Risk Managment
Risk report
The CENTROTEC Group has systematically focused on the topic of sustainability, and the spotlight of the group’s activities is on the development, manufacturing and sale of system solutions for the energy-efficient heating, ventilation and climate control of buildings, including the use of renewable energies. CENTROTEC’s activities thus promote the responsible use of energy, help the environment and exploit the market opportunities arising in this area. These market opportunities are created through accessing new markets or penetrating existing markets with established, improved and new innovative product solutions from such areas as condensing boiler technology, solar technology and building climate control. Integrated systems that require expertise in several product areas are also becoming increasingly prevalent.
CENTROTEC’s objective is to exploit fully the opportunities that present themselves in this context, both through organic growth and through an active acquisitions strategy, while nevertheless guaranteeing the highest possible degree of stability and risk limitation. The latter means in particular that it rigorously applies a strict set of criteria when selecting and analysing takeover options and financing and integrating acquisitions. For this strategy, CENTROTEC relies on the one hand on the extensive experience and market knowledge of its group and segment management, and on the other hand on systematically monitoring and steering the risks that this business model entails.
To monitor and control the various risk areas, CENTROTEC implements a group-wide risk management system that is constantly being refined and assessed for effectiveness. This requires all significant companies in the group to submit regular reports on the nature, likelihood and potential impact of identified risks, in accordance with the existing guidelines. Operating business is moreover closely monitored by the respective members of the Management Board. With this as the basis, it is possible to initiate an early response within the risk management system and involve various escalation hierarchies right up to the Management Board and Supervisory Board in good time, depending on the potential value of the risk, in order to avoid or hedge risks.
Risk areas
Risks from the economic environment and the industry
The business performance of CENTROTEC, too, is fundamentally dependent on the wider economic environment and on general cyclical developments, especially in Europe. With regard to its industry context, CENTROTEC operates in the area of building investment in the broader sense; in the 2011 financial year this area stabilised at a fairly low level in Europe, the group’s main sales region, in the aftermath of the global economic crisis. Germany began to see growth in both new housing construction and in the commercial construction sector in 2011 compared with the very weak previous year. On the other hand commercial construction in most other European countries experienced a marked decline in 2011. The same was true of public-sector construction activity throughout Europe. Activity in the sphere of building investment also serves as an important indicator for CENTROTEC. However, business was latterly able to detach itself to some extent from the general trend in the construction industry by focusing on energysaving solutions, of which the public is becoming increasingly aware. Irrespective of increasingly shortterm cyclical fluctuations, CENTROTEC energy-saving solutions are achieving lasting appeal for both new buildings and particularly for the retrofit and renovation market as well as for municipal projects. This effect can be attributed to long-term growth in energy-efficient building refurbishment as a proportion of the overall market, together with the increased priority given to energy-saving solutions in each construction project.
Statutory framework conditions and public subsidies nevertheless continue to have an influence. For instance a scaling-back of subsidies if the general conditions otherwise remain unchanged could lead to falling revenue or slower revenue growth. A large number of changes were made at various points throughout the year, causing considerable uncertainty among end customers. Nevertheless, with climate protection remaining as pressing a concern as ever, along with the further rise in energy prices probably to substantially higher levels in the medium to long-term and growing efforts to achieve greater energy independence, CENTROTEC does not expect any change in the fundamental framework for energy-focused building refurbishment. Other European countries, but also other parts of the world, are increasingly adopting many of the measures already practised in Germany, involving increasingly stringent requirements or higher levels of subsidies. Specifically in the area of subsidies, however, the financial crisis could prompt certain countries to freeze financial aid or suspend state measures to promote construction activity and protect the climate. Above and beyond these state incentives and directives, there will be growing awareness of and pressure on each individual to actively cut their energy costs while helping the environment, providing a useful basis for maintaining the market’s positive development. The failure of the recent years’ climate change conferences, most recently in Durban, to agree yet on far-reaching joint aims and measures will increase the pressure on both individuals and entire countries to act.
The development in prices for fossil fuels moreover has a major influence on readiness to invest in efficient heating, ventilation and climate technology and the use of renewable energies. The high price level now reached and the further rise specifically in oil, gas and coal prices expected in the medium to long term nevertheless offer more opportunities than risks. Price arguments aside, the question of independence from suppliers is a factor that should not be underestimated for those considering switching to renewable energies and making savings through energy efficiency. The current debate surrounding the exploitation of unconventional fossil fuels, and specifically the natural gas that is bound up in various types of rock, is to some degree throwing previous assumptions on the resources of fossil energy reserves and their projected price movements open to question, but so far has focused merely on technical availability and the extent of these resources. The direct and indirect impact on the environment of this form of exploitation, facilitating the continuing unharnessed use of fossil energy, is still going largely unheeded in most current studies and would substantially reduce the profitability of this form of energy if it were given suitable weight. In the prevailing conditions, however, the increased use of unconventional gas could take the edge off price rises for fossil fuels in the short term and thereby reduce the economic necessity of modernising systems or using renewables. Notwithstanding the short-term economic benefits, the increased use of such energy sources could seriously aggravate the problem of climate change and will need to be suitably addressed through policy decisions and regulations.
Corporate strategy risks
Growth through acquisitions is one aspect of CENTROTEC’s strategy. The high organic growth of recent financial years in itself harbours risks. One key challenge is to adapt the internal organisation and processes swiftly to the new, larger entity each time and to integrate the acquired or newly established, predominantly foreign businesses into the corporate structure. If ties between new entities and the existing group are too weak, a loss of transparency and control can ensue. Forcing the corporate culture onto new entities can cause employees to lose their ability to identify with products and companies, ultimately lead to a weakening of the market position and thus of the market value. CENTROTEC therefore strives for a balance between control and entrepreneurial freedom at its group companies. The dovetailing of acquired or newly established entities with the group is promoted by an overarching integration management approach and continually monitored until the entity is finally fully integrated into the group-wide mechanisms of control and steering. The structure of the group as a whole is continually scrutinised for potential for improvements that are implemented by reorganisation projects in the individual segments, in order to establish a workable basis for the continuing sustained development of the group.
Until now, the focus of business has been on core European countries, specifically in Western Europe. The overwhelming proportion of revenue is generated in the eurozone. This emphasis gives rise to limited exposure to risks from changes in foreign exchange rates. Business outside the eurozone and in othercountries outside Europe will also become increasingly important. The aim here is to establish a broader basis for sales and thus reduce dependence on the German and Dutch markets. The previously manageable risks from possible exchange rate movements are hedged selectively within the group by means of appropriate instruments. The fundamental risk of a devaluation of the euro nevertheless goes hand in hand with increased opportunities for exports to countries outside the eurozone. On the other hand, an appreciation in the value of the euro could harm the sales prospects of the group’s products, which are made predominantly in the eurozone. In this respect the goal is to reduce the risk by spreading sales markets more widely through internationalisation.
A growing international spread furthermore entails wide-ranging risks arising e.g. from changing political and legal circumstances, transport and processing risks, and cultural differences. For its further expansion, CENTROTEC relies in particular on strong local partners with extensive market and logistics expertise and knowledge of their local context. By aligning the interests of the partners involved and regularly revisiting and examining risk positions in the context of risk management, the market opportunities that arise are thus kept under control and risk minimisation is gradually optimised.
Risks from operating business
CENTROTEC addresses the potential risks in the operating sphere of the group’s individual companies through extensive, ongoing measures.
Reliable deliveries, in particular for supplies procured internationally, are assured on the one hand through close technical cooperation with important suppliers and on the other hand by maintaining at least two sources of supplies in each case. Rising procurement prices constitute another potential risk at the procurement end. Depending on the segment and product area, this risk is controlled by methods such as shoring up long-term supplier relations and corresponding price agreements, and by continually observing the market and optimising procurement sources. Price developments in commodity and supply markets are being actively monitored; at the same time potential for compensating for price increases is being identified through the group-wide profitability improvement programmes and suitable improvements implemented.
Potential risks within the production or service areas of the group companies are addressed by means of internal guidelines drawn up at the level of the individual companies, and certification to international quality standards such as ISO 9001, ISO 14001 and ISO TS 16949. However, in line with CENTROTEC’s strategy and as a reflection of their broad operational leeway, the individual group companies always take the most rigorous quality standards in their specific sectors as the benchmark. To safeguard product quality and minimise the associated risks, quality-critical components of CENTROTEC products are subjected to comprehensive quality checks both during the entire production process and in the end products. The methods and systems used to this end are examined and regularly updated in line with the latest standards. The risk of accidents and plant breakdowns is countered by providing suitable training for customers and employees, and implementing accident prevention regulations and task instructions. The risk of production plant breakdowns is addressed by preventive maintenance and ongoing monitoring of the operating parameters. Plant itself is insured against potential forms of loss in line with its value.
The development of innovative products fundamentally entails the risk that the desired outcome may not be achieved despite the expending of considerable resources. To minimise this fundamental development risk, intensive exchanges and peer reviews of product development activities take place between the individual group companies, as does very intensive market analysis. The internationally growing sales organization is also increasingly called upon to contribute its market knowledge. This helps to identify off-target developments at an early stage and gives top priority to market-led product development work. All capital investments and development projects are in addition evaluated intensively and promptly in the context of group-wide development activities, looking at the overall portfolio and the individual opportunities and risks involved.
At the sales end, there is the potential risk of the loss of important customer relations, in particular with key accounts. Dependence on individual customers is fundamentally reduced by focusing predominantly on products for end users. For example CENTROTEC’s biggest customer accounted for around 3 % of consolidated revenue, with all other customers well below that figure. At the level of the group companies, this threshold is nevertheless exceeded in individual cases. The loss of contact for instance with a wholesale or key account fundamentally always has a palpable impact on revenue and earnings for both the group and the group company. This risk of dependence is countered by active management of customer relations and by diversifying the sales channels in the various markets. These tasks involve continually monitoring the sales channels in the individual segments and countries for scope for expansion in line with the strategy. Revenue dependence on individual customers has furthermore fallen along with the growth already realised, and will continue to decline hand in hand with the future growth that is being targeted.
There is a further risk in the sales sphere from the growing pressure on the prices of CENTROTEC products, in particular from existing or new competitors. CENTROTEC believes it is in a strong position in its various segments thanks to its existing technological lead and the market position it has already achieved. The product portfolio is moreover regularly scrutinised for potential for innovations that will safeguard and extend its competitive position. Although there exists an overall risk of price pressure on CENTROTEC products, positions have been achieved and mechanisms set up to keep this area of risk under control.
The customary insurance cover has been taken out to minimise the general risks from operating business. This includes in essence business interruption, business liability, legal protection, business and property, credit sale, loss of earnings and serial losses insurance, as well as D&O cover for Management Board members, managing directors and non-executive directors. There is in addition special property insurance cover (damage by the elements) for warehouses.
Personnel risks
There fundamentally exists the potential risk of losing managers and employees in key positions, with the corresponding consequences for the company. CENTROTEC addresses this potential risk on the one hand by adopting a sensitive approach to the integration of newly acquired entities (see “Corporate strategy risks”) and on the other hand by diversifying its personnel base as part of developing the grouporganisation as a whole. The further development and regular training of employees in their individual specialist areas are promoted, and the independent initiative of employees to develop and implement new approaches and methods is encouraged. As a result, CENTROTEC is able to offer its employees longterm perspectives for development and thus helps to minimise fluctuation in key positions by giving its employees a high level of job satisfaction. These are important measures for guarding against a general future risk of shortages of specialists; this risk is also specifically addressed by training measures for young people that are tailored to the needs of the individual group companies. CENTROTEC furthermore enables Management Board members, managers and employees in key positions to share financially in the group’s long-term growth prospects through the group-wide stock options scheme, boosting loyalty
to the group by means of such a long-term incentive system.
In addition, specifically at times of general economic buoyancy there is the risk of excessive rises in costs in the personnel area as a result of high wage and salary increases. This risk is countered by active personnel costs management and trust-based partnership between the workforce and the management in a spirit of mutuality. The consequences of potential high pay settlements are also cushioned by further revenue rises and the ongoing optimisation of processes throughout the group, but may fundamentally lead to greater pressure on earnings.
Information technology risks
In the domain of information technology, the possibility cannot fundamentally be excluded that problems will arise with existing systems or future extensions to existing systems, such as introductions of new software releases, or that system failures will hamper business operations. The customary precautions and security measures in the IT sector are adopted to limit these risks. The appropriateness of the security measures in information technology is regularly checked and the systems and processes in use adapted to changing requirements if necessary. In addition, a cautious migration approach is adopted for the integration of new business units to avoid major risks to business operations, for instance as a result of incompatibility between systems or inadequate reflection of specific business features. Furthermore, the number of systems used throughout the group is progressively being reduced to avoid possible errors or incompatibility and further optimise systems maintenance.
However, the operating units are increasingly integrated at systems level in line with their business requirements. A topical example is the roll-out of a joint ERP system in all companies of the Gas Flue Systems segment from 2009; three further companies were migrated to the new joint system in 2011.
Financial risks
Financial risks for CENTROTEC result largely from the use of borrowed capital for financing its growth, and especially its acquisitions. The opportunities successfully taken in the past to generate high, steadily rising earnings in this way go hand in hand with the potential risk of falling or even lost earnings, with the corresponding financial consequences. In the financing of external growth, CENTROTEC limits the risk it bears by fundamentally restricting it locally to the entities in question (ring-fenced financing) and subjects the current and future profitability of all corporate entities and compliance with the relevant financial ratios to comprehensive profit and earnings controlling. Deviations are thus rapidly identified and any corrective measures needed can be implemented promptly and thoroughly. For financing, the interest rate risks for mostly variable-rate loans are hedged predominantly by means of interest rate derivatives. In the past, CENTROTEC has in addition paid back borrowings according to schedule in order to minimize the resulting financial burdens and maintain sufficient financial leeway.
CENTROTEC responded swiftly to the potential risk of more limited access to financing from the banking sector following the financial crisis, and in 2008 realised an overall concept to safeguard the group’s short and long-term financing for the next few years. Adjustments to financing are made as required within the individual groups, in line with the needs arising from those groups’ business operations and the funding requirements. Together with the substantial reduction in borrowings over the past few years, there are consequently adequate reserves to keep pursuing the development of the group under our own momentum, with additional leeway for seizing any external options that might present themselves.
For more detailed information on the financial situation of the CENTROTEC Group, we refer to the Notes to the Consolidated Financial Statements from page 86.
Miscellaneous risks
The supplying and selling of products, plant and services may expose the CENTROTEC Group and its individual companies to legal risks due to the possibility of deliveries not being as per agreement, along with product liability claims, product defects, quality problems, breaches of intellectual property or the failure to comply with fiscal regulations. Despite a comprehensive quality management activities and corresponding regularly optimised organisational structures, such risks cannot be ruled out altogether. To guard against this exposure, warranty provisions are created to the customary extent for our business operations and corresponding product liability insurance cover is taken out, based on figures from experience of failures and corresponding warranties for potential customer claims, and to reflect potential accountability. All customer complaints are moreover systematically checked and processed, then investigated with a view to identifying scope for internal optimisation.
There are currently no cases of litigation pending that could entail significant financial obligations, including ones which could threaten the enterprise as a going concern.
The existing 26.14 % interest in CENTROSOLAR is recognised using the equity method at EUR 7.4 million as at the end of 2011. The result for CENTROSOLAR consequently impacts CENTROTEC’s income statement through the investment result, and thus has a direct but non-cash effect on the group’s earnings before tax; the accumulated figure is recognised in the investment value. The maximum risk is therefore limited to the recognised investment value.
Directors’ assessment of the risk situation
The assessment of the risk situation of the CENTROTEC Group is based on ongoing risk management, for which the company management discusses the status of risks and their possible impact and approves any necessary corrective measures, as well as ensuring that the operating units are closely monitored by the appropriate Management Board members. The fundamental risks to business include a great many external risks which the company is unable to influence directly, but the probability and potential impact of which are analysed regularly. There are in addition potential risks attributable to internal factors, for which the management has created instruments and methods so that they can be identified early on and measures to prevent or curb their effect implemented.
The risks mentioned here do, however, go hand in hand with numerous opportunities, which are described in greater detail in the outlook and the reports on the segments. As matters stand the management regards the opportunities and risks profile as balanced, with no risks to the company as a going concern.In 2011, the core areas of the group made positive progress and peripheral activities that were experiencing problems were terminated. The detailed current and anticipated future developments in the individual areas of business have been described at length in the segment reports. The overall economic situation in Germany was fundamentally stable in 2011, though the economic environment in other sales markets was in some cases much more difficult. Both globally and nationally a mixed pattern is emerging for 2012, and the ongoing uncertainty prompted by the sovereign debt crisis means another recession but potentially also another crisis could occur. This may spread throughout an entire region, or simply affect individual countries. At the start of the 2012 financial year the direction of the economy as a whole is not foreseeable because of the unresolved euro crisis and the many economic challenges that exist worldwide, nor can the consequences for the markets addressed by CENTROTEC be predicted. All in all, however, even if certain sales markets experience an economic slowdown, the unabated rise in energy consumption means the significance of energy conservation and climate protection in the form of innovative system solutions in buildings is likely to continue rising worldwide. In order to seize the opportunities that arise from this situation, CENTROTEC has a broad-based market position and an innovative product range. Moreover, as repeatedly demonstrated in the past, the group companies are capable of rising to the challenges of an increasingly difficult market through the flexibility that their cost structure and cash flow gives them. The options available to it include using the flexibility that exists within its production capacity to hire temporary workers and apply flexible working hours models, as well as continually reassessing and adapting investment spending in order to increase capacity and access to new markets in response to demand. As in the past, CENTROTEC will very carefully examine the acquisition options that continue to be available, and will assess such propositions specifically in terms of their viability in the current rapidly changing economic climate. The group’s ongoing profitability improvement programmes will moreover focus on optimising materials and commodities procurement costs in order to actively confront current and future price rises.