Implementing an FX Hedging Strategy to Facilitate International Growth
by Mark Stegeman, Vice President and Assistant Treasurer, and Robert Waddell, Global Treasury Manager, Brown-Forman Corporation
Brown-Forman has experienced dramatic expansion in recent years, fuelled by the growing domestic and international popularity of brands such as Jack Daniel’s, Southern Comfort, and Finlandia Vodka, to name a few. For example, in 2002, around 23% of our revenues were generated outside of the United States. Today, this figure is around 58%, with growing market share in both Europe and other parts of the world, particularly Mexico, Australia and Turkey. We have embarked on an ambitious strategy to continue expanding both the Jack Daniel’s family of brands and the rest of our portfolio internationally, as well as consolidating our market leadership position in the United States. To successfully achieve these objectives, we have identified a number of both developed markets, such as the United Kingdom, Australia, Germany, France and Spain, and emerging economies such as Poland, Mexico, Russia, China, Brazil and India as target growth regions for the future. To facilitate this continued expansion, and avoid the negative impact of increased exposure to foreign currency volatility, we needed to put in place an efficient and robust forecasting and FX hedging process.
Focus on forecasting
Over recent years, we have evolved our forecasting process to enable greater visibility over exposures. We implemented the final component of SAP’s Corporate Finance Module (our treasury workstation) in 2004, which has helped enormously in bringing together FX exposures from across the group, based on budget information input by business units. Although we have grown through both M&A and organic expansion, we have maintained a highly centralised infrastructure, including a single instance of SAP globally, which ensures the completeness and consistency of forecast information. Furthermore, we are able to record transactions and perform hedge accounting in SAP, which provides a highly integrated process and takes away much of the manual effort that would otherwise be required. In addition, we continue to assume hedge effectiveness via ’critical terms match’ provision for hedge accounting as opposed to performing hedge effectiveness testing, although this capability exists in SAP.
A new approach to FX hedging
Our hedging approach has also changed significantly. We are principally an exporter, and unlike some of our competitors, that are often able to distribute production to other regions, we do not have substantial natural hedges, as many of our major brands such as Jack Daniel’s are produced in the United States. In the past, we made hedging decisions each year at budget time, so in one year we might hedge a majority of an exposure, but not the same percentage the following year. Additionally, we would put on all of our coverage for our fiscal year over a couple of months period of time to hedge to the budget rate, resulting in a ‘cliff’ effect in our hedging the following year. We therefore wanted to find a way to protect the business against significant currency volatility within an acceptable risk tolerance and cost of hedging. We worked with Barclays, one of our partner banks, to formulate a new FX hedging strategy, and performed a historic analysis of our performance had the proposed new FX strategy been in place. This was a valuable process by enabling us to validate a new approach and improve confidence with less risk.