2019 saw “Export 2.0” – phase two of the industry export plan – published by the Scotland Food & Drink Partnership. Building on the success of phase one (2014-19), the Plan affirms the Partnership’s commitment to supporting Scottish producers as they grow their businesses, and Scotland’s biggest export.
But whether primarily exporting or producing for the UK market, the UK food and drink sector is one destined to be affected by global factors. That influence is felt most keenly in those parts of the sector reliant, to whichever extent, on agricultural commodities.
In this second of three blogs on finance, we look at pricing risk for commodities, and forward sales.
So what pricing risk do commodities face?
Cereals, livestock, dairy products, animal feed, fruit and vegetables all fall under the banner of agricultural commodities.
Whether businesses are primary producers, farming these themselves, or are secondary producers reliant on their supply for their own products (think grain for spirits), bountiful harvests, prolonged adverse weather or supply chain disruption within the UK or elsewhere in the world affect supply which, assuming consistent demand, will directly affect pricing. Where costs are – to any extent – fixed, fluctuating prices will directly affect profitability. The nature of these disruptions makes them impossible to predict and almost impossible to manage for themselves. The alternative then is to seek to create greater certainty elsewhere, in order to manage their effect on the business.
How can this risk be managed?
Forward purchases / sales
Forward contracts are one option for managing that risk. A forward contract provides that a business will buy or sell specified produce (in terms of both amount and quality) at a specified future time for a specified price. The price is set at the time the contract is entered into.
Forward contracts may be utilised by businesses to:
- provide the business with greater certainty as to future pricing and cashflows;
- allow the business to prepare more robust forecasts and budgets;
- mitigate the risk of external, global factors adversely affecting seasonal income (primary producers) or expenditure (secondary producers); and/or
- mitigate the risk of external, global factors adversely affecting key elements of the supply chain (secondary producers); and
- demonstrate appropriate risk management to the market – i.e. funders and other stakeholders.
Food for thought
As with any financial product entered into in advance, there is a risk that the financial markets move against the forward contract – i.e. prices rising (primary producers) or falling (secondary producers) such that the business would have received a better price had it negotiated it at the point of sale / purchase.
If, as likely, the business already has facilities in place with a bank or other lender, the facility documentation is likely to prevent the business from entering into a forward contract without the prior consent of the lender.
In addition, as a financial product there will be a cost associated with entering into any forward contract. That cost will require to be assessed against the particular pricing risk.
Taking the right advice
Another situation where one size does not fit all. Key factors which may drive further consideration might be the extent of the business’s exposure to one or more commodities, its diversity of income (primary producers), availability of substitutions (secondary producers) and the intended future direction of the business. Appropriate tax and accountancy advice will also be essential.
Brodies is able to assist in discussions with your existing lender, as well as advising on the interaction between existing facility documentation and a new potential finance product and/or the contractual terms of particular products. For further information please get in touch with Amy McVey or your usual Brodies contact.
The theme of Brodies Food & Drink Conference 2019 is New Markets: New Opportunities. The conference will provide an engaging forum to discuss exciting new opportunities and growth areas for the sector. For more information and to register your place please click here.
On September 11, 2019