Comprehensive Report: Woolworth's Currency Risk and Financial Strategy

This report provides a comprehensive analysis of Woolworth's currency risk management strategies, focusing on the impact of the AUD/USD exchange rate decline. It examines how this fluctuation affects the company's import and export activities, particularly in the Chinese and US markets. The repo...Read More

Q 4.
Pursuant to the exchange rate directive presented in Question 1, wherein, the exchange rate
AUD/USD witnessed a stark decline from 0.94 to 0.69, on a generalized basis, the price currency
(AUD) has relatively appreciated compared to the base currency (USD) which has relatively
depreciated. This results in the cheapening of imports and a higher cost overhead of exports to
Woolworth making it comparatively less competitive in the international domain.
Since, the favourable basis herein is based on cost(imports) and not revenue(exports) itself, the
strategic directive for Woolworth would involve a reduction of it’s Cost of Goods sold. Now on a
superficial basis, this may seem an unnecessary profit drain, but compared to higher export cost
resulting in a loss of revenue, this cost offset is imperative to maintain a similar wealth level and
market position.
Further, Woolworth as a group can hereby garner a favourable group based import activity.
However, the irony of export argument doesn’t stand true when it comes to Woolworth’s biggest
international market base in China. China happens to be the biggest demand based consumer when
it comes to Woolworth’s products since the market therein has adapted to the company’s sheer
quality based products prompting them to pay a premium price therein. Since, the Chinese currency
of Yuan is pegged with USD to the tune of ¥/USD as of mid 2019, a relative depreciation of US
currency with AUD results in a relative appreciation of Yuan with respect to Woolworth’s products
which are exported in terms of a standardized currency of USD. This results in relative cheapening of
exports of Woolworth to China only – a double positive whammy since it accrues manifold benefits
(however, restricted to China only).
The fact of the matter is that the apparels being high in demand in China, can be capitalized on a
demand price hike as was evident by the fact that a Woolworths Select Pink Himalayan Salt grinder
selling for $3 in Australia garnered an upscale tick of up to $11.50 in China (59RMB) – this showcases
an aggressive expansion opportunity that can be worth capitalizing on in order to take advantage of
the current consumer favourability and cement a noteworthy position in the Chinese market.
However, with respect to the US market, since Woolworth’s products have become more expensive
on account of relative currency depreciation, the company will face stiff competition and an
impenetrable market unless it targets to break in the same using a cost leadership strategy thereby
reducing it’s cost basis and effectively increasing it’s value generation to it’s American customers
(Product differentiation would be less useful as it has already been established that the company’s
products are already high in demand).
The concerns of Woolworth do not end here, because it still faces a major risk on account of
currency fluctuations which cannot be hedged against by only setting apart cash reserves for
provisioning to act as a cushion – this will serve an expensive affair which will be difficult to sustain
as it reduces the company’s flexibility and it’s exercising power with respect to different projects.
Woolworth would need to engage in exhaustive delta gamma neutral hedging to virtually square off
any losses in totality. The same can be done by either engaging in a curated forward contract that
would effectively put a safeguard on the company’s foreign exchange exposure on account of pre set
exchange rates which will help the company to accordingly fix it’s prices with potential clients.
Woolworth can also engage in a cross-rate hedge wherein, it could peg it’s currency with Yuan since
China is it’s most sought after international client against USD – this could also result in a triangular

arbitrage for Woolworth if the markets happen to be inefficient thereby certifying a solid other
source of income. Referring to Woolworth’s 2018 annual report, Woolworth has clearly solidified it’s
claim with respect to the same by stating it’s activities involving “interest rate swap contracts, cross
currency interest rate swaps and forward foreign exchange contracts and options” forming an
effective portion of the overall cash flow hedges they undertake.
The company also needs to hedge it’s translation exposure. Since Woolworth has already pegged it’s
currency stake at AUD being it’s functional and reporting currency, it has suffered losses to the tune
of $ 28.8 million in 2016 as depicted in it’s annual report for the year 2017, in an attempt to hedge
it’s locational currency USD – this brings into question the effectiveness of hedges used therein.
Further, a strategic direction would involve Woolworth setting up a standardized Foreign Currency
Translation Reserve (FCTR) that would incorporate dynamism with which the exchange rates
fluctuate. Since, the company has reported in it’s financial statements that it’s forex differences arise
on account of operational activities pertaining to the foreign climate and from monetary receipts
and expenditures which are unplanned and are based on contingencies, it would make sense to
adopt a FCTR which would take into account such probabilities.
These policy adoptions would not be too difficult to consider, since as per a research report
presented by Infront Analytics in the year 2018, Woolworth has been assigned a relative risk score of
9 on a scale of 1 to 10 with 10 signifying the lowest risk possibility. Combined with a positive till date
local currency price change to the tune of 24.8%, it does seem that Woolworth is a less risky
alternative in it’s overall peer group.
All in all, the company has to take into account any potential currency fluctuations and subsume it in
it’s export and import pricing of it’s commodities neutralizing any forex losses – however, this would
involve extensive forecasting using relevant pricing models such that the overall basis risk is lower,
and the reconciliation between the spot and forward rates of AUD/USD are speedier. A dynamic
pricing strategy substantiated with sufficient currency reserves in the form of provisions would play
a key role therein and have an overall positive bearing on the strategic direction of the company
with an inner subliminal upward push in operations.