Current risk environment
The outbreak of war in Ukraine at the beginning of 2022 apruptly interrupted the supposed return to a “new normal” after the COVID-19 pandemic, and subsequently led to a series of new global crises. The International Monetary Fund forecasts growth in global gross domestic product of 3.4 percent for 2022.
In particular, unprecedented shortages and associated increases in the cost of raw materials and energy had a significant impact on the global risk environment in 2022. As a consequence, the Lenzing Group was directly affected by the massive increase in energy costs in 2022, especially at its European production sites. The significant increase in chemical and logistics costs deriving from the rise in energy costs, as well as shortages in this area, placed an additional burden on the Lenzing Group’s business result in 2022.
Global inflation as well as China’s zero-Covid policy have massively affected the global textile and apparel industry.
Risks such as supply chain interruptions, cyberattacks and the consequences of climate change are becoming increasingly significant.
A detailed analysis of the trends in the global fiber market during the reporting year and the related risks for the Lenzing Group is presented in the “General Market Environment” section.
Lenzing risk outlook for 2023
Rising volatility in many areas increases the global risk of polycrises and is affecting the Lenzing Group to varying degrees.
For 2023, the IMF forecasts global economic growth of 2.9 percent. Global inflation is expected to decrease from 8.8 percent in 2022 to 6.6 percent in 2023, and to 4.3 percent in 2024, according to the IMF.
Risks for the operating result arise in particular from diminishing demand on the world fiber market and associated low fiber prices, as well as from price fluctuations for important raw materials and energy. High inflation and the resultant rising interest rates pose an additional risk for future financing. Growing demand for sustainable solutions in the world is adding to the pressure on the conventional viscose segment.
As a consequence, the company continues to regard itself as very well positioned with its adapted strategy and its focus on sustainable growth deriving from specialty fibers.
The Group’s own supplies of dissolving wood pulp are secured in the long term thanks to continuous capacity expansions, in particular the successful start-up of the pulp mill in Brazil in 2022, and sufficient market supply.
Following historic highs in prices for energy, raw materials and logistics in the first half of the year, signs of a slight decrease in prices in these segments emerged at the end of the financial year under review. From today’s perspective, these markets are expected to remain highly volatile.
As far as currencies are concerned, the US dollar fluctuated against the euro within a range of around 15 percent, while the Chinese yuan fluctuated against the euro in a range of around 7 percent. A depreciation of the two currencies would have a negative impact on Lenzing’s open currency volumes. The liquidity risk is estimated to be moderate for 2023, although rising interest rates may have a negative impact on earnings.
No significant loss events arising from operational, environmental or product liability risks occurred in the reporting year.
Non-operational risks such as cyber and compliance risks and the associated potential reputational damage are of increasing relevance for Lenzing. Risks due to “green claims” as well as challenges in sustainable recruitment, not least due to demographic change, are also playing an increasingly important role in this context. Lenzing continuously counteracts these risks with Group-wide standards and training as well as its global organizational structure.
The main purpose of risk management in the Lenzing Group is to safeguard and strengthen the company through an adequate, objective and transparent assessment of financial, operational and strategic risks, including those related to ESG issues. The Lenzing Group’s Managing Board, together with the heads of the reporting departments, conducts extensive coordinating and controlling operations as part of a comprehensive integrated internal control system that covers all locations. The timely identification, evaluation and response to strategic and operational risks form essential components of these management activities and make a significant contribution to the company’s value. This approach is based on a standardized, Group-wide monthly reporting system and the ongoing monitoring of strategic and operational plans.
Lenzing uses an established, company-wide risk management process that ensures the central coordination of risks and their monitoring in a comprehensive risk management system for the entire Group. Together with the operating units, significant risks are identified and assessed and then communicated and transparently presented to the Managing Board and to other managers. Proactive analysis of potential risks or near misses is just as much the aim of risk management as the task of actively controlling risks and evaluating appropriate measures with the business units concerned. In connection with climate change, risk management has also been identifying and assessing climate-related risks and opportunities as well as their short-, medium- and long-term effects on the Lenzing Group since 2020, and deriving appropriate mitigation measures. This takes into account the requirements of the TCFD (Task Force on Climate-Related Financial Disclosures) as well as the EU Taxonomy and associated future obligations to report climate-related opportunities and risks.
Risk management strategy
The Lenzing Group pursues a multi-step approach to risk management:
Risk analysis (based on the COSO®1 Framework)
The Central Risk Management Department conducts semiannual risk discussions with a five-year time horizon with all production locations and functional units. Long-term opportunities and risks are also analyzed in connection with ESG issues. The main risks, as well as an increasing number of opportunities, are recorded and quantitatively assessed in accordance with international COSO® standards. All risks are presented outside the consolidated statement of financial position and the consolidated income statement. The financial impact of a potential loss on Group EBITDA or on cash and cash equivalents is taken into consideration. The risks are simulated against planned EBITDA, and the range of potential deviations from the respective budget is determined. Lenzing uses simulation software for this purpose, which also calculates other KPIs such as Value at Risk and a risk-adjusted ROCE. Risks that cannot be measured in monetary terms are recorded qualitatively.
Depending on the impact on the company, efforts are made to avoid, minimize or transfer risks through appropriate measures or, in certain cases and if necessary and reasonable, to intentionally assume them.
Individual risks are assigned on the basis of the existing organization matrix. Each risk is assigned to a member of the Managing Board as “risk owner” and to a risk officer.
The effectiveness of the risk management system used by the Lenzing Group was evaluated by KPMG Austria GmbH pursuant to Rule 83 of the Austrian Corporate Governance Code (ACGC) as part of a special audit in the reporting year.
The main risks are presented in detail in a report and discussed with the Managing Board and the Audit Committee. The risk report is also submitted to the Supervisory Board.
1 Committee of Sponsoring Organizations of the Treadway Commission
Market environment risks
As an international corporation, the Lenzing Group is exposed to a variety of risks. The trend in prices and volumes for textile fibers and, to a lesser extent, also for nonwoven fibers, is cyclical as it is dependent on global and regional economic conditions. Lenzing fibers compete with cotton and synthetic fibers in many submarkets. Consequently, price trends for these products also have an influence on Lenzing fibers’ revenue and sales volumes trends.
The Lenzing Group counteracts this risk by steadily increasing the share of specialty fibers in its global product portfolio and a consistent sustainability and innovation strategy. In addition to increasing the share of specialty fibers, the aim is to further expand the company’s role as a leader in sustainability and the circular economy in the fiber sector. Lenzing fibers also offer a differentiating feature in the conventional fiber sector with their high sustainability and quality standards combined with customer-oriented and solutions-oriented technical support.
The Lenzing Group relies on a strong international market presence, especially in Asia, combined with a first-class regional support network for customers, as well as a high level of customer-oriented product diversification.
The Lenzing Group generates around 40 percent of its fiber revenues with a mid-double-digit number of customers. Customer concentration in the pulp sector is comparatively higher than in the fiber sector. A decrease in sales to these major customers, or the loss of one or more major customers without an immediate replacement, poses a certain risk. The company counteracts such risk with its global presence and the continuous broadening of its client base and sales segments. Potential default on trade receivables is covered by clear receivables management and global credit insurance.
Competitive and innovation risks
The Lenzing Group is exposed to the risk of losing its position on the fiber market due to greater competition or new technologies developed by competitors. In particular, the Lenzing Group could relinquish its market position if it were no longer able to offer its products at competitive prices, if its products were to fail to comply with customer specifications and quality standards, or if its customer service were to fail to meet customer expectations. Lenzing counteracts this risk with research and development activities that exceed the average for the sector, and by a high level of product innovation and steady cost optimization. The Lenzing Group – similar to other producers – is exposed to the risk that acceptable or superior alternative products may become available and at more favorable prices than wood-based cellulose fibers.
Laws and regulations
The Lenzing Group is confronted with different legal systems and regulations in its global markets. A change in laws or other regulations (e.g. import duties, product classifications, environmental requirements etc.), as well as a more stringent interpretation of existing regulations and laws, could lead to significant additional costs or competitive disadvantages. The Lenzing Group maintains certified management systems for quality management according to ISO 9001, for environmental management according to ISO 14001, and for safety management according to ISO 45001. Legal compliance in connection with these management systems is regularly audited both internally and externally.
With its own legal and compliance department, the Lenzing Group has a corporate division that performs corresponding consulting services and risk assessments.
In response to the far-reaching implications of global climate warming for society and ecosystems, governments and further stakeholders are likely to introduce more stringent laws and regulations. For example, in addition to reducing carbon credits issued in the EU, new taxes on carbon dioxide emissions could be introduced, among other measures. Other regions and countries are currently also planning to implement similar steps. The implementation of regionally differing measures could have a negative impact on the Lenzing Group’s civic performance and success. The Lenzing Group is implementing a number of measures to reduce climate-related transition risks, and to further enhance resilience in this area.
Intellectual property risks
A risk exists that Lenzing’s intellectual property may be infringed or incompletely protected. The Lenzing Group counters such risks by means of a dedicated intellectual property protection department.
Climate change and marine pollution
Increasing awareness of problems caused by climate change, such as rising sea levels, the frequency and severity of natural disasters, and a growing risk from pollution of the world’s oceans by plastic waste and microplastics, are creating major risks for the entire fiber industry. By producing biodegradable fibers, Lenzing regards this development as an opportunity for its business model.
The Lenzing Group has recognized the far-reaching effects of climate change on society and ecosystems and offers a sustainable alternative with its innovative and biodegradable products. Lenzing is constantly working to set clear sustainability targets and is continuously seeking ways to enhance its energy efficiency as well as opportunities to utilize renewable energy sources or those with lower carbon dioxide emissions. As early as 2020, Lenzing became the first fiber manufacturer to commit to carbon neutrality by 2050.
ESG (Environment, Social and Governance)
As part of a materiality analysis, Lenzing surveyed material issues in relation to its sustainably oriented business model in 2021 using a multi-stage and holistic approach. Relevant opportunities and risks are assigned to each ESG topic area, which are integrated in the Enterprise Risk Management System and successively taken into account in Lenzing’s long-term strategic business planning.
In the environmental responsibility area (Environment), the main focus topics in the risk matrix comprise climate-related issues in connection with global warming (carbon dioxide reduction) as well as sustainable raw material procurement (wood, chemicals) and the growing water shortage in certain regions. Increasing regulation, particularly in relation to the taxation of greenhouse gases and the pricing of carbon, represents a significant risk for Lenzing. Regulations concerning greenhouse gas emissions have already been introduced in countries where Lenzing operates carbon-intensive processes. Lenzing is consistently working on the implementation of energy efficiency measures, as well as the reduction of carbon dioxide emissions in order to reduce the potential burden of eco-taxes.
For Lenzing, wood is the most important natural resource for the production of its biodegradable cellulose fibers. Despite sustainable sourcing policies and backward-integrated production, a risk exists that wood prices will rise further due to climate change, increasing global demand for biomass, and alternative land use.
The global textile industry, especially the fashion industry in which Lenzing’s products are frequently deployed, is regarded in a critical light due to its sometimes resource-intensive consumption of raw materials and its production processes. Lenzing identifies significant business opportunities through access to new and emerging markets with innovative new products and technologies. Innovation, sustainability and the circular economy lie at the core of Lenzing’s corporate strategy.
The production of pulp and fibers is associated with high levels of water consumption and emissions. Lenzing operates a careful global water management system that ensures compliance with both local laws and global standards. Lenzing is counteracting the increasing scarcity of water by continuously improving resource utilization and by optimizing the selection of sites for the expansion of production capacities.
In the area of social responsibility (Social), the main risks lie in the area of both physical as well as mental long-term health and safety of employees and society, which Lenzing is increasingly countering in the HR area with its own department for “Social Sustainability”.
In the area of corporate governance (Governance), risks such as cyberattacks (see “IT risks”) as well as poor compliance with corporate governance and resulting risks are material. Lenzing is continuously tightening its internal rules and expanding its compliance organization accordingly.
Procurement risk (including pulp supplies)
The Lenzing Group purchases large volumes of raw materials (wood, pulp, chemicals) and energy for the manufacture of its cellulose fibers. Fiber production and related margins are exposed to risks arising from the availability and prices of these raw materials, which can fluctuate to the Lenzing Group’s disadvantage and may increase as a consequence of climate change. Such risks are countered through the careful selection of suppliers based on price, reliability and quality criteria, EcoVadis-based sustainability assessments, as well as the establishment of long-standing, stable supplier-customer partnerships, in some cases with multi-year or long-term supply agreements. In addition, all suppliers must comply with Lenzing’s Global Code of Conduct for Suppliers. Nevertheless, a risk exists of violations of this code, which may have a negative impact on the Lenzing Group and its stakeholders along the value chain. Supply chain risks may also result from disruptions caused by natural disasters.
Lenzing has also entered into long-term contractual relationships with selected raw material suppliers and service partners. These agreements require Lenzing to purchase specified quantities of raw materials on standardized terms and conditions, which may also include price adjustment clauses. Lenzing may consequently not be able to adjust prices, purchase volumes or other contract conditions over the short term in order to respond to market changes.
Operating risks, environmental risks and risks relating to climate change
The production of wood-based cellulose fibers involves complex chemical and physical processes that cause certain environmental risks. These risks are very well controlled thanks to proactive and sustainable environmental management, closed production cycles, ongoing emissions monitoring and state-of-the-art production techniques. Lenzing continuously works on increasing safety and environmental standards through voluntary references such as the EU Ecolabel. As the Lenzing Group has operated production facilities at several locations for several decades, risks arising from environmental damage in earlier periods cannot be completely excluded.
Although the Lenzing Group has set very high technological and safety standards for the construction, operation and maintenance of its production sites, the risk of breakdowns, disruptions and accidents cannot be completely excluded. These types of disruptions can also be caused by external factors over which Lenzing has no control. It is impossible to provide direct protection against certain natural hazards, such as cyclones, earthquakes and floods. Moreover, a risk exists that personal injury, material and environmental damage, both within and outside the production facilities, could result in substantial claims for damages and even criminal liability.
The Lenzing Group’s production activities are concentrated at a small number of locations. Any disruption at one of these facilities has a negative impact on the company’s business operations.
Product liability risk
The Lenzing Group markets and sells its products and services to customers worldwide. These business activities can lead to damage to customers, or along the value chain, through the delivery of a defective product by Lenzing or one of its subsidiaries. Moreover, product safety can be jeopardized by pollution, which may cause problems in the value chain, such as potential health implications for employees and customers. Lenzing is also subject to local laws in the countries where its products are delivered. Especially in the USA, the potential implications are considered to be severe. Such risk is countered by a special department that focuses exclusively on customers’ problems in processing Lenzing products and on handling complaints. Appropriate precautions in the production process and regular quality inspections have been implemented. Third party damages caused by Lenzing are covered by a global liability insurance program.
For a detailed description of financial risks refer to notes 35 to 38 in the notes to the consolidated financial statements.
The Lenzing Group’s production sites are subject to local tax regulations in their respective countries and are required to pay corporation tax as well as other taxes. Changes in tax legislation or different interpretations of prevailing regulations could lead to subsequent tax liabilities.
Increasingly stringent international codes of conduct and legal regulations are placing additional demands on Lenzing in terms of compliance and monitoring. Inadequate controls in business processes or a lack of documentation can lead to the violation of applicable laws or regulations, and significantly jeopardize reputation and commercial success. Lenzing addresses this risk by, among other measures, continuously developing its Group-wide compliance organization, the corporate code of conduct that is valid throughout the Group, as well as directives addressing the areas of bribery and corruption, money laundering and antitrust practices. Further information on compliance is provided in the Corporate Governance Report.
Lenzing depends on highly developed information technology (IT) systems for its daily operations. IT systems are vulnerable to a range of problems, including software and hardware malfunctions, malicious hacking and cyberattacks, physical damage to key IT centers, and computer virus infections. Consequently, any major damage, disruption and/or circumvention of its existing IT systems may hamper Lenzing’s business operations.
Personnel risks may arise through the turnover of key staff as well as the recruiting of new staff at all global sites. The Lenzing Group has established a Human Resources Department which operates internationally and coordinates personnel planning with the respective sites. It is responsible for the central management and monitoring of all personnel-related issues, including the organization of global management and training programs for potential executives.
At the production facilities, Lenzing Group employees as well as external contractors’ workers and employees are potentially exposed to a risk of injury. Lenzing’s “Heartbeat for Health & Safety” program takes such risk into consideration and includes a strategic approach to risk reduction, precautionary measures and extensive training. For more information, please refer to the Lenzing Group Sustainability Report.
Risks relating to major projects
The Lenzing Group is continuously expanding its capacities in numerous projects. Major projects entail the inherent risk of cost and time overruns, which Lenzing counters with a standardized planning process, consistent project management, ongoing cost controls as well as insurance solutions and risk transfer. In addition to the ongoing risk management process, Monte Carlo simulations are used for projects of this size to model the sensitivity of the key financial indicators.
Risks from an external perspective and for other stakeholders
As a globally operating company, the Lenzing Group is aware of its social responsibility. The risks described in the risk report refer primarily to the effect on the Lenzing Group’s assets and earnings. As one of the sustainability leaders in its sector, the Lenzing Group seeks a balance between the needs of society, the environment and the economy. The company assumes such responsibility, particularly with respect to potential effects of its operations on neighbors of the production sites and in relation to society as a whole. Active stakeholder work to mitigate risks (partnerships for systemic change) and to create additional benefits for people and the environment is a clear goal of the Lenzing Group’s innovation and operating activities. The Lenzing Group was again awarded platinum status in EcoVadis’s CSR rating in the reporting year. This evaluation covers the most important practices in the Corporate Social Responsibility (CSR) area. In cooperation with its partners, the Lenzing Group is working on understanding the risks for stakeholders and on finding solutions to mitigate such risks. This work is based on open communication and transparency as well as continuous improvement of technologies and sustainable practices.