In today's globalized world, even minor movements can have a significant impact on markets, particularly the foreign exchange (FX) market, which is highly volatile. This market is affected by fluctuations in currency, exposing all parties to FX risks. Any significant changes can heavily weigh on consumer confidence and cause massive fluctuations and uncertainty in foreign currency, as was seen after Russia's invasion of Ukraine.

Consumer giants, such as Proctor & Gamble (P&G), are the biggest players in the FX market, where their gross margins are susceptible to FX rate changes. Therefore, it is essential for these companies to have FX risk management strategies that allow them to mitigate any impact. This report will delve into the FX risk management strategies of P&G, one of the biggest US consumer giants, and evaluate its efficiency by comparing it with different global manufacturing companies.

International transactions and currency fluctuations expose all entities to foreign exchange risks, which can gravely affect an organization's position in the market. These risks can shrink the company's fiscal sales and net earnings, impacting its bottom line. There are typically three types of exchange-rate risks: transaction exposure, translation exposure, and economic exposure.

Multinationals are vulnerable to fluctuations in interest rates, inflation, and currency rates in their countries as they conduct business internationally and use a range of foreign currencies. P&G is subject to market risks such as fluctuations in interest rates, currency exchange rates, and commodity prices. To control volatility associated with net exposure, the corporation uses derivative instruments and engages in hedging activities when it comes to various financial transactions.

P&G finances operations in several countries throughout the world, exposing them heavily to both translation and transaction risk. With half of its revenue generated from outside of the U.S., P&G faced a 6% FX impact alongside a 1% plunge (equivalent to $0.8 billion) on net sales in 2022 from an unfavorable foreign exchange environment. Additionally, the company has over $5.8 billion in foreign subsidiaries primarily in European and Asian countries, putting P&G in a vulnerable position at the time of valuation from FX fluctuations. Additionally, it faces operational risk from its association with third-party relationships, including suppliers, contract manufacturers, distributors, contractors, and external business partners in different countries, transacting in foreign currency.

Most of P&G's risk distribution is concerned with FX, ranging from macroeconomic & financial related risks, business operational risk, credit risk, business strategy risk, commodity prices risk, and interest rate risk. To mitigate these risks, P&G employs a "Board Oversight of Risk" to ensure that the company's risk management is astute. It consolidates these risks naturally by leveraging its diversified portfolio of exposures and hedges the rest with derivatives as opposed to using financial market instruments. The company's corporate policy stipulates legitimate hedging activity.

P&G primarily utilizes forward contracts and currency swaps with maturities less than 18 months to manage FX risks associated with the financing of its operations. Additionally, it also uses futures and options to manage the price volatility of raw materials that may arise from FX fluctuations. It designates cash flow hedges and net investment hedges to manage FX risk and has counterparty credit guidelines to manage credit risk. The company manages its translation risk by net investment hedging by either entering foreign cross-currency swaps or by borrowing in foreign currencies and hedging the debt.

P&G closely monitors the positions of its derivatives using techniques such as market valuation, sensitivity analysis, and value-at-risk (VaR) modeling. VaR is often used by P&G to assess the riskiness of its foreign exchange position over a certain period, determining whether certain risks are worth hedging.

Overall, P&G's risk management strategy is highly effective in mitigating the impact of FX risks. By using a variety of techniques and closely monitoring its positions, P&G is able to manage its risk exposure effectively, ensuring the stability and sustainability of its business.

P&G's Cash Flow Statement for FY 2022 shows a loss of $497 million in exchange rate changes on cash, cash equivalents, and restricted cash. Of this, $432 million was recorded as FX adjustments (Figure 1). In 2021 and 2020, FX adjustments were stated as $101 million and -$139 million, respectively. When compared to the previous five years, P&G's foreign currency rate adjustments reached their lowest level in FY 2022 (Figure 2).

P&G's headquarters are in North America, where it was first founded and where it has the most operations. The company has expanded into 180 countries, which are divided into Europe, Greater China, Asia Pacific, Latin America, India, the Middle East, and Africa, accounting for 49%, 21%, 10%, 8%, 6%, and 6% of all sales, respectively.

The graphs above show the volatility in the Euro and Chinese Yuan exchange rates over the course of FY 2022. These swings in the exchange rate of foreign currencies affected P&G's foreign exchange risk management, especially in regions where the company had the highest proportion of sales.

Hedging activities help reduce the impact of exchange rate fluctuations on business financial performance. However, fluctuations in the currency exchange rates of certain countries can still have an impact on net sales, costs, and net profitability. Businesses should closely monitor their competitors' hedging tactics.

Johnson & Johnson (J&J) used foreign forward contracts and currency swap contracts to mitigate FX risks, while Colgate-Palmolive (C&P) used a combination of fixed and floating interest rates with loan issuances, interest rate swaps, and commodity hedging contracts. P&G had a lower Value-at-Risk (VaR) than J&J (1.32 vs. 1.52, respectively) over a one-year horizon with 95% confidence interval (macroaxis 2023). However, Colgate-Palmolive's VaR was not included in their annual report (Colgate & Palmolive 2022).

P&G may want to consider other risk management strategies, such as strategic risk management, scenario analysis, and natural hedging, that align with the company's strategic goals. Scenario analysis can help P&G identify and manage risks associated with its international subsidiaries and third-party suppliers and distributors.

An alternative risk management strategy is transferable risk management, which involves shifting risk to other parties through insurance or outsourcing. While this approach can effectively reduce an organization's risk exposure, it can also incur significant costs in terms of insurance premiums or outsourcing fees. On the other hand, risk avoidance involves abstaining from actions or situations that may pose a threat to the company. While this may prevent potential risks, it could also hinder the business from taking advantage of opportunities or achieving its goals.

In analyzing Procter & Gamble's financial performance in the past five years regarding FX risk management, it is challenging to determine the effectiveness of its strategies. The company experienced significant losses in market capitalization in FY 2022 due to a combination of unmanageable risks, including the pandemic and political unrest in Europe, which had a significant impact on its net sales. While Procter & Gamble's current risk management approach seems to be functional, incorporating some of the other strategies mentioned could better align its risk management strategy with its strategic goals.

References:

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- Procter & Gamble Annual Report 2022. Retrieved from https://www.pginvestor.com/financial-reporting/annual-reports/default.aspx

- Procter & Gamble Financial Statement 2022. Retrieved from PG-2022-Financial-Statements.xlsx (live.com)

- Colgate & Palmolive Annual Reports. Retrieved from https://investor.colgatepalmolive.com/financial-information/annual-reports

- Johnson & Johnson Annual Reports. Retrieved from https://www.investor.jnj.com/asm