Strategic risks

Risks associated with price trends and availability of raw materials

In 2014 natural rubber, synthetic rubber and petroleum based raw materials (especially chemicals and carbon black) will remain an uncertain factor in the Group’s cost structure, due to the sharp volatility witnessed over the past several years and their impact on the cost of finished products (about 37% of cost of sales).

In 2013, commodity prices – especially natural rubber – were negatively impacted by the capacity of mature economies to recover and lower than expected economic growth in the People's Republic of China.

Pirelli expects that commodity prices in 2014 will remain substantially steady at their 2013 levels. Uncertainty will clearly persist, mainly due to the impact on commodity markets of the tapering off of quantitative easing in the United States and/or possible conflicts or geopolitical tensions.

Contingent price scenarios for the principal commodities purchased by the Group are simulated on the basis of their historic volatility and/or the best information available on the market (e.g. forward prices). On the basis of various scenarios, sales price increases and/ or other internal cost efficiency recovery actions have been identified (e.g. use of alternative raw materials, reduction of product weight, improvement of process quality, and reduction of discarded material) as necessary to guarantee the forecast profitability levels.

Financial risk

The Group is exposed to financial risks. These are principally associated with foreign exchange rates, raising funds on the market, fluctuations in interest rates, the ability of customers to honour their obligations to the Group, and the price of financial assets held as investments. Financial risk management is an integral part of Group business management and is handled directly by headquarters in accordance with guidelines issued by the Finance Department on the basis of general risk management strategies defined by the Managerial Risk Committee.

Exchange rate risk

The varied geographical distribution of Pirelli production and commercial activities entails exposure to transaction and translation exchange rate risk.

Transaction exchange rate risk is generated by the commercial and financial transactions executed in currencies other than the functional currency due to exchange rate fluctuations between the time when the commercial or financial relationship is established and when the transaction is completed (collection or payment).

The aim of Group policy is to minimise the impact of transaction exchange rate risk related to volatility. For this reason, Group procedures envisage that the Operating Units be responsible for collecting all information related to assets and liabilities exposed to transaction exchange rate risk. Forward contracts are made to hedge this risk, with the Group Treasury whenever possible.

The items subject to exchange rate risk are mainly represented by receivables and payables denominated in foreign currency.

The Group Treasury is responsible for hedging the net position for each currency. In accordance with established guidelines and restrictions, it closes all risk positions by trading derivative hedging contracts on the market, which typically take the form of forward contracts.

Furthermore, as part of the annual and three-year planning process, the Group makes exchange rate forecasts by using the best information available on the market.

The fluctuation in exchange rates between the time when the forecast is made and the time when the commercial or financial transaction is established represents the transaction exchange rate risk on future transactions with respect to the targets announced to the market. The Group periodically monitors the opportunity to enter into hedges on future transactions.

In these cases, it typically uses forward purchases and risk reversal options (i.e. zero cost collars).

Currency translation risk: Pirelli owns controlling interests in companies that prepare their financial statements in currencies other than the euro, which is used to prepare the consolidated financial statements. This exposes the Group to currency translation risk, which is generated by the conversion into euro of the assets and liabilities of subsidiaries whose functional currency is not the euro. The principal exposures to currency translation risk are constantly monitored, but it is not currently deemed necessary to adopt specific policies to hedge this exposure.

In 2013 the principal currencies of emerging countries where Pirelli operates depreciated against the United States dollar (USD), and particularly the Venezuelan bolivar, Argentine peso, Egyptian pound and, to a lesser extent, the Brazilian real and Turkish pound. This generalised trend of depreciation in emerging country currencies, partly due to exogenous factors – such as U.S. Federal Reserve Bank monetary policy – and specific internal macroeconomic conditions, combined with appreciation of the euro against the U.S. dollar has had a comprehensively negative impact on the Group.

In 2014, Pirelli expects – consistently with leading market operators – continuation of the present trend of depreciation tracked by leading emerging country currencies, attributable once again to the impact of changes in U.S. Federal Reserve Bank monetary policy and specific country risk factors (particularly in regard to the Venezuelan bolivar and Argentine peso).

Finally, Pirelli expects that the current euro/dollar exchange rate trend to reverse, with the euro weakening from its levels at the end of 2013. Once again, significant uncertainty persists, such as the monetary policy decisions that will be taken by central banks on both sides of the Atlantic.

Liquidity risk

The principal instruments used by the Group to manage the risk of not having sufficient financial resources to meet its financial and commercial obligations at the agreed terms and conditions consist of annual and three-year plans and cash-pooling plans, which give a full and fair view and measurement of positive and negative cash flows. The differences between plans and actual data are constantly analysed.

The Group has implemented a centralised cash pooling system for the management of collection and payment flows in compliance with various local currency and tax laws. Banking relationships are negotiated and managed centrally, in order to ensure coverage of short and medium-term financial needs at the lowest possible cost. The procurement of medium and longterm resources on the capital market is also streamlined through centralised management.

Prudent management of the risk described above requires maintaining an adequate level of cash equivalents and/or highly liquid short-term financial instruments, and the availability of funds through an adequate amount of committed credit facilities and/or recourse to the capital market.

In addition to the available portion of the euro 1.2 billion revolving credit facility due on November 30, 2014, of which euro 575 million had been used at December 31, 2013, the Pirelli Group draws on the capital market by diversifying the products and maturities used to seize the best opportunities available from time to time. For example, in December 2012 a private placement was executed in several tranches on the United States market for a total of USD 150 million, and a Schuldschein (German law loan) was obtained, again in several tranches, for a total amount of euro 155 million. The generation of cash flow and profile of debt maturities did not entail particularly significant transactions in 2013.

The EMTN (Euro Medium Term Note) programme was finalised in July 2013. This is a document platform for the issuance of bonds on the Euromarket – whose maximum amount was set at euro 2 billion. The Board of Directors periodically resolves on the maximum amount of bonds that may be issued and their time horizon under this programme. The program aims at promptly seizing the best financing opportunities to provide continuous support for business growth in the face of volatile financial markets and possible restrictions on access to credit. The bonds may be placed only with professional investors.

Interest rate risk

Fluctuations in interest rates impact the market value of Group financial assets and liabilities and net financial expenses.

Group policy tends to keep the ratio of exposure to fixed rates and variable rates at around 70% fixed rate and 30% variable rate.

To maintain this general ratio, the Group enters into derivative financial instrument contracts, typically interest rate swaps.

Price risk associated with financial assets

Group exposure to price risk is limited to the volatility of financial assets, such as listed and unlisted stocks and bonds, which represent 4.6% of total Group assets. Derivatives contracts that would limit the volatility of these assets are not normally made.

Credit risk

Credit risk represents Group exposure to contingent losses resulting from default by commercial and financial counterparties.

To limit commercial counterparty default risk, the Group has implemented procedures to evaluate its customers’ potential and financial solidity, monitor expected incoming cash flows and take credit recovery action if necessary. The aim of these procedures is to define customer credit limits. Further sales are suspended when those limits are exceeded. In certain cases customers are asked to provide guarantees. These mainly consist of standby letters of credit issued by parties with excellent credit or personal standing.

Less frequently, mortgage guarantees may be requested.

Another tool used to manage commercial credit risk is the execution of insurance policies: beginning in January 2012, a two-year master agreement was made with a leading insurance company for worldwide coverage (the policy excludes Egypt, Venezuela and China) of the credit risk related mainly to sales in the replacement segment (with the acceptance rate in December 2013 running at about 79%).

The foregoing master agreement was also renewed in 2014.

In 2013 the general situation of trade receivables was substantially the same as at December 31, 2011.

The Group transacts only with financial counterparties having high credit ratings for the management of its temporary cash surpluses or trading of derivative instruments.

Pirelli does not hold government bonds issued by any European country, and constantly monitors its net credit exposures to the banking system. Pirelli does not exhibit significant concentrations of credit risk.

Restructuring of the financial receivable from Prelios S.p.A.

Following restructuring of the financial receivable from Prelios S.p.A. completed in August 2013, the company now owns three types of financial assets:

  • Prelios shares (listed on the stock market);
  • shares in the special purpose vehicle Fenice, which owns Prelios class B shares;
  • the “convertendo” equity instrument.

In addition to the price risk limited to the volatility of financial assets, such as listed shares, the company is also subject to the risk of economic and financial performance and execution capacity of the Prelios S.p.A. business plan.