Enterprise Risk Management

UGG Corporation

Jatin Bahl (11/06)

Amit Sukhija (29/06)
Nakul Jinsi (143/06)
Sneha Singh (52/06)
Facts of the case
A company named UGG corporation is in the
agri business.
 It has characteristics of a farmer cooperative,
and a public listed company.
 Regulated by Canadian Wheat Board (CWB)
 Hired Willis group, a risk management
consultancy
 Their analysis revealed that major risk is from
weather fluctuations.
 Company has to choose between three
alternatives to manage its risk.
About UGG
 Based in Winnipeg, Manitoba
 Provides commercial services to farmers
 Listed on Toronto & Winnipeg SE
 Has both members and shareholders
 4 main business segments:
 Structure

UGG Corporation
Forms 80% of the
revenue

Grain Handling
Crop Production Communication
Services Livestock Services
Services Services
(Mkt. share - 15%)
UGG’s Risk Analysis
 Environmental liability
 Effect of weather on grain volume
 Counterparty risk
 Credit Risk
 Commodity price and basis risk
 Inventory risk
Points of consideration
 Hugeearnings volatility of 2 major
business units – Grain Handling & Crop
Production. (80% of revenue is at stake)
 Std.Deviation (grain handling – 10,450)
 Std Deviation (crop protection – 5,600)

 Huge capex in 1998-99.

 Grain handling and Crop production are
most prone to weather risk.
Weather Risk – the lone terror…?
 Environmental liability – A low severity risk, can
be retained
 Counterparty risk – Though frequency is high,
the severity (as shown by Willis) is low
 Credit Risk – Can be retained (60% revenue
comes from CWB)
 Commodity price and basis risk – Insignificant
(Regulatory mechanism)
 Inventory risk – Can be retained or insured.
How weather poses a risk?

Bad Weather Y = α + β1(time trend) + β2 (Avg. June temp) + β3 (Avg. July precipitation)

Average R2 for wheat in three cities = 65%

Average R2 for Oats in three cities = 64%
Low Crop Yields

Industry r = 84%, UGG r = 80%

Low UGG’s
Grain Volume
For each tonne of shipments, a gross profit of 21.2 Can
Dollars.
Low UGG’s Profit
Grey Areas in the case…
 Why Crop production services are not
taken into account?????
 Adjusted R2 would have been more
appropriate.
 Average adjusted R2 wheat in 3 cities = 61%
 Average adjusted R2 oats in 3 cities = 60%
Risk Management alternatives
 Risk Retention
 Weather Derivatives
 Insurance Contract
Evaluation of all the Alternatives
Risk Retention
 Advantages:
 No cost will be incurred
 Uncertainty over market reaction towards the
risk protection
 But can Risk be ignored:
 Additional capital requirement
 No additional premium for retaining this risk.
 Huge capex already done
 Fluctuating earnings/CFs will deter the image…
…..
………. this is how
Weather Derivatives
 A weather index can be developed by a weighted average means of
temperature and precipitation
 UGG’s Gross Profit having a linear relationship with this index.
 Risk can be hedged using weather-put options

Potential Problems:
 Feasibility of developing such an index.
 Highly illiquid market for such derivative instruments
Insurance Contract
 UGG getting its grain shipments insured
from weather risk.
 Payments to be made using industry wide
shipment data.
 To avoid moral hazard
 Anintegrated overall insurance policy is
also under consideration
Data given

Years Industry Output Industry Crop Yield UGG Output

1981 26871 30.9 4289
1982 30392 34.7 4842
1983 33142 37.4 5367
1984 33905 33.3 5320
1985 27183 28.6 4020
1986 27443 32.5 4394
1987 33322 40.0 5368
1988 33435 36.3 5072
1989 23364 26.3 3928
1990 29682 31.3 4954
1991 33376 38.4 5498
1992 34374 37.3 5720
1993 30989 37.0 5125
1994 33489 38.0 5503
1995 35898 39.1 6059
1996 29877 38.0 4937
1997 35663 39.0 5591
1998 33921 38.0 5170
1999 29729 36.9 4328
Problems
 Q1: Correlation between Ind. shipment and UGG
shipment – 0.94
 Q2: Correlation between Crop yield and UGG
shipment - 0.80
Q3:
 Benefits to shareholders
 Stable cash flows
 Prospects of higher RoE
 Benefits to members/farmers
 A more focused approach – will be able to think
 Protection during extreme weather (unfavorable) conditions
Q4:
 Yes, because
 Since members own well-diversified portfolios,
they will be less inclined towards protecting the
company.
 Conflict of interest – 2 types

 No, because
 Regulation, multitude representation
 Therefore, Insurance Policy will be preferred.
Q5:
 The profitability of UGG varies with the weather as:

GP*(0.64/21.2) = α + β1(time trend) + β2(Avg. June temp) + β3(Avg. July precipitation)

 Thus, the above equation can be modified as:

 GP = α’ + β1’ (time trend) + β2’ (Avg. June temp) + β3’ (Avg. July precipitation)
 Where α’, β1’, β2’, β3’ are all modified coefficients derived by multiplying 33.152 with original
coefficients.

 Average Industry Output = 31300, std. dev = 3390, Std. Dev.*3 = 10100
 UGG average output = 5025, UGG Mkt Share = 15%
 Correl = 94%
 Worst case scenario, Industry Output = 21200t, UGG = 3180t
 Worst case profit for UGG = 67400, avg profit = 106000
 Insurance Cover = 38600

 Definition for Loss = Deviation from Avg. Industry Output

Thank You – Questions Please
?