Factors and non-typical events having a material impact on the Group’s operations

Assessment of factors and non-typical events having a material impact on the Group’s operations and financial performance

Impairment losses recognised by African Investment Group S.A., a subsidiary of Grupa Azoty POLICE

Further to Grupa Azoty POLICE’s Current Report No. 34/2016, a complex, multidimensional process of documentation review and analyses was begun in June 2016 to present a reliable measurement of assets and liabilities associated with African Investment Group S.A., a subsidiary. Analyses and examinations focused primarily on phosphate rock deposits, which represent a material item of the Group’s assets, as reported by Grupa Azoty POLICE in Current Report No. 27/2016 of May 30th 2016. Documents held by Grupa Azoty POLICE were analysed and examined in detail, attempts were made to obtain additional relevant information, and work related to impairment testing of the assets was performed, as reported by Grupa Azoty POLICE in Current Report No. 64/2016 of December 22nd 2016.

In the successive quarters of 2016, following completion of the particular stages of reviews and analyses, Grupa Azoty POLICE made adjustments to valuations of individual assets.

In the second and third quarters of 2016, in relation to African Investment Group S.A., decisions were made to recognise impairment losses on past due receivables, to write down phosphate rock inventories as having no commercial value, and to write off exploration and evaluation expenditure on the Lam-Lam deposits and the non-depreciated value of the Lam-Lam field after mining operations in that area were finally discontinued in 2014. In August 2016, a decision was received from Senegalese authorities stating that the exploration licence for the Kayar Offshore field (covering ilmenite, rutile, and zirconium) would not be extended. An estimate of the mineral resources made by African Investment Group S.A. had shown that incurring high expenditure on exploration was too risky. In consequence, intangible assets classified as exploration and evaluation assets relating to the Kayar area were written off and charged to costs.

With no prospects for profitable production from the mineral sand deposits in the Sud Saint Louis licence area (the key factor underpinning the project unprofitability was that the identified heavy minerals resources were not sufficient to ensure the project life of more than five to eight years), a decision was made to write off intangible assets classified as exploration and evaluation assets relating to the Saint Louis area.

Based on a thorough review and analysis of documents, the Grupa Azoty POLICE management board determined that a material error had been made in the final accounting for the acquisition of shares in African Investment Group S.A., which had been presented in the Group’s consolidated financial statements for 2014. As a result, the Group’s consolidated financial statements for 2015 also contained an error. To rectify the situation, correction of previous periods’ errors was made in the 2016 financial statements.

The fundamental error made in the calculations underlying the final accounting for the acquisition was a failure to take into account the need to construct a phosphate beneficiation plant. This led to underestimation of the capital expenditure, operating expenses and time required to reach a stage of project completion where it would be possible to launch production of phosphate rock with commercial value. The change was attributable to the lower quality of phosphate rock deposits in the Kebemer area. Since it had been initially assumed that the phosphate rock would have a high content of phosphorous (P₂O₅ equivalent) and as such would not require traditional flotation beneficiation, but only crushing and screening, natural drying was assumed. However, the drilling campaign carried out between December 2013 and June 2014 in the Kebemer exploration licence area revealed that the field parameters were much worse than initially assumed (with thicker overburden and lower phosphate quality).

Analysis of the documentation also revealed that the assumed size of the resources in the other field (Lam-Lam) was also wrong.  To the best of knowledge, the total phosphate rock production from the Lam-Lam field, which was discontinued in mid-2014, was 110.7 thousand tonnes of phosphate rock, and not 314 thousand tonnes, i.e. the figure used in the final accounting for the acquisition.

The above assumptions were changed as part of the correction of accounting for the acquisition. As a result of correction of the erroneous assumptions, the exploration licences disclosed as the value of mineral deposits (as at August 28th 2013) were revalued.

Following correction of the accounting for the acquisition of African Investment Group S.A. with respect to the acquired exploration licences disclosed in property, plant and equipment as mineral deposits, the net value of the acquired assets and assumed liabilities is negative.

Adjustment to the fair value of the acquired assets (mineral deposits) and the deferred tax liabilities related to those assets, resulted in recognition of goodwill in place of a gain from a bargain purchase. Goodwill of PLN 93,141 thousand, recognised as a result of the correction of the accounting for the acquisition, was allocated to the investment in the phosphate mining facility, identified as a cash-generating unit on acquisition of the majority interest in African Investment Group S.A.

To assess the goodwill recognised on the correction of the accounting for the acquisition, the goodwill was tested for impairment as at December 31st 2013.

The estimated present value of future cash flows determined based on the assumptions made using the then available data was negative. Therefore, an impairment loss was recognised for the full amount of the goodwill.

For a detailed description of the assumptions made for the purpose of impairment testing of goodwill, see the consolidated financial statements of Grupa Azoty for the 12 months ended December 31st 2016.

In the statement of financial position Grupa Azoty POLICE continues to disclose the expenditure incurred on exploration and evaluation of mineral resources from the date of acquisition of shares in African Investment Group S.A., in the amount of PLN 64,047 thousand (of which PLN 63,224 thousand is attributable to the Kebemer exploration licence area). This results from the need to continue the work on examining the geological documentation and the need to obtain a scoping study compliant with international standards, required under the reporting policy implemented by the Group. These activities are expected to be completed in the second half of 2017, and then relevant decisions concerning the future of the project will be made.

Effect of one-off events related to African Investment Group S.A. on the 2016 net profit/(loss) *

*Amounts translated into PLN at the average exchange rate for XOF in 2016. 

Effect of one-off events related to African Investment Group S.A. on the 2015 net profit/(loss)*

*Amounts translated into PLN at the average exchange rate for XOF in 2015.

Effect of one-off events related to African Investment Group S.A. on profit/(loss) brought forward as at January 1st 2015*

* Amounts translated into PLN at the historical exchange rate for XOF.

In the consolidated financial statements for 2016, profit before tax includes the following adjustments:

• impairment losses on African Investment Group S.A.’s receivables past due for more than one year, covering 100% of the receivables amount: PLN 20,031 thousand,
• write-down of phosphate rock inventories presented by African Investment Group S.A. as work in progress deemed slow moving inventories for over two years, due to no commercial value of the product: PLN 10,838 thousand,
• recognised provision for future liabilities for technical consultancy related to phosphate rock supplies from Senegal: PLN 9,411 thousand, allocated to other expenses,
• PLN 900 thousand write-off of intangible assets classified as exploration and evaluation assets relating to the Kayar area, following the authorities’ decision not to extend African Investment Group S.A.’s exploration licence for ilmenite, rutile, and zirconium deposits in the Kayar Offshore field – an estimate made by AFRIG S.A. showed that incurring high expenditure on exploration was too risky,
• write-off of intangible assets classified as exploration and evaluation assets relating to the St. Louis area by African Investment Group S.A.: PLN 4,241 thousand.

In the consolidated financial statements for 2015, profit before tax includes the following adjustments:

• PLN 10,222 thousand write-off of intangible assets classified as exploration and evaluation assets relating to the Lam-Lam phosphate rock deposits - charged to costs following discontinuation of production.

Impairment loss at Zakłady Azotowe Chorzów S.A., a subsidiary of Grupa Azoty PUŁAWY

On February 13th 2017, the management board of Zakłady Azotowe Chorzów S.A. (a subsidiary of Grupa Azoty PUŁAWY) passed a resolution to recognise a PLN 10.0m impairment loss on the assets of the fat processing unit. In accordance with IAS 36, the company’s management board identified indications that the recoverable amount of those assets may have decreased below their respective carrying amounts. The fat processing unit continues to operate below its full processing capacity. While the company recently recorded an increase in the average selling price of oleochemicals, prices of the key raw material (liquid animal fat) remain high, which significantly limits the company’s ability to generate cash inflows from the sale of stearine and other oleochemicals.

Having considered these indications, the management board of Zakłady Azotowe Chorzów S.A. tested property, plant and equipment and intangible assets for impairment. The test confirmed the validity of recognising another impairment loss on the assets of the fat processing unit. The first impairment loss of PLN 18.4m was disclosed in the financial statements for 2015. The current impairment loss of PLN 10.0m will be disclosed in the financial statements of Zakłady Azotowe Chorzów S.A. for 2016.

The effect of the event described above on the consolidated results of the Grupa Azoty PUŁAWY Group, and thus on the consolidated financial statements of the Group (and, more specifically, on the Group’s consolidated EBIT for 2016) is negative at PLN 10.7m, including PLN (0.7m) on measurement of the company’s assets at the time of acquisition of Zakłady Azotowe Chorzów S.A. by Grupa Azoty PUŁAWY.

Volatility of exchange rates

The key factors with a bearing on the Group’s financial results in 2016 included the downgrade of Poland’s credit rating by S&P and the slowdown in the Chinese economy, followed later during the year by the Brexit referendum in the UK, Donald Trump’s surprising win in the US presidential elections, and increased volatility of the emerging market currencies. All these factors spurred three waves of weakening of the Polish złoty against the euro and the US dollar, separated by short-term appreciations of the Polish currency based on the strong foundations of the Polish economy.

During 2016, the Polish currency lost approximately 3.8% against the euro and 7.1% against the US dollar over December 31st 2015. The average PLN/EUR exchange rate in 2016 was approximately 4.4% lower than in 2015, while the average PLN/USD exchange rate declined by approximately 4.5% over the same period.

Decisions by the leading rating agencies, in January 2017, to keep Poland’s sovereign credit rating unchanged, coupled with forecasts predicting stable GDP growth, point to further potential strengthening of the Polish currency against the euro in 2017.

However, external risks, including the difficult condition of Italian banks, uncertainty surrounding Brexit and the US’ actual policy in relations with Europe will exacerbate the risk of the złoty again depreciating against the US dollar, especially in the wake of the potential weakening of the euro against the US dollar. It can therefore be expected that in 2017 the PLN/EUR exchange rate will remain within the medium-term range (PLN 4.20-4.40), with some room for appreciation if the Polish economy continues to perform well and there is no further escalation of the external risks identified above. In the meantime, the PLN/USD exchange rate may continue to weaken, matching the volatile EUR/USD exchange rate.

Taking into consideration the Group’s currency risk exposure, the current and anticipated exchange rate fluctuations are unlikely to pose a risk to the Group achieving its targets for 2017, given that the potential strengthening of the Polish złoty against the euro may entail a parallel weakening of the currency against the US dollar. Furthermore, the political risks in the US and the EU significantly limit the złoty’s potential to strengthen its position.

The Group monitors the current and planned net currency exposures and reduces the resulting currency risk by applying selected hedging instruments. In the reporting period, the main tools used by the Group were: natural hedging; factoring and discounting of receivables denominated in foreign currencies; and currency forwards covering up to 80% of the remaining currency exposure with time horizons of less than 6 months, and up to 50% of the remaining currency exposure with time horizons between 6 and 12 months.

Pursuant to the ‘Financial Risk Management Policy (currency and interest rate risks)’, the Group may enter into hedging transactions with horizons of up to 24 months (as long as such transactions reduce the adverse effect of exchange rate fluctuations on the cash flows, and it is possible to secure the EUR/PLN or USD/PLN exchange rates higher than those assumed in the budget) and up to 3 months (if it is possible to hedge the exchange rate at which a commercial transaction was executed).

Execution of currency hedging transactions where the hedge horizon is more than 24 months or the transaction does not conform to the Financial Risk Management Policy requires approval by the Management Board based on the recommendation of the Finance Committee.

In 2016, the Group’s hedging tools were EUR and USD swap forwards, reflecting its planned net exposure in both currencies. The Group’s result on hedging transactions executed in the first six months of 2016 was PLN (4,264) thousand. The result on revaluation of hedging instruments was negative at PLN (6,476) thousand.

In 2016, the Group’s total result on hedging transactions and revaluation of hedging instruments was negative at PLN (10,741) thousand.

On the unhedged net currency exposure, the Group reported a net gain on realised and unrealised foreign-exchange differences of PLN 10,717 thousand.

In 2016, the Group’s total result on foreign exchange differences and currency derivative transactions (including revaluation as at the end of the reporting period) was negative at PLN (23) thousand.

The weakening of the average PLN/EUR and PLN/USD exchange rates relative to 2016, favourable to the Group, was accompanied by strong market volatility, which limited the exchange rates’ positive effect on the Group’s financial results in the period. The loss on measurement and exercise of currency forwards was offset by gains on current currency transactions and foreign-exchange differences.

In 2016, the parent’s hedging tools were EUR swap forwards, reflecting its planned net exposure.

The parent’s result on hedging transactions executed in 2016 was PLN (2,733) thousand. The result on revaluation of hedging instruments was negative at PLN (609) thousand.

On the unhedged net currency exposure, the parent reported a realised foreign exchange gain of PLN 1,050 thousand, and a net loss on unrealised foreign-exchange differences of PLN (495) thousand.

In 2016, the parent’s total result on foreign exchange differences and currency derivatives (including revaluation as at the reporting date) was PLN (2,787) thousand (including PLN (1,683) thousand on realised foreign exchange differences and currency hedging transactions, and PLN (1,104) thousand on unrealised items and hedging).

Since September 28th 2015, the Group has applied cash flow hedge accounting. The hedged items are highly probable future income from sale transactions in the euro, which will be recognised in profit or loss in the period from December 2018 to June 2025. The hedging, covering currency risk, is a euro-denominated credit facility of EUR 100m as at December 31st 2016, repayable from December 2018 to June 2025 in 14 equal half-yearly instalments of EUR 7,143 thousand each. As at December 31st 2016, the fair value of the facility was PLN 444,874 thousand. As at December 31st 2016, the hedging reserve included PLN (7,165) thousand on account of the effective hedge. In 2016, the Group did not reclassify any hedge accounting amounts from other comprehensive income to the statement of profit or loss.

Prices of CO₂ emission allowances.

In the first half of 2016, prices of CO₂ emission allowances declined markedly, to rebound in the last quarter of the year. Some of the EUA transactions were executed by the Group at the time when the allowances traded low, which had a positive effect on total valuations of the Group’s CO₂ futures at the end of the period. In 2016, the Group reported a PLN 3,502 thousand gain on valuation of the futures.

Some of the transactions were executed by the parent in a period when their prices were low and thus in 2016 the parent recorded a PLN (152) thousand loss on valuation of futures contracts for the purchase of CO₂ emission allowances.

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