Clearwater started as a lobster distributor in 1976 at Belford, Nova Scotia and went public as an income trust in mid-2002. The funds that were raised from the IPO were subsequently used to finance the company significant growth strategy. The firm would turn to the largest publicly traded shellfish company in North America. The company policy would be encapsulated by three pillars of business which included innovation, vertical integration and species and market diversification.
The component of innovation articulated the development and adoption of technologies and practices that substantively enhanced growth and ensured the sustainability if the resource base. The pillar of integrity heightened the control of the value chain which started from harvesting, processing and marketing and delivery subsequently generating efficiencies through cost and the control of quality. The pillar on diversity was advanced through the creation of a natural hedge against downturns in the availability and thus the quota of any particular species, the changes that occur in customer markets to effectively hedge against the value of a given currency or the change of Clearwater products demand from a particular region.
Sources of problem facing Wight
Robert Wight, Clearwater Seafoods Income Fund vice president and chief financial officer in the mid of January 2006, was preparing a conference call schedule in a weeks time with the financial community on the company financial results for the year ended December 31st, 2006. He was faced with a predicament on what was the best strategy to turn the company exchange rate crisis and other operating challenges and change the sentiments of the investors who wanted assurance their distributions would be reinstated.
The first source of problems occurred due to the currencies the company was using to earn income were losing value relative to the Canadian dollar which Clearwater used to incur expenses. Subsequently, the value of the units had decreased by 35 percent. This led to the suspension of the monthly distributions to unit holders, and it was the first time since the company converted to a unit trust. Three months later after the suspension, the major stakeholders at the company wanted assurances that a strategy had been put in place to deal with the problems.
The investors at Clearwater were aware that the company had an active foreign exchange risk management program though there understanding of the same was limited and thus formed a source of a problem. The program was made of two components that included; forward contracts and options. The forward contracts were used by the firm to offer certainty in the exchange rates in a period of 12 months or longer. The forward contracts key aim was the establishment of a degree of stability in the Canadian dollar cash flows for contracts that were for a long period with the customers in the foreign markets.
The sale of call options was taken care of the sale of some of the foreign denominated currency with the aim of generating premium income. The premium income actualized from the sale of the call option was exercised if the buyer of the call could sell the Canadian dollar in exchange of foreign currency at a rate agreed upon. If the buyer failed to exercise it, the firm pocketed the premium. The determination of the strike price was accentuated by a price that Clearwater was willing to hedge the cash flows thus providing premium income while hedging cash flows at a rate acceptable by Clearwater.
From the above description on Clearwater future contract and call options a problem arose because the firm could not fully hedge the future foreign currency revenues and this it was not possible to completely offset the currency fluctuations. Wight thus had to make a decision on the future of the foreign exchange risk management program.
The role the Canadian dollar appreciation plays in this current situation and how it differs with the situation Clearwater facing when the Canadian dollar was depreciating
The appreciation of the Canadian dollar in comparison to the US dollar was consistent since 2001 with the general depreciation of the US dollar. The situation turned to serious in mid-2004 for Clearwater when the Canadian dollar started to appreciate against the other major currencies the firm did business as well. Subsequently, the distribution payments were suspended, and the company was forced to revisit the short-term and long-term business priorities. The Canadian dollar dramatic upswing had an impact on Clearwater earnings from the sale of seafood around the world and from the foreign exchange operations. This was evident due to the sharp decrease in the EBITDA. Moreover, the appreciation of the Canadian dollar compared to the sterling pound, the euro, and the yen had a negative impact on the sales to a tune of Cdn$9.2 million.
The situation on an appreciating Canadian dollar differs with when the Canadian dollar depreciates because the company uses various currencies such as the dollar, the sterling pound, the euro and the yen to earn income about the use of the Canadian dollar in which the company uses to incur the expenses. Besides, when converting the export sales into Canadian dollars, it was less Cdn$17.6 million of what would have accrued in the financial year 2005 had the Canadian dollar not appreciated.
The alternative, the costs, and benefits associated with each alternative and how each alternative addresses Clearwater need to generate cash for fund growth and quick resumption of distribution payment.
The increase in Clearwater trades in foreign exchange options. The foreign exchange trading is considered to be profitable which would assist that Clearwater mobilizes its cash flows in different currencies and put them to better use. The trade-off would be realized on the ability of the company to hedge its future cash flows. Placing emphasis on the foreign exchange risk management on risk minimization would substantively provide greater certainty in cash flows but would bring down the capability of Clearwater to generate the levels of profits that had been observed in the early 2000s. This strategy on financial hedging and foreign exchange market opportunities would permit more immediate result and thus a quick reinstatement of the distributions.
The change of operational strategy in Clearwater. This perspective would be carried out in varied ways by either decreasing the exposure of the firm to foreign currencies or diversify further the operations into other markets. The diversification of the operations into other markets could substantially alleviate some of the need to hedge the risk that comes from the foreign exchange by either decreasing the size of the foreign currency exposure or increasing the ability of Clearwater to change prices as the exchange rates changes. This strategy, however, would be considered long-term thus decreasing the chances of Clearwater reinstating distributions quickly.
How to deal with financial risks that are related to the changing value of the Canadian dollar in determining the strategy pursued and a how it would differ with past policies that concerned investors.
Wight, in the conference call, had to come up with a substantive method to pragmatically improve the magnitude and stability of the value of the Canadian dollar to the global cash flow of the company. The unit holders of the company needed a credible strategy, and timeline could in the short term, check on the decline of the firms unit trust and reinstate the distributions. With the varying interests accentuated by founders who were the largest unit holders needed a long-term strategy and the vast majority of the remaining investors required short term results.
An ideal approach that Wight should use accentuates the realignment of cost and revenue from currency exposures. The company uses foreign currencies to conduct sales and use the Canadian dollars to pay for the expenses. The appreciation of the Canadian dollars relative to the other currencies led to losses when converting these currencies to Canadian dollars. Wight can effectively create a natural hedge against the fluctuations in currency by offsetting the sales in a foreign currency against expenses using the same foreign currency. This perspective would thus reduce exposure.
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