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Introduction

Clearwater Seafood was a seafood exporting firm which suffered from a decline in sales

revenue due to the appreciation of Canadian dollars and other business risks. As a result, the

company failed to distribute dividends under income trust. The company had to hold a

conference for shareholders and adjust its strategy to tackle such problem it faces.

In the first part of this report, both exchange rate risk and business risk will be illustrated

according to its financial performance and operating process. The second part includes any

recommendation in my point of view.

Foreign Exchange Risk

Foreign exchange risk is the risk of an investment’s value changing due to changes in

currency exchange rates. Foreign exchange risk can be divided in to three types which are

translation, transaction and economic risk. Translation risk occurs from the potential loss due

to the moment when foreign currency is transferred into home countries currency.

Transaction risk is the risk of adverse exchange rate movements occurring in the course of

normal international trading transactions. The economic risk is the effect of exchange rate

movements on international competitiveness.

For transaction risk, let’s concentrate on the sales revenue and the exchange rate in

corresponding period. From Appendix 1, we can conclude that US dollar and Japanese Yen to

Canadian dollar value decreased since 2002, and Euro to Canadian dollar decreased sharply

since 2004. In the same period, as shown in Exhibit 5, Clearwater’s sales revenues in US

dollar decreased from $205,000 in 2003 to $183,400 in 2004 and $146,000 in 2005. The sales

revenue in Japanese Yen saw the similar picture. In 2003, the sales revenues were $33,000,

but then it decreased to $28,000 in 2004 and to $26,000 in 2005. In all, accompanied with the

appreciation of Canadian dollar, significant lower profits generated from foreign markets led

to the decreases in the total sales revenue, from $350,000 in 2003 to $345,000 in 2004 and

$315,000 in 2005. As shown in Appendix 2, over 80% of Clearwater’s revenue was from

transaction with foreign currencies, so the firm’s revenue can be considered significantly

influenced by the appreciation of Canadian dollar in this period.

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Figures in Exhibit 8 can confirm the translation risks. The foreign currency translation cost

fluctuated from 2003 to 2005, which was $1.443m, $3,006m, and $1.236m in specific. An

abnormally high translation cost can be observed in 2004. Translation costs may not have

linear relationship with exchange rate, but they indicates the fluctuation of exchange rate

which may create extra risk when constructing sales or cost budget to make future risk

hedges.

Economic risk refers to the competitiveness in international market. In this case, the

exchange rate of USD and Euro to Canadian dollar played the main role. The company’s

international competitiveness was obviously weakening because USD was depreciating

gradually. Not only the revenue converted to Canadian dollar, but also the sales revenue in

American market was shrunk. Take the end of 2005 for example, the company had $62

million and Euro 12 million contracts respectively, which meant that every one-cent change

in exchange rate of US dollar and Euro to Canadian dollar would trigger US$505,000 and

Euro 285,000 fluctuation in sales and gross profit. That is quite a lot considering the

company’s whole sales and profits.

The company did implement an active foreign exchange risk management scheme through

forward contracts and options. 50% of the cash flows were hedged by forward contracts,

which can provide certainty in exchange rates in 12 months or longer. Also, it sold call

options. If options were exercised, the company could make the transaction under a pre-

determined exchange rate. Nevertheless, only 50% of cash flows can be covered by the

forward contracts. Moreover, the short position of call option also would brought about extra

risks if the value of home currency moved to an unexpected direction. Such potential loss

could be infinite. Also, $22.5 million unqualified forward contract was a high-risky factor.

Business Risk

1. Need stable funds to support its strategy against competitors

This kind of risk can be categorised to strategic risk in business risk. The company mainly

has three core strategies to maintain its competitiveness against peer companies: innovation,

management of value chain and diversity of products. They are all driven by not only a great

quantity, but also stable funds in every period. For instance, the cutting-edge technologies

are supported by edged equipment and high-quality research groups. To hire an expertise and

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maintain the equipment require enormous cash inflow every year. Similarly, the management

of value chain also needs managers with high salary costs. On the other hand, to diversify

products requires a large number of cash inflows in one period. Digging new produce species

and entering new markets costs a lot, including installation cost, cost from political barriers,

discount costs to beat local competitors and so on. Unfortunately, as mentioned above, due to

the fluctuating exchange rate of other factors, its profits are not stable and sufficient enough.

It is doubtful that its core strategy can be implemented as expectation. A future decline in

sales revenue can be expected, following the failure of strategy.

2. The risky value-added processing in different countries

Value-added processing is a customer driven process which produces products in a manner

that enhances its value. It can bring more risks for Clearwater when it is applied in various

countries. There are 23 offshore harvesting vessels owned by Clearwater. Clearwater has

offices in China, the United States, the United Kingdom, Japan and Argentina, which apply

their own strategy and follow different logistics according to local conditions. Four

distribution hubs are located in London, Brussels, Louisville and Halifax. The company

defines the value added process as which is related to produce fresh, high quality and variety

of products to satisfy customers in different countries with efficient distribution.

Theoretically, diversity of market may significantly increase uncertainty of such process. Any

change in this business cycle can result a big problem. For example, a change in price of any

raw material in any countries may force the company to reconstruct its operating process.

Any change of local customer’s preference may influence the company’s revenue in these

countries. A new entrant into the market or a change of local government’s politics may make

the value-added process inefficient. In all, the flexibility of operating process makes the

monitoring more costly and it is more likely not to be in accordance with the company’s

whole strategy.

3. The risks derived from the nature of product

The seafood harvesting plays a vital role in Clearwater’s business because it is the base of

sufficient resources supply. Nevertheless, the seafood harvesting is seasonal in nature. As a

result, the transactions are more frequent in the second half of each year which may bring

about a liquidity risk. Also, a change in climate or natural environment can impact the quality

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and quantity of fishery. As long as the resources supply is influenced, the whole business

process and value chain is uncertain.

4. Political risks from Canadian government

The industry is regulated by the Department of Fishery and Oceans (DFO). They determine

the firm’s volume and species to catch and quotas for every company. The regulators are

likely to cut down the company’s quotas or reduce the total allowable catch amount due to

the decreasing amount of some species. Any change in TAC is a risky factor.

5. The uncertain future of the whole industry.

Recent years have seen an increasing number of people realizing the importance of ocean

protection. Hazard risk may emerge due to the exploiting ocean resources. It is entirely

possible that the range of fish catching may be limited because of both the pollution and

ocean protection. On the other hand, however, people also realize the nutritional value of

seafood. Farmed fish could be preference. More risks will ensure when the company modifies

its industrial structure.

Suggestions to reduce foreign exchange risks

Before 2003, the company benefited from the weak Canadian dollars, but after Canadian

dollar started to appreciate in 2003, its revenue followed an unfavourable trend. The pervious

hedge strategy may not be applicable anymore. Nevertheless, according to Exhibit 10, no

change in its foreign exchange management was made.

As the Canadian dollar’s appreciation is expected to last for further years, the company can

put more funds into the short position of put contract, which is at an appropriate level to

avoid too many risks. If it is possible, the company can encourage the institutional customers

to purchase products in Canadian dollar to limit currency risks. Moreover, the company can

match receipts with payments in one currency by controlling the volume of trading.

Similarly, asset and liability matching is also a choice. By analyzing the duration of assets

and liabilities, the company can match the amount of inflow of assets and debt payment to

offset the costs from exchange rates. Finally, the strategy of leading and lagging deserves to

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be utilized. It refers to getting receipts early and making payment late when the Canadian

dollar is less valuable and is expected to appreciate and vice versa.

Suggestions to reduce business risks

Firstly, considering the diversity of products and markets involved, a centralized operating

structure may not be a good one. Each part of the firm’s value chain and value-added

processing is totally different and cannot be well-managed under a centralized structure. It is

better to implement a decentralized organisational structure. Under such structure, sales

budget, motivation plan and business strategies are set separately to reflect the local

conditions. Moreover, the dividend payment system with income trust should be adjusted. To

benefit the firm in long term by generating higher capital gain, dividend payment should be

decided by CEO instead of by monthly binding.

Secondly, the company is recommended to focus more on producing high-value seafood to

more profitable markets, rather than continue to expand its product categories. In Appendix 4,

scallop is the species with best performance which deserves more concentration. Also in

Appendix 3, US market accounts for about 50%. As US market has no significant advantage

on seafood consumption over other countries, the company should pay more attention to

some emerging markets, such as China which has more potential. The sales in China only

contribute for 1.8% during 2005, which are too little.

Thirdly, to invest in some insurance is a good idea. As mentioned before, because of the

nature of its resources, a sudden change in climate or environment can cost the company a

lot. Purchasing some insurance on it can prevent the company from a disaster.

Fourthly, the firm’s innovation and edged technologies is its core competitiveness which the

company should keep investing on. Acquisition is a considerable way to maintain such

advantage. The level of tariff, exchange rate and local policy should be taken into

consideration when determine the company to acquire.

Finally, with the TAC quota, the company should not receive all TAC, but find out the

profitable one, for example, scallops to invest. According to Appendix 4, scallops are the

most profitable part. However, the TAC allocations on sea scallops and argentine scallops are

48.7% and 50% respectively which is significantly lower than that of lobster which is 87.5%.

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Appendix 1

2002 2003 2004 20050

0.5

1

1.5

2

2.5

3

1.566 1.462 1.382 1.307

0.013 0.013 0.012 0.011

1.511 1.615 1.6131.478

2.369 2.464 2.3822.188

Canadian dollar/foerign currencies)

USD JPY Eur GBP

Appendix 2

2002 2003 2004 20050.00%

10.00%

20.00%

30.00%

40.00%

50.00%

60.00%

70.00%

Percentage of sales in foreign cur-rencies

USDJPYEurGBPother

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Appendix 3

2003 2004 20050.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%40.00%

Sales by Geography

USA Canada Europe JapanChina Aisa Others

Appendix 4

2003 2004 20050.00%5.00%

10.00%15.00%20.00%25.00%30.00%35.00%

Sales by Species

scallops lobster clams ground fishshrimp crab others