Case Study in Clearwater Seafood

Introduction

Clearwater Seafoods Income Fund (Clearwater) is a Canadian seafood exporting company established since 1976, and it converted into an income trust in 2002. Around 2005, this company had suffered a decrease of 35% in value due to appreciation in Canadian dollars, and it then suspended its distributions to unit holders. Three months later, the investors were asking if Clearwater had an appropriate strategy to handle this crisis and could reinstate the distribution. Besides, Robert Wight, the vice-president (finance) and CFO of the company, also faced a dilemma whether he should focus on the short-term profitability or the long-term development of the company, which are opinions from different unit holders, in the new foreign exchange environment.

In order to help Clearwater to tackle these problems, this report will firstly address the foreign exchange risks faced by the Clearwater, as well as the business strategy risks. Then, possible strategies to deal with these risks will be discussed. And an overall suggestion and conclusion will be given at the end.

Foreign Exchange Risks Analysis

As an internationally exporting company, Clearwater received foreign currencies and transferred its revenues into Canadian dollars. And the foreign exchange risks management operation also contributed a massive amount to its income. As a result, the company was exposed to severe foreign exchange risks which could be divided into three parts: translation risk, transaction risk and economic risk.

Firstly, Clearwater had a volatility in accounting results when translating revenues from foreign subs into Canadian dollar due to several offices operated internationally, including China, the United States, the United Kingdom, Japan and Argentina. The expenses occurred in translations were very unstable from year to year. According to the income statement of Clearwater (Exhibit 8), these expenses increased by 108.32% from 2003 to 2004 and decreased by 58.89% from 2004 to 2005.

In addition, the Clearwater faced transaction risk which is the risk of adverse exchange rate movements occurring in the course of normal international trading transactions. For the company, this risk mainly stemmed from the sale of goods, and it was also affected by the derivatives used in its foreign exchange risk management operation.

The exported products of Clearwater accounted for 80.9% of its total sale in 2005. As a result, the appreciation of home currency would be very likely to incur a huge loss on the revenues earned internationally. Also, the strong Canadian dollar had already caused a Cdn$17.6 million loss compared with non-appreciation situation. Without proper foreign exchange risk management, it is reasonable to expect millions of dollars of losses occurred due to the unpredictable movements in Canadian dollars.

However, Clearwater had used forward contracts and options to hedge its foreign positions. Unfortunately, less than 50% of its foreign cash flows were effectively covered. Hence, a considerable position was still exposed to the transaction risk. And these forward contracts could lead to liquidity risks and default risks since they are not standardized. Moreover, the company used short call positions to hedge its positions and to gain profit from the weak position of Canadian dollars. This strategy was no long suitable when Canadian dollars appreciated and it could cause theatrically infinite potential loss when the home currency continues to appreciate against other currencies.

The third part of foreign exchange risk is economic risk, and it is the effect of exchange rate movements on international competitiveness. In this case, it is obvious that the risk is the appreciation of Canadian dollars.

Business Risks Analysis

Clearwater operates mainly in the year-round offshore seafood harvesting industry which is highly regulated by the Canadian government. The business strategy risks faced by the company can be divided into internal and external risks.

The external risks for the company arises from factors outside the company’s control such as natural resources, regulations, commodity prices changes and foreign exchange rate changes. For Clearwater, the risk of regulation change is an important external risk as the harvesting licenses, which set the total allowable catch (TAC) and determined the quotas for each company, are totally controlled by the government. However, considering the company’s post business strategy which tried to take a leadership in working with regulators, this risk was relatively low. On the other hand, three risk factors were of relatively high risks for the company: the seasonal nature of fishing, the occurrence of natural disasters and the rise in fuel prices. The first two factors would largely affect the core business of the firm and the last one would increase the transportation cost. And, as discussed in the previous part, the foreign exchange risk is very high for the company. As a result, the company was exposed to ‘medium to high’ external risks.

The internal risks for the company are those risk factors inside the company. Considering the situation that the company did not have sufficient funds to make distributions, it clearly faced a financing risk for its business operations. It included but not limited to the operating and maintenance of its 23 offshore harvesting vessels, development of innovative technology, diversification of species and markets, and the new project in Taiwan. The growth strategy of Clearwater required enormous amounts of money and there was a risk that not enough funds could be collected.

Nevertheless, the centralized management structure of the company led to a risk of ineffective management as several offices located internationally and the core management team might not understand the situations in each area.

Another internal risk came from the structure of the business. In a form of income trust, Clearwater promised regularly payments to unit holders, which put pressures on the company to maintain the high level of net income in order to have sufficient retained earnings to develop itself. However, as shown in Exhibit 11, there had been several times that the company made distributions more than its distributable cash amount, which means less retained earnings can be used by the company.

And the last internal risk is that, comparing with its competitors, Clearwater did not have a retail brand to promote itself even though it exists the longest time. Additionally, its product range is much less than its competitors according to Exhibit 10.

Discussions and Recommendations

Wight suggested three alternatives possible for the company. However, they all have their limitations in solving the complicated situation faced by the company. In my opinion, a combination of different strategies would be a good choice.

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