-term interest rates at a low level during 2015 and beyond favourably impacts the risk assessment.
Further information on the financial position and finance strategy of the Group as well as on the management of financial risks is found in the report on the economic position and in the Notes.
Our Group-wide opportunity and risk management also considers environmental developments.
Our customers want to improve their carbon efficiency and be supplied with information on their CO2 emissions, which we regard as a positive trend. Such an increase in environmental awareness presents new business potential: with our mail, parcel and express products as well as air and ocean freight transport, we not only lead our industry in the areas of energy-efficient transport, transparent emissions reports and climate-neutral products, but we also offer customer-specific solutions to reduce carbon emissions.
Over the past years, the Group has ensured that its business activities are well positioned in the world’s fastest growing regions and markets. We are also constantly working to create efficient structures in all areas to enable us to flexibly adapt capacities and costs to demand – a prerequisite for lasting, profitable business success. With respect to strategic orientation, we are focusing on our core competencies in the mail and logistics businesses with an eye towards growing organically and simplifying our processes for the benefit of our customers. Our earnings projections regularly take account of development opportunities arising from our strategic orientation. In the specified period under consideration, risks arising from the current corporate strategy, which extends over a long-term period, are considered to have a low relevance for the Group. In addition, the divisions face the following special situations:
In the PeP division, we are responding to the challenges presented by the structural change from a physical to a digital business. We are counteracting the risk arising from changing demand by expanding our range of services. Due to the e-commerce boom, we expect our parcel business to continue growing robustly in the coming years and are therefore extending our parcel network. We are also expanding our range of electronic communications services, securing our standing as the quality leader and, where possible, making our transport and delivery costs more flexible. We follow developments in the market very closely and take these into account in our earnings projections. For the specified forecast period, we do not see these developments as having a significant potential to result in a negative impact.
In the Express division, our future success depends above all on general factors such as trends in the competitive environment, costs and quantities transported. After having spent recent years successfully restructuring our business and substantially improving cost structures, we are focusing on fostering growth in our international business. We expect a further increase in shipment volumes. Based on this assumption, we are investing in our network, our services, our employees and the DHL brand. Against the backdrop of the past trend and the overall outlook, we do not see any significant strategic opportunities or risks for the Express division beyond those reported in the section entitled “Opportunities and risks arising from macroeconomic and industry-specific conditions”.
In the Global Forwarding, Freight division we purchase transport services from airlines, shipping companies and freight carriers rather than providing them ourselves. Under favourable circumstances, we succeed in purchasing transport services on a cost-effective basis. We thus have the opportunity of generating higher margins. When circumstances are not favourable, we bear the risk of not being able to pass on all price increases to our customers. The extent of the opportunities and risks essentially depends on trends in the supply, demand and price of transport services as well as the duration of our contracts. Comprehensive knowledge in the area of brokering transport services helps us to capitalise on opportunities and minimise risk.
Our Supply Chain division provides customers in a variety of industries with solutions along the entire logistics chain. Our success is highly dependent on our customers’ business success. Since we offer customers a widely diversified range of products in different sectors all over the world, we can diversify our risk portfolio and thus counteract the incumbent risks. Moreover, our future success also depends on our ability to continuously improve our existing business and to grow in our most important markets and customer segments. We do not see any significant strategic opportunities or risks for the Supply Chain division beyond those reported in the section entitled “Opportunities and risks arising from macroeconomic and industry-specific conditions”.
For us to render our services, a number of internal processes need to be integrated. In addition to fundamental operating processes, these include supporting functions such as sales and purchasing as well as corresponding management. Should we succeed in aligning our internal processes to meet customer needs whilst simultaneously lowering costs, this could lead to positive deviations from current projections. We are steadily improving internal processes with the help of our First Choice initiatives. This improves customer satisfaction whilst reducing our costs. Our earnings projection already incorporates expected cost savings.
Logistics services are generally provided in bulk and require a complex operational infrastructure with high quality standards. To consistently guarantee reliability and punctual delivery, processes must be organised so as to proceed smoothly with no technical or personnel-related glitches. Any weaknesses with regard to posting and collection, sorting, transport, warehousing or delivery could seriously compromise our competitive position. We therefore adapt all processes to current circumstances as needed. We also take preventive measures to guard against disruptions or malfunctions in our operational processes. Should disruptions nonetheless occur, contingency plans will come into effect to minimise the consequences. Some risks from business interruptions are also partly protected by our insurance policies.
The security of our information systems is particularly important to us. The goal is to ensure continuous IT system operation and prevent unauthorised access to our systems and databases. To fulfil this responsibility, the Information Security Committee, a sub-committee of the IT Board, has defined guidelines and procedures based on ISO 27002, the international standard for information security management. In addition, Group Risk Management, IT Audit, Data Protection and Corporate Security monitor and assess IT risk on an on-going basis. For our processes to run smoothly at all times, the essential IT systems must be constantly available. We ensure this by designing our systems to protect against complete system failures. In addition to third-party data centres, we operate central data centres in the Czech Republic, Malaysia and the United States. Our systems are thus geographically separate and can be replicated locally.
We limit access to our systems and data so employees can only access the data they need to do their jobs. All systems and data are backed up on a regular basis and critical data are replicated across data centres.
All of our software is updated regularly to address bugs, close potential gaps in security and increase functionality. We employ a patch management process – a defined procedure for managing software upgrades – to control risks that could arise from outdated software or from software upgrades.
Based on the measures described above, we estimate the probability of experiencing a significant IT incident with serious consequences as very unlikely.
Our E-POST products – first and foremost E-Postbrief – come with our pledge of security and data protection. In 2014, the associated platform was re-certified by the German Federal Office for Information Security in accordance with its standards for IT-Grundschutz in a seamless continuation of the previous certification. In addition, the 2013 certification from TÜV Informationstechnik GmbH pursuant to the criteria for trusted site privacy is still valid. This confirms compliance with the legal standards and applicable data protection regulations.
As a mail and logistics services group, it is particularly important that we have qualified and motivated employees in order to achieve long-term success. However, demographic change could lead to a decrease in the pool of available talent in various markets. To minimise the risk of failing to acquire a sufficient number of qualified employees, we have implemented various measures designed to motivate, commit, develop and promote our employees.
We use Strategic Resource Management to address the risks arising from an aging population and the capacity shortages that may result from changing age and social structures. The experience gained is used to continuously improve this analysis and planning instrument. The Generations Pact agreed with trade unions in Germany also contributes to taking advantage of the career experience of employees for as long as possible whilst at the same time offering young people a career perspective.
Possible increases in both chronic and acute disease pose another risk to sustaining business operations. For example, an infectious disease such as Ebola that initially strikes only locally can quickly have a global impact when spreading via networked trade routes and global traffic flows. We are responding to this risk with a systematic health management programme and cross-divisional co-operation.