The Meat Industry – FX Management During Times of Uncertainty
13 May 2020 · 3 min read
The meat industry has seen sharp ups and downs in response to the Coronavirus pandemic. While demand took a hit in early January 2020 when China started the lockdown, the sector’s recovery is clouded by processing plant closures in the United States and Europe.
As they scramble to adjust to the new scenario, finance teams across the industry are concentrating, quite understandably, on short-term financing and cash flow issues. Adding to the confusion, volatility in currency markets creates yet another source of uncertainty.
The sharp gyrations in the EUR-USD and EUR-GBP exchange rates in March and April 2020 are raising awareness —among meat industry executives— about the economic and financial impact of foreign exchange (FX) on importers and exporters. As discussed in a recent webinar organised by Kantox, the Coronavirus crisis provides the opportunity to review the weaknesses of the FX risk management practices that are common in the industry — and to consider new solutions that enable the modern meat-producing company to become more competitive, while keeping currency risk at bay.
Avoiding currencies: a massive opportunity cost
From a currency risk management perspective, meat industry participants are often weighed down with backward, costly and time-consuming practices that are not up to the task of dealing with currency risk while protecting profit margins. Overwhelmed by what they consider to be a daunting task, and overconfident about their capacity to shift currency risk onto other participants, some firms choose to deal in just a handful of currencies. This, however, is a misconception. Let us see why.
One the buying side, the practice of avoiding currencies creates opportunity costs, as firms forgo the chance to widen the range of potential suppliers with better pricing and more favourable payment terms. Recent meat plant closures illustrate how critical this can be during a crisis. A more technical point refers to forward points, the difference between forward and spot exchange rates. By sourcing in currencies that trade at a discount to USD or EUR, and by hedging the corresponding exposure, firms can gain an additional source of revenue.
On the selling side, customers are more likely to accept offers in their own currency. When the Russian client of a European meat exporter delays payment due to a sudden fall in the rouble, what seemed like a good idea (to sell in EUR) can quickly turn into a nightmare.
Currency risk cannot be eliminated—it is merely transferred onto somebody else. Selling in different currencies allows companies to shift the burden of FX risk away from their clients’ shoulders. This, in turn, provides the opportunity to add a markup and to increase profit margins, or to gain market share by becoming more competitive—a welcome source of differentiation in the low-margin meat industry.
FX risk management in the meat industry: some outdated practices persist
While more and more firms understand the advantages offered by currencies, they are often impaired by outdated and costly FX hedging practices. A quick glance at currency markets in March 2020 is enough to illustrate the folly of not hedging, as a 5%-7% move in exchange rates is enough to wreak havoc on profit margins. When hedging against currency risk, some firms still apply currency hedging programs based on monthly, quarterly or annual forecasts. These programs create the risk of over-hedging, as actual results may deviate sharply from forecasts.
Other firms choose to manage FX risk by periodically adjusting their pricing to prevailing exchange rates. While it simplifies the process of managing risk, this practice may prevent them from taking advantage of favourable currency market moves. If a sudden bout of USD strength creates an advantage for a European-based meat exporter selling in China, the commercial team may lose the opportunity to gain competitiveness and market share because a higher FX rate is rigidly applied for pricing purposes.
The way ahead: FX automation
The weakness of FX risk management systems and practices is often exacerbated by the weight of legacy manual processes that are all too common in the meat industry, where small-to-medium sized firms lack the resources to effectively capture and monitor the firm’s exposure to currency risk. End-to-end FX automation provides a way out of this conundrum. With FX automation, the finance team of the modern meat company can protect margins and take advantage of favourable movements in currency markets by aligning pricing and exchange rates in a dynamic way.
FX automation also allows firms to gain real-time, 24/7 exposure data visibility in any currency pair, and to capture the benefits of buying in local currencies —including the optimisation of forward points— while simultaneously eliminating the risk in foreign currency-denominated transactions. As an added bonus, operational risk is reduced as human error is taken out of the equation. In today’s unpredictable operating environment, FX automation is fast becoming an indispensable asset for the modern meat company.