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 /  /  / Individual Risks

Individual Risks

Business unit allocations
The main price and procurement risks inherent in the raw materials and energy required primarily affect the Strip Steel, Plate / Section Steel and Mannesmann business units in the Salzgitter Group. This is similarly applicable to production downtime risks relating essentially to key plant equipment and machinery such as the rolling mills. The economic risks for companies belonging to the corporate finance and fiscal group are coordinated and controlled by the management holding across all business units.

Sectoral risks
Starting with macroeconomic changes in the international markets, the trends of

  • prices on the sales and procurement markets,
  • energy prices and
  • the exchange rates (above all USD – EUR).

are particularly significant for the Salzgitter Group.

In order to minimize the associated business risks, we monitor the relevant trends and take account of them in risk forecasts. This is also true of potential restrictions resulting from financial or political measures affecting international business. Uncertainty prevails as to how this situation will develop.

Our business is burdened by the ongoing structural crisis in the steel market, massive competitive distortions from direct and indirect nationalization, and foreign policy developments. This is compounded by the UnitedKingdom leaving the EU (“Brexit”), the political imponderables from the Russia-Ukraine conflict, in Turkey and in the Near and Middle East, as well as by the direction the US trade policy may take in the future. We regard the persistently high import pressure as well as Germany’s respective European energy and environmental policy as particularly serious factors of influence for our future development. Risks to the survival of the company may arise under certain circumstances from these scenarios.

A burdening effect is meanwhile also emanating from the numerous, often purely trade defense mechanisms from countries outside the EU that are no longer aimed at China alone but similarly at EU producers. SZAG is directly affected by an ongoing antidumping lawsuit in the US against heavy plate and wide strip imports from Germany, among other countries. On November 7, 2016, the US Department of Commerce imposed preliminary duties. A preliminary duty of 5 % was imposed on SZAG. A decision on final duties is anticipated at the end of March 2017.

SZAG produces rolled steel and steel tubes as well as focusing on trading as well as plant and machinery engineering. This broad-based holding portfolio goes some way to reducing the Group’s dependency on the strongly cyclical nature of the steel industry. We limit risks from changes in the steel and tubes markets by ensuring fast decision-making processes which allow us to adapt rapidly to new market conditions.

Policies on the climate and energy, the German Renewable Energies Act (EEG), along with emission trading and energy systems, for instance, are already causing burdens today. Compared with the status last reported, there has been a reevaluation of the risk situation to factor in considerations that the EEG was adjusted with effect from January 1, 2017, with consequences for electricity generated for own consumption. This amended version ultimately rules that the exemption on electricity generated for own consumption from the EEG levy will be basically retained in the future. Only if, for example, a power generating system or generator is replaced or significantly upgraded in a power plant will this trigger a proportion of 20 % of the EEG levy on the electricity produced from such a system or part of a system in the future. Due to this amendment, we therefore retract the respective risk estimated and quantified at € 139 million a year. Additional costs already foreseeable in this context at a significantly lower level compared with the former risk assessment have been included in the planning. The background to this scenario is in particular that the Group’s most important power generating unit, namely the power plant of Salzgitter Flachstahl GmbH (SZFG), was extensively upgraded only a few years ago. We are not anticipating more major replacements or significant upgradings in the area of power production.

Furthermore, our Group will likely have to purchase CO2 allowances for the fourth ETS trading period commencing 2021. Indirectly associated in this context is the risk of a price increase in the electricity sourced externally. In terms of these two aspects, we still assess risk to be in the order of a maximum € 155 million a year. We view the probability of occurrence of the CO2 emissions trading issue as generally likely. The amount of loss will hinge on the development of the political environment. The proposal to adjust the Emissions Trading Directive from 2021 onward put forward by the EU Commission in mid-2015 and the results in the meantime from the committees of the European Parliament have likely increased the fundamental probability of burdens of this kind occurring.

In the procurement of CO2 allowances, we keep an eye on the threat of escalation in the current legal situation and prices.

Beginning with the cost aspect, using all energy sources sparingly is an important aspect for us, which is why we operate intensive groupwide energy monitoring.

Price risks of essential raw materials
During 2016, price trends on the international procurement markets were of a heterogeneous nature. Whereas iron ore largely remained within a price band similar to 2015, coking coal saw an absolute price rally from the summer onward. We assume that burdens can be passed on to customers, so that we do not anticipate any risks that could constitute a threat to our company as a going concern. We fundamentally endeavor to even out fluctuations in the price of raw materials through natural hedging: The Group applies a permanent system of monitoring sales and procurement to ensure congruence between the fixed-price procurement of raw materials and the fixed-price sale of our products. This system allows changes to be recognized at an early stage so that any resulting risk can be dealt with in time. In addition, we use hedging to a limited extent mainly for iron ore as well as increasingly for coking coal.

Procurement risks
We counteract the general risk from supply shortfalls of raw materials (iron ore, coal) and energy (electricity, gas) by safeguarding their procurement, firstly by way of long-term framework contracts, and secondly through ensuring our supply from several regions and/or a number of suppliers. In addition, we also operate appropriate inventory management. Our assessment of our supply sources confirms our opinion that the medium-term availability of these raw materials in the desired quantity and quality is ensured. We procure our electricity largely on a contractually secured basis if our needs exceed our own generating capacity. In addition, we have established a groupwide project to sustainably enhance energy efficiency. In order to be equipped for power cuts, though infrequent, we invest in particularly sensitive areas, such as emergency power generators in the computer center. For the reasons cited above, we believe that supply bottlenecks are unlikely, and no adverse effects are therefore anticipated. We keep abreast of the further growth of renewable energies in order to detect potential medium-term risks to the stability of our supply.

The scheduled and punctual rail transport of iron ore and coal from the international port in Hamburg to the Salzgitter site is especially important. Our contractual partner in guaranteeing this logistics task is DB Cargo AG, the freight subsidiary of Deutsche Bahn AG. We have developed a detailed contingency plan to deal with any adverse effects, such as strikes. This plan includes foresighted stockholding and intensive coordination between DB Cargo and ourselves to keep train transport running regularly to the greatest possible extent. Another viable alternative is the more intensive use of the railway facilities owned by the Group, as well as resorting to inland waterways to transport partial shipments. Moreover, we counteract possible constraints that could hinder the supply of materials by rail at the weekend and public holidays through closely coordinating activities with railway operators or opting to use our own means of transport more intensively.

Selling risks
A risk typical of our business may also result from sharply fluctuating prices and volumes in our target markets. In assessing the current economic environment with regard to the outlook for the financial year 2017, we refer to the section entitled “Overall Statement on Anticipated Group Performance”.

We counteract the general risk to our company as a going concern by maintaining a diversified portfolio of products, customer sectors and regional sales market to achieve a certain balance in our risk portfolio. Owing to the aforementioned steel crisis and uncertainty in the project business on the large-diameter pipes market, the economic impact on the individual business units is not fully offset, even given an improvement in capacity utilization.

Financial risks
Our management holding defines the financial structure. It coordinates the funding and manages the interest rate and currency risks of companies financially integrated into the Group. The risk horizon that has proven to be expedient is a rolling period of up to three years aligned to the planning framework. The guidelines issued require all companies belonging to the group of consolidated companies to hedge against financial risks at the time when they arise. For instance, risk-bearing open positions or financing in international trading must be reported to Salzgitter Klöckner-Werke GmbH (SKWG) by the respective subsidiaries. SKWG then decides on hedging measures, taking account of the Group’s exposure at the time. On principle, we permit financial and currency risks only in conjunction with processes typical to steel production and trading. Please also see the sections on “Currency risks” and “Interest rate risks”. The financial risks are clearly relative when taken in proportion to the operating risks.

Currency risks
Our procurement and sales transactions in foreign currencies naturally harbor currency risks. The development of the dollar, for instance, exerts a major influence on the cost of procuring raw materials and energy, as well as on revenues in the tubes business or in mechanical engineering, for example. Although the effects are mutually counteracting, the need for dollars for procurement activities predominates owing to the business volumes that vary greatly. We generally set off all EUR–USD denominated cash flows within the consolidated group, a process known as netting, thereby minimizing currency exposure.

To limit the volatility of financial risks, we conclude derivative financial instruments with terms whose value develops counter to our operational business. The development of the market value of all derivative financial instruments is regularly ascertained. Moreover, for the purpose of the annual financial statements, we simulate the sensitivity of these instruments in accordance with the standards laid down under IFRS 7 (see the section entitled “Notes to the Consolidated Financial Statements”). Hedging arrangements are not disclosed as hedge accounting positions in the accounts.

We do not hedge translation risks arising from the converting of positions held in a foreign currency into the reporting currency, as these are of secondary importance in relation to the consolidated balance sheet. More information can be found in the “Notes to the Consolidated Financial Statements”. As a result of the preventive measures, we believe that currency risks do not constitute a threat to the company as a going concern.

Default risks
We counter our receivables risks by practicing stringent internal exposure management. We limit around two-thirds of these risks through trade credit insurance and other collateral. We monitor the unsecured positions meticulously as well as evaluating and taking them into account in our business transactions.

Liquidity risks
The management holding monitors the liquidity situation within the Group by operating a central cash and interest management system for all the companies that are financially integrated into the Group. This system defines internal credit lines for the subsidiaries. If subsidiaries have their own credit lines, they are responsible for minimizing the associated risk themselves and for reporting on potential risks in the context of the Group management and controlling structures. Risks may also arise from the necessary capital and liquidity measures taken on behalf of the subsidiaries and holdings if their business should develop unsatisfactorily in the longer term. We do not, however, anticipate any burdens from this area of risk that could constitute a going concern risk. We counteract this risk by means of rolling liquidity planning. In view of the cash and credit lines available, we do not perceive any danger to our Group as a going concern at this time.

Interest rate risks
The cash and cash equivalents item, significant in relation to the balance sheet total, is exposed to interest rate risk. Our investment policy is fundamentally oriented toward investment categories with appropriate credit ratings while, at the same time, ensuring the availability of the assets. In order to monitor the interest rate risk, we regularly conduct interest rate analyses the results of which are directly incorporated into investment decisions. On the liabilities side of the balance sheet, a further decline in the yields of first rate corporate bonds could in particular cause a further increase in the pension provisions needing to be formed. Should this risk occur – the assumption being that the scope will be limited given the already historically low interest rate level – the Group’s robust balance sheet forms a sound basis for compensatory measures.

Tax risks
The recording and documenting of tax risks are carried out by the companies integrated into the tax group in close coordination with the holding company’s tax department. SZAG, Salzgitter Mannesmann GmbH (SMG) and SKWG are responsible for provisioning, for example, in respect of the risks inherent in audits conducted on their tax group. Subsidiaries taxable as individual entities, above all international companies belonging to the Trading, Mannesmann and Technology business units, are responsible for their own provisioning. Provisions have been set up to cover any identifiable tax risks.

Since the spring of 2014, the Braunschweig public prosecutor’s office has been investigating various Group companies on grounds of suspected tax evasion. The investigation proceedings concerning the formation of allegedly fiscally impermissible provisions, the non-capitalization of acquisition and manufacturing costs from a tax standpoint, as well commission payments and credit notes not recognized under tax legislation, are ongoing. SZAG and its subsidiaries are cooperating unconditionally with the investigating authorities and have hired external attorneys to investigate the matter comprehensively. We believe that the tax returns in question submitted by the Group companies are in compliance with the statutory regulations. In view of knowledge currently available, and taking the overall circumstances into account, there is no serious or overwhelming probability of claims being asserted in excess of the amounts already set aside against group companies from the investigation proceedings.

Production downtime risks
We counteract the risk of unscheduled, protracted downtime of our key plant equipment and machinery through regular plant and facility checks, a program of preventive maintenance, as well as a continuous process of modernization and investment. In order to contain other potential loss or damage and the associated production downtime, as well as any other compensation and liabilities claims, the Group has concluded insurance policies that guarantee that the potential financial consequences are curtailed. The scope and content of insurance cover is reviewed on an ongoing basis and adjusted, if necessary. We consider the probability of events occurring that are not covered by appropriate insurance – and the associated potential loss – to be manageable.

Legal risks
In order to exclude potential risks arising from a possible breach of the manifold fiscal, environmental, competition-and corruption-related rules and regulations and other legal provisions we require our employees’ strict compliance. The Executive Board has communicated its fundamental set of values by distributing a Code of Conduct to all the Group’s employees. We seek extensive legal advice from our experts as well as, on a case-by-case basis, from qualified external specialists. Comprehensive training supports the process of raising our employees’ awareness of this aspect. In our opinion, there are no discernible material legal risks.

Personnel risks
SZAG actively competes on the market to attract qualified specialists and managers. The company counters the risk of fluctuation and the associated loss of knowledge by means of broad-based measures designed to develop its personnel. To this end, specialist career paths have been explicitly introduced with the aim of creating appropriate career prospects for our specialists. In our knowledge transfer, which is applied groupwide, we have developed an instrument that, in the case of successor staff, ensures continuity in the transfer of all knowledge-based information, contact and business connections pertaining to the respective professional activity. Moreover, we also offer attractive company pension schemes that, given the dwindling benefits under the state pension scheme, are becoming increasingly important.

We initiated the “GO – Generation Campaign 2025 of Salzgitter AG” back in 2005 against the backdrop of demographic trends with the aim of responding in good time to the impact of these trends on our Group, thereby securing our innovative strength and competitiveness in the long term. The project is focused on the systematic preparation of all employees for a longer working life. Given our manifold measures, we believe that we are well prepared in this area of risk.

As of January 1, 2014, SZAG and its domestic Group companies carried out the examination on adjusting company pensions prescribed under Section 16 of the German Occupational Pensions Improvement Act (BetrAVG). The financial position of each individual company is definitive for the adjustment decision. Given the unsatisfactory financial situation, the pensions awarded by several Group companies were not adjusted as of January 1, 2014. A model procedure was signed with IG Metall for the purpose of reducing legal costs. Under this agreement, the decision-making principles of the legally valid model procedure are to be transferred to other employees with pension expectancies of the respective companies.

In the meantime, judgments that are not yet final have been made in the court of first instance in four model proceedings.

Full subsequent adjustment to company pensions as of the reporting date of December 31, 2016, would result in an increase in the capitalized net pension obligation of around € 31.8 million. Of this amount, € 7.3 million would have to be reported as past service charge through profit and loss and € 24.5 million without effect on income in the context of revaluations. Transfers in companies for which the respective provisions were formed in the financial years 2015 and 2016 respectively have not been taken into consideration.

Product and environmental risks
We meet the challenge of product and environmental risks with a multitude of measures aimed at securing quality. Examples include:

  • certification in accordance with international standards,
  • continuous modernization of plants,
  • ongoing development of our products,
  • quality assurance integrated into processes and
  • comprehensive environmental management.

Right at the manufacturing stage we aim to supply our customers with the agreed specifications, ensured through quality assurance systems.

SZAG’s head of Environmental Protection and Energy Policies is tasked with centralizing and coordinating environmental and energy policy issues affecting all companies, representing the Group externally in matters relating to the environment and energy policies, and managing individual projects affecting the whole Group, as exemplified by the program to sustainably raise energy efficiency.

Risks from owning land and property may arise, particularly from inherited contamination. We counteract these risks, for instance, by fulfilling our clean-up duties. In terms of financial precautions, an appropriate amount of provisions are formed. To our knowledge there are no unmanageable circumstances arising from this type of risk.

Information technology risks
The growing integration of information systems, also in the context of “Industry 4.0”, and the demand for their permanent availability place increasingly greater requirements on the information technology (IT) and the IT infrastructure deployed.

We counteract potential risks and guarantee the availability and security of our information systems by using cutting-edge hard- and software and ensuring the ongoing technological upgrading of our IT infrastructure.

In the context of a multi-year program, the Group is endeavoring to harmonize IT structures that have evolved heterogeneously over time with a view to replacing them by a largely standardized EDP infrastructure. The first sub-projects under this harmonization process have already been completed. Alongside the necessary economic aspect, the compatibility and security of the IT systems and databases are guaranteed. The risks from this area are deemed manageable, and we estimate the probability of an adverse event occurring to be low.

Corporate strategy risks
We invest regularly in securing our future profitability. More detailed information on the individual business units is included in the section on “General Business Conditions and Performance of the Business Units”. We nevertheless see the need for restructuring for market and competitive reasons. We are addressing this in a targeted manner (reorganization of the heavy plate product segment [Ilsenburger Grobblech GmbH and Salzgitter Mannesmann Grobblech GmbH], termination of sheet piling activities [HSP Hoesch Spundwand und Profil GmbH], reorganization of the Mannesmann product segment [completed at the EUROPIPE Group, Dunkirk location, in the process of implementation at Salzgitter Mannesmann Line Pipe GmbH and the Salzgitter Mannesmann Precision Group]). We consider the risks inherent in this restructuring to be manageable.

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