Deutsche Post DHL Annual Report 2013

2013 Annual Report

Risks

Excerpts from Deutsche Post AG's 2013 Group Annual Report.

Risks arising from the political and regulatory environment

Risks associated with the general business environment primarily arise from the fact that the Group provides some of its services in a regulated market. A large number of postal services rendered by Deutsche Post AG and its subsidiaries are subject to sector-specific regulation by the Bundesnetzagentur (German federal network agency), pursuant to the Postgesetz (PostG – German Postal Act). The Bundesnetzagentur approves or reviews prices, formulates the terms of downstream access and has special supervisory powers to combat market abuse.

On 14 November 2013, the Bundesnetzagentur determined the conditions for regulating mail prices requiring approval under the price-cap procedure from January 2014 to December 2018. According to the decision, the general rate of inflation less the productivity growth rate stipulated by the regulatory authority (X-factor) in the amount of 0.2% p.a. constitutes the key factor applicable to mail prices subject to approval. This would necessitate price reductions if the inflation rate in the reference period is lower than the productivity growth rate specified and permit price increases if the inflation rate in the reference period is higher than the productivity growth rate specified. On 2 December 2013, the Bundesnetzagentur approved the higher prices to be charged in 2014 for the products regulated under the price-cap procedure; as a result, this no longer represents a risk.

On 8 June 2013, the Bundesnetzagentur initiated market abuse proceedings against Deutsche Post InHaus Services GmbH, citing discriminatory access conditions for sorting and consolidation services following a complaint by one of the company’s competitors. The party filing the complaint accused the company in particular of offering other postal services providers better conditions for posting and collection than it itself had been offered. Deutsche Post InHaus Services GmbH considers the accusations to be unfounded. The case is still under consideration by the Bundesnetzagentur. Should that agency determine – contrary to expectations – that market abuse has occurred, the company would have to desist from the actions in question. Due to the ongoing abuse proceedings, we are refraining from a risk assessment.

 

Risks arising from market and sector-specific conditions

Risks arising from market and sector-specific conditions are a key factor in determining the success of our business. For this reason we pay close attention to economic trends in the individual regions. Despite the volatile economic climate, demand for logistics services rose in 2013, as did the related revenues. We are nonetheless not able to rule out the possibility of an economic downturn in specific regions and a stagnation or decrease in transport quantities. However, this would not reduce demand for our services in all business units. Indeed, the opposite effect could arise in the parcel business, for example, as a result of an increase in online purchasing amongst consumers. Companies might also be forced to outsource transport services in order to lower costs. Cyclical risks can affect our divisions differently with respect to magnitude as well as point in time, which mitigates the total effect. Therefore, we consider these risks to be medium at best. Moreover, we have taken measures in recent years to make costs more flexible and to be able to respond quickly to a change in market demand.

Deutsche Post and DHL are in competition with other providers. Such competition can significantly impact our customer base as well as the levels of prices and margins in our markets. In the mail and logistics business, the key factors for success are quality, customer confidence and competitive prices. Thanks to our high quality along with the cost savings we have generated in recent years, we believe that we shall be able to withstand the competition and keep any negative effects at a low level.

 

Risks arising from information technology

The security of our information systems is particularly important to us. The goal is to ensure continuous IT system operation and prevent unauthorised access to our systems and databases. To fulfil this responsibility, the Information Security Committee, a sub-committee of the IT Board, has defined standards, procedures and guidelines based on ISO 27001, the international standard for information security management. In addition, Group Risk Management, IT Audit, Data Protection and Corporate Security monitor and assess IT risk on an ongoing basis. For our processes to run smoothly at all times, the essential IT systems must be constantly available. We ensure this by designing our systems to protect against complete system failures. In addition to third-party data centres, we operate two central data centres in the Czech Republic and Malaysia. Our systems are thus geographically separate and can be replicated locally.

We limit access to our systems and data. Employees can only access the data they need to do their job. All systems and data are backed up on a regular basis and critical data are replicated across data centres.

All of our software is updated regularly to address bugs, close potential gaps in security and increase functionality. We employ a patch management process – a defined procedure for managing software upgrades – to control risks that could arise from outdated software or from software upgrades.

Due to the measures described above, we estimate the probability of a significant and momentous incident in the IT sector as being very unlikely so that the risk has an overall low relevance.

Our E-POST products – first and foremost E-Postbrief – come with our pledge of security and data protection. In 2013, the associated platform was re-certified by the German Federal Office for Information Security in accordance with its standards for IT-Grundschutz. In addition, it was again certified by TÜV Informationstechnik GmbH as compliant with the legal standards and applicable data protection regulations pursuant to the criteria for trusted site privacy.

 

Risks arising from internal processes

Logistics services are generally provided in bulk and require a complex operational infrastructure with high quality standards. To consistently guarantee reliability and punctual delivery, processes must be organised so as to proceed smoothly with no technical or personnel-related glitches. Any weaknesses with regard to posting and collection, sorting, transport, warehousing or delivery could seriously compromise our competitive position. We therefore adapt all processes to current circumstances as needed. We also take preventive measures to guard against disruptions or malfunctions in our operational processes. Should disruptions nonetheless occur, contingency plans will come into effect to minimise the consequences. Some risks from business interruptions are also reduced by our insurance policies.

We furthermore use our First Choice methodology to continuously improve our processes and align them even more closely to the requirements of customers. Should this involve capital expenditure, the Board of Management decides on any sums in excess of €25 million. Board of Management committees make decisions on investments of more than €10 million, with a lower threshold of €5 million applying to Corporate Center/Other. The Board of Management is regularly informed about investment decisions so that they can identify any significant risk early on and take the necessary countermeasures.

As a service provider, we do not conduct research and development in a narrower sense. There are therefore no significant risks to report in this area.

As our operating business is organised decentrally and contingency plans are in place no significant risk to the Group was reported with respect to business disruptions arising from internal processes.

 

Risks arising from environmental management

Our Group-wide risk management also considers environmental developments. At present, we are not aware of any environmental risks that could have a significant impact on the Group.

 

Risks arising from human resources

It is the motivation and competence of our employees that make a good impression on our customers and thus shape our long-term success. Demographic change and increased competition for qualified specialists and executives mean that the pool of potential young talent is becoming smaller, particularly in our core market of Germany. The risk therefore exists that we may not be able to recruit and retain a sufficient number of suitable employees. We plan to take various measures to decrease this risk. For example, we place great importance on providing a motivational work environment and suitable professional and employee development programmes.

In many countries, both age and social structures are undergoing a notable shift. To adequately identify and counteract the resulting risk relating to employees’ work capacity and ageing, we have developed an analysis and planning instrument known as Strategic Workforce Management, which supplies strategically well-founded answers based on fact. The Generations Pact entered into by Deutsche Post AG with the trade unions is geared specifically towards demographic conditions in Germany. It ensures that older employees can remain on the job whilst at the same time improving employment opportunities for young people.

According to estimates from the United Nations and the World Economic Forum, there is a risk of chronic, i.e., non-contagious, disease increasing substantially all over the world. We are responding to this risk with a health management programme, which is subject to continual development.

 

Financial risks

As a global operator, Deutsche Post DHL is inevitably exposed to financial risks. These are mainly risks arising from fluctuating exchange rates, interest rates and commodity prices. Using operational and financial measures, we try to reduce the volatility of financial figures due to financial risk.

Risks with respect to currencies may result from scheduled or planned future foreign currency transactions. Significant currency risks from planned transactions are quantified as a net position over a rolling 24-month period. Highly correlated currencies are consolidated in blocks. The identified risks are hedged up to an average of 50% using derivatives over a 24-month period. The most important planned net surpluses at the Group level are in pound sterling, Japanese yen and Korean won, whilst the Czech crown is the only currency with a considerable net deficit. By offsetting the net deficit in US dollars with surpluses in other highly correlated currencies, the net risk in the "US dollar block" at the Group level is nearly offset and thus not actively managed. The average hedging level for the year 2014 was approximately 48% as at the reporting date. The significant risk to the Group’s earnings position would be a general appreciation of the euro. At present, we consider the individual risks arising from developments with regard to the respective currencies of low relevance and those in the currency risk category overall of medium relevance.

The key control parameters for liquidity management are the centrally available liquidity reserves, which should not fall below €2 billion. Deutsche Post DHL had central liquidity reserves of €4.6 billion as at the reporting date, consisting of central financial investments amounting to €2.6 billion plus a syndicated credit line of €2 billion. Therefore, the Group’s liquidity is sound in the short and medium term. Moreover, the Group enjoys open access to the capital market on account of its good ratings within the industry, and is well positioned to secure long-term capital requirements. The Group’s net debt amounted to only €1.5 billion at the end of 2013. Given our existing interest rate hedging instruments, the share of variable interest rate liabilities in non-current financial liabilities in the amount of €4.6 billion is approximately 36%. At present, we consider liquidity and interest rate risks to be of low relevance.

As a logistics group, Deutsche Post DHL’s significant commodity price risks result from changes in fuel prices (kerosene, diesel and marine diesel). In the DHL divisions, most of these risks were passed on to customers via operating measures (fuel surcharges). We only have noteworthy hedging instruments for the purchase of diesel in the MAIL division. At present, we consider commodity price risks to be of low relevance.

Further information on the financial position and finance strategy of the Group as well as on the management of financial risks is found in the report on the economic position and in the Notes.

 

Risks from pending legal proceedings

On 5 November 2012, the Bundeskartellamt (German federal cartel office) initiated proceedings against Deutsche Post based on suspicion of abusive behaviour with respect to agreements on mail transport with major customers. Based upon information from Deutsche Post AG’s competitors and customer surveys, the authorities suspect that the company had violated the provisions of German and European antitrust law. Deutsche Post AG does not share this opinion. However, should the authorities find their suspicions confirmed, they may require Deutsche Post AG to refrain from certain acts or impose fines.

On 25 January 2012, the European Commission issued a ruling on the formal investigation regarding state aid that it had initiated on 12 September 2007. In its review, the European Commission determined that Deutsche Post AG was not overcompensated for providing universal services between 1989 and 2007 using state resources. It also did not find fault with the state guarantees for legacy liabilities. By contrast, in its review of funding for civil servants’ pensions, the European Commission concluded that illegal state aid had, in part, been received. It said that the pension relief granted to Deutsche Post AG by the Bundesnetzagentur during the price approval process led to Deutsche Post AG receiving a benefit, which it must repay to the Federal Republic of Germany; in addition, it must also be ensured that no benefits are received in the future which could be considered illegal state aid. The Commission furthermore stated that the precise amount to be repaid was to be calculated by the Federal Republic. In a press release, the European Commission had referred to an amount of between €500 million and €1 billion. Deutsche Post AG is of the opinion that the Commission’s state aid decision of 25 January 2012 cannot withstand legal review and has filed an appeal with the European Court of Justice in Luxembourg. The Federal Republic of Germany has similarly appealed the decision.

To implement the state aid ruling, the federal government called upon Deutsche Post AG on 29 May 2012 to make a payment of €298 million, including interest. Deutsche Post AG paid this amount to a trustee on 1 June 2012 and appealed the recovery order to the Administrative Court. The appeal, however, has been suspended pending a ruling from the European Court. The company made additional payments of €19.4 million and €15.6 million to the trustee on 2 January 2013 and 2 January 2014, respectively. The payments made were reported in the balance sheet under non-current assets; the earnings position remained unaffected. The European Commission has not expressed its final acceptance of the calculation of the state aid to be repaid. On 17 December, it initiated proceedings against the Federal Republic of Germany with the European Court of Justice to effect a higher repayment amount.

Although Deutsche Post AG and the federal government are of the opinion that the state aid decision cannot withstand legal review, it cannot be ruled out that Deutsche Post AG will ultimately be required to make a potentially higher payment, which could have an adverse effect on earnings.

More information about the state aid investigation and other legal proceedings is provided in the Notes.

Since 1 July 2010, as a result of the revision of the relevant tax exemption provisions, the VAT exemption has only applied to those specific universal services in Germany that are not subject to individually negotiated agreements or provided on special terms (discounts etc.). Deutsche Post AG does not believe that the legislative amendment fully complies with the applicable provisions of European Community law. Due to the legal uncertainty resulting from the new legislation, Deutsche Post AG is endeavouring to clarify certain key issues with the tax authorities. Although Deutsche Post AG is implementing the required measures to a large extent, the differing legal opinions on the part of Deutsche Post AG and the tax authorities will be judicially clarified.

In light of the announced legal proceedings, we have not undertaken a risk classification.

 

Risks arising from corporate strategy

Over the past years, the Group has ensured that its business activities are well positioned in the world’s fastest growing regions and markets. We have also created efficient structures in all areas to enable us to flexibly adapt capacities and costs to demand – a prerequisite for lasting, profitable business success. With respect to strategic orientation, we are focusing on our core competencies in the mail and logistics businesses with an eye towards growing organically and simplifying our processes for the benefit of our customers. In the specified period under consideration, risks arising from the current corporate strategy, which extends over a long-term period, are considered to have a low relevance for the Group. In addition, the divisions face the following special situations:

In the MAIL division, we are responding to the challenges presented by the structural change from a physical to a digital business. We are counteracting the risk arising from changing demand by expanding our range of services. Due to the e-commerce boom, we expect our parcel business to continue growing robustly in the coming years and are therefore extending our parcel network. We are also expanding our range of electronic communications services, securing our standing as the quality leader and, where possible, making our transport and delivery costs more flexible. We follow developments in the market very closely and take these into account in our earnings projections. For the specified forecast period, we do not see these developments as having any significant potential to sustain a negative impact.

In the EXPRESS division, our future success depends above all on general factors such as trends in the competitive environment, costs and quantities transported. After having spent recent years successfully restructuring our business and substantially improving cost structures, we are focusing on fostering growth in our international business. We expect an increase in shipment volumes. Based on this assumption, we are investing in our network, our services, our employees and the DHL brand. Against the backdrop of the past trend and the overall outlook, we do not see any significant strategic risk for the EXPRESS division beyond that reported in the section entitled "Risks arising from market and sector-specific conditions".

In the GLOBAL FORWARDING, FREIGHT division we purchase transport services from airlines, shipping companies and freight carriers rather than providing them ourselves. As a result, in a worst-case scenario there is a risk that we shall not be able to pass on all price increases to our customers. The extent of the risk essentially depends on trends in the supply, demand and price of transport services as well as the duration of our contracts. Comprehensive knowledge in the area of brokering transport services helps us to minimise this risk, which is therefore considered to have a low relevance.

Our SUPPLY CHAIN division provides customers in a variety of industries with solutions along the entire logistics chain. Our success is highly dependent on our customers’ business trends. Since we offer customers a widely diversified range of products in different sectors all over the world, we can diversify our risk portfolio and thus counteract the incumbent risks. Moreover, our future success also depends on our ability to continuously improve our existing business and to grow in our most important markets and customer segments.

We do not see any significant strategic risk for the SUPPLY CHAIN division beyond that reported in the section entitled "Risks arising from market and sector-specific conditions".

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2013 Annual Report

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2013 Annual Report

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