Look to your workers
The undercover investigations at Sports Direct (SPD) and JD Sports (JD.), along with Germany-based delivery giant Hermes, have shone a light on how companies treat their workers. There is clear reputational damage to be done when governance standards are seen to fall short, and the (necessary) remedies can restrain financial performance. Increasing "investment in our people" was one of the factors that held back Sports Direct's underlying cash profits in the first half.
It is not just the retailers that need to think about how the workers in their domestic operations and supply chains are being treated. Under the 2015 Modern Slavery Act, any company with UK operations and global turnover of over £36m now has to provide a 'slavery and human trafficking statement' each year. The contents are not prescribed by the government, although consultants at PwC suggest it should include due diligence processes, supply chain audits and training information.
This governance is especially important at a time when retailers and others are actively cutting production costs and relocating their supply chain to help protect margins, at a time when imported materials are relatively more expensive. Next (NXT) is a good example of a company that has protected its margin by moving into new sources of supply in Burma and Cambodia, and beefing up operations in Bangladesh.
The trade (re)balance
The falling pound's drag on the retailers and manufacturers that import goods or materials has been softened somewhat by their currency hedges, while the same arrangements have limited the upside for dollar earners. Next year, company investors will be keenly observing how both sides choose to proceed.
Not to pick unduly on Sports Direct, but it provided another object lesson in the profit implications of volatile currencies. Its forecasts had assumed a pound-to-dollar exchange rate of around 1.30, and after sterling's post-referendum drop it entered into a hedge to protect its downside. Then the flash crash happened in October, which had the effect of crystallising the exchange rate at 1.19, meaning the company lost £15m in underlying cash profits. The company stands to lose a further £20m by the end of the financial year if the rate stays at an average of 1.20. At the time of writing, it sits at 1.24.
A unique case, perhaps, but it's worth watching the costs of these hedges at a time of greater currency uncertainty as we begin to find out the negotiating positions, and crucially the compromises, on either side of the UK-EU discussions. For companies like Victrex (VCT), a UK-based global exporter that books more than 97 per cent of its sales outside of this country, the big question is how it sets up its hedging programme for its 2018 financial year. It expects the FY2017 boost will now be ahead of its previous £14m-£15m guidance.
Most interesting of all will be how far retailers can avoid having to increase prices. Official inflation figures suggest food prices will be slow to reverse their deflationary trend, but there is already upward pressure on clothing and footwear prices. It's a great time to be making rather than importing: just compare the fortunes of flooring maker Victoria (VCP) and high-street seller Carpetright (CPR). For the former, less than a fifth of its cost base is in euros and dollars, which means it can outcompete rivals on price. Its shares are up by a half in the past 12 months. For the latter, higher import costs are one weight on its margins. Its share price is down two-thirds over the same period.
All that, and we haven't even touched on interest rates. It's set to be a fascinating year.
