How Heineken uses the technique of financial hedging to
keep its organic profits flowing. Sound complicated?
Here's a layman's guide to the tool of finance
To hedge or not to hedge, that is the question
In simpler times
HEDGE YOUR
BETS
How do you sell beer around the world in a grab bag of
currencies, with costs ranging from grain to aluminium, freight
to advertising, and still generate a smooth flow of earnings?
Here's a layman's guide to how Heineken uses the techniques of
the financial market
Heineken's success in the USA, its biggest export market, is key to its image
as a premium brand. Dealing with different currencies has its risks,
however, and Heineken uses some cutting edge financial techniques in
order to minimize them.
The Heineken treasury team combine the world of high finance with a
detailed knowledge of every step in the process of making and selling beer,
from the barley fields to the freighter.
"The thing is, we make beer in one currency and sell it in another," says
Heineken group treasurer Robin Hoytema van Konijnenburg. "In the case of
Heineken, part of the strength of the brand in the USA is that it is an
imported beer and we would shoot ourselves in the foot if we changed
that".
Like many countries exporting from Europe to the United States at the
moment, Heineken is getting paid less in euro terms for its product because
of the weak US currency. For beer exported to the USA, many of Heineken's
costs are in euros. This applies up to the point when the beer goes on a
ship. There are exceptions, such as aluminium for cans, which is priced in
dollars.
To neutralize the effect of the weaker dollar, Heineken can set any costs
incurred in dollars against earnings from US sales. Most costs are in dollars
once the product goes on a ship, including the cost of freight. But this still
leaves many of its costs in euros, which have appreciated over the past
year, while income from its US business is in dollars, which have declined
over the same period. In theory, Heineken could raise prices to offset the
lower dollar but that could hurt sales volumes. The price of beer is set by
the regional Heineken organization according to market conditions.
Hedging aims to delay or reduce the impact of an otherwise volatile
currency exchange by entering into an opposite transaction.
"Hedging is not meant to be speculative in order to earn more money," says
Hoytema van Konijnenburg, "but rather to allow more stable margins, cash
flows and profits in euros."
There are two key areas in which a company will use hedging. The first
is so-called transaction risk, where it produces and sells a product in one
currency but reports its earnings in another. Exchange rates become a risk
when the company translates its earnings back into its home currency.
This affects Heineken in some countries but, in addition, Heineken faces
transaction risk, where transactions take place in different currencies.
Not everyone likes to think about finance while sipping their beer so think,
instead, of a more simple analogy: Heineken as a family of beers.
There is the family home in Holland, where many of the internationally
distributed brands originate.
It is a big family, however, with cousins in many parts of the world, from
Africa to Indonesia. The cousins are made up of separate operating
companies, many of them under license from Heineken and to the same
standards as back home.
The cousins sell in regions around the world, so, rather than travelling
from Holland, they can be made locally by Dutch-trained master brewers.
As they are produced and sold locally, in the same currency, there is no
need for hedging of so-called transaction risk.
The operating companies are owned by Heineken International,
however, and pay dividends to the mother company. Heineken's treasury
can hedge these dividends to enhance the predictability of earnings and
cash flow. It can also hedge any loans to those companies, although long-
term equity investments are not usually hedged.
Once upon a time, foreign trade was simpler. Before the Second World War,
the major economies adhered to the Gold Standard. This meant your
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