Management review

Treasury and financial risk management

The group’s financial risks are managed by the group treasury function in accordance with a formal Board-approved treasury policy. The policy sets a range of formal targets for managing the group’s exposure to fuel prices, interest rate changes and foreign currency movements. These targets are achieved through the use of forward fuel price fixes, interest rate and exchange rate swaps, and fixed rate finance. In addition, foreign acquisitions and operations are funded in local currency where possible. The result of this policy has been to reduce to insignificant levels the foreign exchange risk when translating overseas assets and liabilities into sterling and to increase euro borrowings as the group expands in mainland Europe.

• Commodity risk
• Interest rate risk
• Foreign currency risk
• Credit risk
• Liquidity risk
• Capital risk

Commodity risk

The group’s general policy is to maintain fuel price fixes at least 12 to 15 months ahead on a rolling basis. The requirement to fix fuel is determined after taking into account the extent to which businesses are protected from fuel price volatility through contract price indexation. Following the award of the CrossCountry contract, a fuel fix was put in place covering 75 per cent of the anticipated fuel usage of the contract up to its expiry. The group’s forward fixing of fuel, excluding associates for 2008 and 2009, at 25 February 2008, compared with 2007, was:

On a like-for-like basis, fuel costs, excluding fuel taxation, are likely therefore to decrease moderately in 2008, but with the prospect of an increase in 2009 if current prices in the market are maintained. The total fuel consumption in 2007 was approximately 365 million litres. The CrossCountry franchise is anticipated to consume around 100 million litres of fuel per annum.

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Interest rate risk

Fluctuations in interest rates are managed by a combination of interest rate swaps and use of fixed rate debt. Actual hedged debt at 31 December 2007 was 83 per cent. The target level of hedged debt is 80 per cent of group net debt, achieved within a banding of 65 per cent to 95 per cent of net debt. Hedged debt for this purpose represents fixed rate finance and swaps over one year’s duration at inception.

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Foreign currency risk

As noted previously, the group policy on foreign exchange exposure is that the risk of translating non-UK assets and liabilities into pounds sterling should be reduced to insignificant levels. At 31 December 2007, the exposure was six per cent of non-UK assets. The risk is managed through the use of funding in local currencies and by entering into foreign currency swaps of durations up to three years. The majority of such swaps also encompass fixed interest rates, thus also providing interest rate protection between EURIBOR, LIBOR and CIBOR. The group also enters into foreign exchange forward contracts to hedge specific cash flows arising with overseas suppliers. The fair value of the group’s cross currency swaps and foreign exchange forward contracts at 31 December 2007 was a liability of £23.1 million.

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Credit risk

Credit risk arising from operational suppliers and customers is managed at a local level and is subject to periodic reviews by central management and the group’s internal audit function. Credit limits are in place for customers, many of which are local authorities or local transport authorities. Due to the nature of certain contractual arrangements, particularly where the agreement and settlement of allocations of passenger revenues between multiple service providers can take more than one year to complete, certain customer debts can often exceed one year before settlement. This is common, and the incidence of impairment of such debt is both rare and immaterial. The group also manages its exposure to debit risk in respect of financial institutions that provide credit to the group. The group nominates and approves banks and lease providers with whom it will deal with. All group companies are required to bank with the nominated bankers, which change from time to time due to group refinancing, entry into new markets and changes to credit ratings.

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Liquidity risk

In addition to daily local monitoring, the liquidity of the group is monitored fortnightly, via group net debt reports showing the level of drawdown compared to available facilities for all components of net debt, and monthly against forecasts and budget. Future liquidity is monitored through detailed three-month cash forecasts prepared on a rolling monthly basis, and through forecasts for each financial year updated approximately quarterly throughout the year. At a strategic level, long-term liquidity is assessed as part of the five-year strategic planning process, which is updated annually. The above reviews support compliance with group policy, which is to maintain an average weighted maturity of hedged debt of at least 18 months at any point in time, and to maintain a 12 month in advance, foreseeable level of unutilised available facilities of more than £100 million. At 31 December 2007, hedged debt maturity was 19 months and headroom on facilities was approximately £470 million.

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Capital risk

The group monitors its capital risk on a continuous basis to ensure that, having regard to the anticipated and possible future requirements, sufficient capital exists to fund operations and provide returns to shareholders, and that the Weighted Average Cost of Capital (WACC) of the group is optimised. There are a number of alternative methods of calculating WACC and there are also variations caused by doing business in the different markets in Europe in which we operate. Our current assessment is that the group WACC is around seven per cent.

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