3. Capital and financial risk management

Net debt, which is calculated as the difference between interest-bearing liabilities and cash and cash equivalents and marketable securities, decreased by CHF 6 million to CHF 232 million in the year under review (previous year: CHF 238 million). The reason for this slight decrease was primarily related to the free cash flow (CHF 132 million) minus the dividend payments to GF shareholders and minority shareholders amounting to CHF 114 million.  

The following table shows in detail the various categories of other financial liabilities by currency and interest rate:

In the year under review GF concluded a new syndicated loan agreement:

The syndicated credit line provides the GF Corporation with the financial flexibility to swiftly act as for instance in the case of acquisitions and was not drawn at the end of the year. In addition to other terms, the syndicated credit line is subject to a covenants with respect to the net debt ratio (ratio of net debt to EBITDA). The conditions of the syndicated credit line are considered to represent standard conditions for such types of arrangements.

The bonds placed on the market as well as the syndicated credit line are subject to standard cross-default clauses, whereby the outstanding amounts may all become due if early repayment of another loan is demanded of the company or one of its main GF Corporate Companies owing to a failure to meet the credit terms. As of the balance sheet date, the effective credit terms had been met.

The interest-bearing financial liabilities also include loans payable to employee benefit plans in the amount of CHF 1 million (previous year: CHF 4 million). 

Financial liabilities comprise bank loans, mortgages, and bonds. They are recognized at their amortized cost. Borrowing costs are recognized in the income statement using the effective interest method. Borrowing costs that can be allocated directly to the construction, build-up, or purchase of a qualifying asset are capitalized as part of the acquisition or manufacturing costs of the asset.

Assets pledged or restricted on title in part or whole amounted to CHF 12 million (previous year: CHF 16 million).

In the year under review, CHF 3 million (previous year: CHF 8 million) of pledged assets related to land and buildings. The decrease of CHF 4 million mainly arose from Hakan Plastik AS in the GF Piping Systems division. The company adjusted its financing structure.

CHF 1 million related to machinery and equipment (previous year: CHF 2 million), while CHF 5 million related to accounts receivable (previous year: CHF 6 million). There are no pledged or assigned inventories.

CHF 3 million related to liquid assets (previous year: CHF 0 million). The increase of CHF 3 million mainly arose from the Chinaust companies in the GF Piping Systems division. The companies have assigned cash deposits for the issuance of bankers drafts.

The assets are pledged or restricted on title as collateral for bank loans.

Liabilities relating to financial lease contracts in the amount of CHF 11 million (previous year: CHF 14 million) were mainly due to the leasing of machines by GF Piping Systems and GF Casting Solutions. The leasing obligations are included in “Other financial liabilities at fixed interest rates” and are disclosed in note 3.1 (3.1.1 Interest-bearing financial liabilities).

The present value of finance leases is recognized in the non-current assets and in the other financial liabilities on the balance sheet when most of the contractual risks and rewards have been transferred to the GF Corporate Company. Lease installments are divided into an interest and a repayment component based on the annuity method. Assets held under such finance leases are depreciated over the shorter of their estimated useful life and lease term. Operating lease installments are reported in the income statement under operating expenses.

As of 31 December 2019, the share capital comprised 4’100’898 registered shares with a par value of CHF 1 each. Total dividend-bearing nominal capital amounted to CHF 4’100’898.

The main equity ratios developed as per following table:

The Corporation uses two ratios to monitor equity: the equity ratio and the return on equity. The equity ratio represents equity as a percentage of total assets. Return on equity is net profit expressed as a percentage of average equity. These ratios are reported to the Executive Committee and the Board of Directors on a regular basis. While the total equity increased, total assets reduced resulting in an increase of the equity ratio to 43.0% (previous year: 41.5%).

GF strives to maintain a strong balance sheet with equity ratio of 35% to 40%. The target for return on equity is above 15%.

Current financing arrangements do not include financial covenants requiring a minimal capital requirement (absolute amount in CHF). Current financial covenant include a minimum equity ratio (relative measure). As per 31 December 2019, the financial covenants were not breached.

The Board of Directors presents a proposal for the appropriation of retained earnings to the Annual Shareholders’ Meeting. Over the medium term, the target is to distribute between 30% and 40% of the consolidated net profit to shareholders. 

For the financial year 2019 the Board of Directors is proposing to the Annual Shareholders’ Meeting a dividend payment out of the retained earnings of CHF 25 in total per registered share (previous year: CHF 25 in total per registered share).

Until 17 April 2020, the maximum authorized share capital is CHF 600’000 divided into  600’000 registered shares each with a par value of CHF 1. The conditional capital consists of a maximum of 600’000 shares divided into 600’000 registered shares each with a par value of CHF 1.

The maximum amount of the authorized or conditional capital is reduced by the amount that authorized or conditional capital is created through the issue of bonds or similar debt instruments or new shares.

Reserves that cannot be distributed to the shareholders amount to CHF 83 million (previous year: CHF 90 million).

The GF Corporation buys treasury shares to meet its obligation under the different share-based compensation models offered to the Board of Directors, the Executive Management and the Senior Management. For further information on share-based compensation for the Board of Directors and the Executive Management see Compensation Report and note 4.3.

Treasury shares are recorded at average acquisition cost as a negative position in equity. Gains or losses arising from the disposal of treasury shares are taken to the capital reserves.

Enterprise risk management as a fully integrated risk management process was systematically applied in 2019 at all levels of the GF Corporation. The three Divisions, the Corporate Staff and all significant GF Corporate Companies prepared a risk map in May and November including the key risks in the areas of strategy, markets, operations, management and resources, financials as well as sustainability. The likelihood of the risk occurring was classified into four categories. Where possible and appropriate, the identified risks were subject to a quantifiable assessment, taking into consideration any measures already implemented. Alternatively, a qualitative assessment of the risk exposure was applied.

The risk council, consisting of representatives of the Divisions and the Corporate Staff and headed by the Chief Risk Officer, held two meetings. Main content of the discussions were the enhanced handling of cyber risks and the execution of adequate measures as well as the optimization of the sustainability risk reporting. In addition, the divisional risk maps were closely analyzed.

In accordance with the semi-annual risk reporting process, the Executive Committee and the management of the Divisions discussed the risk maps twice. They defined, at the appropriate level, the key risks of the GF Corporation, the Divisions and the Corporate Companies, and determined adequate measures to mitigate those risks. The Board of Directors has reviewed the enterprise risk management most recently in February 2020 and analyzed the corporate and divisional risk maps as well as defined the key risks and the risk mitigation measures.

The multi-stage procedure, including workshops at division management, Executive Committee and Board of Directors level, has proven to be very effective, as has having Internal Audit assess the risk maps prepared by the GF Corporate Companies.

Following key risks were identified: slow-down of the economic growth due to political and economic uncertainties, mainly in China, the impact of the lower automotive sales in Europe on some GF Casting Solutions plants in Europe and cyber risks. Measures to reduce these and other risks were defined and are being implemented in line with the strategic targets of the Corporation and the three Divisions.

The Board of Directors bears ultimate responsibility for financial risk management. The Board of Directors has mandated the Audit Committee with monitoring the development and implementation of the risk management principles. The Audit Committee reports regularly to the Board of Directors on this matter. The Audit Committee is supported by the Head of Corporate Controlling and Investor Relations in this task.

The financial risk management principles are designed to identify and analyze the risks to which the Corporation is exposed and to establish appropriate control mechanisms. The principles of financial risk management are regularly reviewed, taking into consideration changes in the relevant financial markets and in the Corporation’s activities.

Through its different business activities, the GF Corporation is exposed to various financial risks such as credit risk, market risk (including currency risk, interest rate risk, and price risk), and liquidity risk. The following sections provide an overview of the extent of the individual risks as well as the goals, principles, and processes employed for measuring, monitoring, mitigating and managing the risks.

As per balance sheet date, the maximum amount of credit risk including off-balance sheet commitments was as follows:

Cash is predominantly deposited with leading Swiss, German, US and Chinese banks with a credit rating of at least BBB– (Standard & Poor’s). Further and in accordance with the investment policy, all financial transactions are only entered into with counterparties deemed creditworthy. In addition, cash holdings are allocated to different banks in order to limit the counterparty risk. The maximum amount of cash to deposit with a bank is defined in relation to its credit rating. Cash deposits, current accounts and cash investments have a maturity of less than three months.

Transactions involving derivative financial instruments are only entered into with counterparties with at credit rating of at least BBB– (Standard & Poor’s). The purpose of such transactions is to hedge against currency risks.

The risk of concentrated credit risks on trade accounts receivable is limited due to the large number of customers and their wide diversification across industries and regions. The extent of credit risk is determined by individual characteristics of the customers and in order to assess this risk, the creditworthiness of customers is assessed on a regular basis.

The maximum credit risk on financial instruments corresponds to their carrying amounts. No additional arrangements have been entered into, that would increase the risk above the carrying amounts.

The table below shows the foreign currency forward nominal and market values of the foreign currency contracts used to mitigate currency risk:

Given its international activities, the GF Corporation is exposed to currency risk. Currency risk occurs in connection with transactions (in particular the purchase and sale of goods) which are effected in currencies different from the functional currencies. Through such transactions the corporation is mainly exposed to changes in the euro and US dollar exchange rates. These currency risks can be reduced by purchasing and producing goods in the functional currency (congruency principle) or by entering into foreign currency forwards (cash flow hedges), usually for a maximum of twelve months.

The fair value hedges include foreign currency forward contracts that are used to hedge loans to GF Corporate Companies in foreign currencies. Unrealized gains and losses from changes in the fair value are reported in the financial result. These fair value hedges are mainly in US dollar, euro, Canadian dollar and Romanian leu and have an expiry of no more than 12 months of the balance sheet date. 

The fair value hedges also include foreign currency forward contracts that serve to hedge currency risks on receivables and payables. Like the currency effects on the underlying balance sheet item, gains and losses from changes to the fair value of these contracts are recognized in “Other operating income”. These fair value hedges are mainly in US dollar and euro and have an expiry of no more than 12 months of the balance sheet date.

Assuming unchanged exchange rates, a cash outflow of CHF 443 million (gross) (previous year: CHF 462 million) would be offset by a cash inflow of CHF 447 million (gross) (previous year: 463 million), giving a positive replacement value of CHF 4 million (previous year positive replacement value of CHF 1 million).

Derivative financial instruments used to hedge balance sheet items (fair value hedges) are accounted for at market values through the income statement. Hedging transactions on probable future cash flows (cash flow hedges) are initially accounted for at market values through equity. Later, when an asset or a liability results from the hedged underlying transaction, the gains and losses previously recognized in equity are transferred to the income statement. In the case of cash flow hedges the volume of the foreign currency forward contracts is limited to a maximum 75% of the probable future cash flows.

The interest rate risk may involve either changes in future interest payments owing to fluctuations in market interest rates or the risk of a change in fair value of interest bearing liabilities.

As fair value accounting is not applied for interest bearing liabilities, changes in market interest rates are not expected to have a material impact on the income statement.

However, there is an expected impact from variable interest rate instruments on the cash flows. It is expected that a one-percentage-point increase in the general level of interest rates would increase the ordinary result by CHF 4 million (previous year: CHF 4 million). A reduction in the interest rate by a one-percentage-point decrease is expected to reduce the ordinary result by the same amount.

Listed securities of CHF 4 million (previous year: CHF 4 million) are exposed to price risk. Since the value of these securities is low compared to the total assets, no significant impact on the income statement is expected from price fluctuations.

The following table shows the contractual maturities (including interest rates) of the financial liabilities:

The liquidity risk is the risk that GF is unable to meet its obligations when they fall due. Liquidity is constantly monitored to ensure that it is adequate. Liquidity reserves are held in order to offset the usual fluctuations in requirements. At the same time, the Corporation has unused credit lines in case more serious fluctuations occur. The total amount of unused credit lines as of 31 December 2019 was CHF 768 million (previous year: CHF 591 million). The increase is explained by the increase of the syndicated loan agreement by CHF 150 million. The credit lines are maintained with different banks in order to ensure swift and adequate access to these credit lines.