Risks and risk management

It is crucial for Peab’s profitability to have well developed routines for identifying and managing risks. This process also creates possibilities to take advantage of business opportunities that arise. Changes in external circumstances and the economy require constant vigilance and adaptability. The global economy was surprisingly positive in 2017 with accelerating growth that was noticeable in our home Nordic market. In 2018 the spotlight in Sweden will be focused on how prices develop on the housing market, the normalization of the monetary policy and the general Swedish election in September.

RISKS AND UNCERTAINTY FACTORS

Peab’s business is exposed both to operational and financial risks. How much risks affect Peab’s profits and position depend on how well the company handles daily operations. In addition, as a construction and civil engineering company, Peab is vulnerable to external risks such as developments in the economy and changes in circumstances due to amendments in laws and regulations, and other political decisions. See also External circumstances and the market for a description of economic developments on Peab’s markets. The parent company is indirectly affected by the risks described in this section.

Peab’s business is largely project-related. There are a number of different contract forms where risk levels vary depending on the type of contract. However, with any type of contract ambiguities can arise concerning the terms, which can lead to delimitation issues that create a dispute with the customer.

Regarding the dispute related to the construction contract of Mall of Scandinavia see note 2.

RISK MANAGEMENT

Managing operative risks is a continuous process considering the large number of projects the Group is starting up, carrying out and completing. Operative risks are managed in the line organization in the business areas through established procedures, processes and control systems. Financial risks are associated with capital tied up in the company and its capital requirements.

Operative risks Description Action
Contract risks Peab’s business is largely project related and each project is unique in its configuration and other circumstances.

Erroneous calculations can lead to incorrect tenders, which can then lead to losses in projects regardless of how well they have been carried out. There are a number of contract types and the risk level varies accordingly. Regardless of the type of contract, grey areas in the terms can lead to disputes with customers about where responsibility lies. This makes it hard to assess the result of both ongoing and completed projects.

Peab’s operations are subject to market risks in the form of price risks such as unforeseen cost increases for material, subcontractors or the employee salaries. The risks vary depending on the type of contract.

Structured risk assessment is crucial to ensure that risks are identified and priced in bids that are tendered and the underlying calculations. The right resources in projects ensures that they will be carried out according to stipulated procedures, and with the right products and methods.

Price risks are managed through efficient purchasing processes with the right suppliers, largely procured through central contracts.

Risks relating to suppliers and subcontractors (SC) Suppliers/SCs who do not conform with existing laws, conventions and Peab’s contracts and regulations can lead to infringements regarding the environment, ethics, human rights and the work environment. Choosing the wrong supplier/SC can lead to quality defects, delivery delays or no delivery at all in the case of bankruptcy.

Violations, defects and delays caused by suppliers/SCs can have a negative effect on Peab’s profitability and brand.

All the contracts Peab signs with suppliers/SC stipulate the rules and regulations for the specific project and for doing business with Peab.

The Code of Conduct and the ethics clause for suppliers are attached to all contracts. These clarify, among other things, what is expected of suppliers, and consequences in case of non-compliance with the Code of Conduct, working condition demands, human rights and workplace safety regulations.

During 2017 Peab further developed procedures and methods within the framework of “reliable business”, with particular focus on the work environment, working conditions, trustworthy supplier chains and sustainability. Please read more here.

Skills recruitment risks Peab is dependent on attracting and keeping competent employees in order to fulfill customers’ expectations. Competition for the skills Peab needs is intense, which makes the recruitment process a high priority. Peab works strategically with short and long term skills recruitment as well as concrete measures like establishing alternative supply channels in cooperation with every aspect of the education system, active integration work, extensive internal training and running our own upper secondary school, the Peab School.

The company has launched a career map aimed at clarifying and enabling paths for development for every employee, regardless of their role or background. Peab’s goal-oriented work with equality, diversity and equal treatment is a part of our effort to handle risks connected to recruiting needed skills, which also contributes to greater diversity in the industry.

Project development risks The risks affecting the profitability of Peab’s housing project developments are, in addition to the risks linked to production, circumstantial factors such as the general economy, interest rates, customers’ willingness to buy and other market conditions. Peab’s commercial property development faces similar risks, including the fact that the investor market’s willingness to buy also influences sales conditions. A common factor for development operations is the risk in zoning for the exploitation land since decisions taken by the authorities can have a great impact on land values and thereby future projects’ profitability. The sales risk is reduced through set requirements for advance sales before production starts in housing projects. Corresponding risk management for commercial property development is the requirement for a certain level of rented space before production start. From a risk perspective it is also important to shorten lead times from land acquisition to finished project in view of the risk for changed market prerequisites.
Work environment risks Work related accidents at Peab’s work sites can lead to employees or suppliers/SCs getting hurt or, in the worst case, killed. This can lead to fines, legal sanctions and brand damage. To prevent incidents and accidents at work sites Peab develops quality-ensured work methods and trains personnel in this area. Focus is on planning and risk assessment early on, and learning from reported risk observations, incidents and accidents.
Ethical risks Ethical risks can entail Peab employees not following our Code of Conduct and involving themselves in irregularities, bribes or corruption. Ethical risks can also be connected to transgressions of human rights by suppliers. This can lead to fines, legal sanctions and brand damage. Systematic ethic work focused on preventive education, a well-defined Code of Conduct and strict consequences for transgressions are the foundation of a strong brand and healthy competition. Monitoring suppliers prevents risks in the supplier chain and a whistle-blower system ensures the right to anonymously point out ethical risks.
Environmental risks Peab is also exposed to environmentally related risks. Serious environmental accidents at Peab’s construction sites can have a considerable effect on the local environment, lead to fines and brand damage. Extreme weather can cause problems and delays on work sites and in the supply chain. Higher costs for energy and the emission of greenhouse gases can have a negative effect on Peab’s profitability and brand. Peab works with prevention focused on climate impact, streamlining resource use and phasing out environmentally and health hazardous substances. Education and training are also an important part of handling environmental risks.
IT risks Peab is raising the level of digitalization in our business, which in turn requires greater access to our IT system. Identifiable risks are IT attacks and a lack of continuity planning, which can lead to shutdowns in operations. Because of the current level of dependence on IT, these shutdowns can be extensive and have a major effect on our business for a long time. This can have far-reaching consequences on both our financial results and brand. Peab IT works systematically with IT security which includes mapping IT risks, routine follow-ups according to a review plan, monitoring external circumstances, continuity planning and license management. Focus is on preventative actions to ensure access to information and IT tools. New legal requirements and threats are continually analyzed and prioritized.

 

Financial risks and risk connected to financial reporting Description Action
Financial risk-taking Financial risk-taking is connected to the business’ capital and investment needs. The need for capital is different for each of Peab’s four business areas. Contract construction in Construction and Civil Engineering normally have a positive working capital that contributes to financing the other operations. Industry binds capital in fixed assets with an ongoing need for investments. Project Development binds capital when investing in land and development rights until they are sold. Peab’s financial goal of an equity/assets ratio of over 25 percent is the means by which the Group governs financial risk-taking. For business areas Industry and Project Development tied-up capital is managed through fixed frameworks. All investments in Peab follow a set investment routine in which an investment group decides on all investments. Tied-up capital in business areas Construction and Civil Engineering is managed through payment balance requirements.
Financial risks The Group is exposed to financial risks, such as interest rate risks, liquidity risks, refinancing risks, exchange risks and credit risks. For further information on financial risks, see note 36.
Risks connected to financial reporting Since Peab uses the percentage of completion method in most of our ongoing projects erroneous project forecasts mean that reporting and follow-ups will be misleading.

A number of balance items are valued based on estimations and assessments and this value can be affected by, for example, the current market and customers’ preferences.

A prerequisite for correct percentage of completion is reliable forecasting. Well-developed procedures and system support for the monitoring and forecasting of each project is crucial to limiting risks of erroneous percentage of completion.

SENSITIVITY ANALYSIS

Peab’s operations are sensitive to changes in, among other things, volumes and margins. The sensitivity analysis below describes how pre-tax profit is affected by changes in some of the important Group variables.

Sensitivity analysis

MSEK Calculation basis Change Pre-tax profit effect
Operative
Volume (operating margin constant) 50,000 +/- 10% +/- 240
Operating margin (volume constant) 4.8% +/- 1 percentage +/- 500
Material and subcontractors 24,000 +/- 1% +/- 240
Financial
Net debt (interest rate constant) 1,216 +/- 10% +/- 3
Average effective interest rate 1)
(net debt constant) 2.6% +/- 1 percentage +/- 22

1) The calculation is based on the assumption that SEK 2,230 million of the total net debt has a fixed interest period shorter than one year and is thereby affected almost at once by a change in market interest rates.