UPM Annual Report 2016

ACCOUNTS

UPM Annual Report 2016

In brief

Strategy

Businesses

Stakeholders

Governance

Accounts

CONTENTS

Strategic risks

TYPE OF RISK

RISK DESCRIPTION

Competition, markets and customers

The energy, pulp, timber, paper, label, plywood and biofuels markets are cyclical and highly competitive.

In all of these markets the price level is determined as a combination of demand and supply, and shocks

to either demand (decrease/ increase in end-use demand, change in customer preferences etc.) or supply

(e.g. new production capacity entering the market or old capacity being closed) may impact both the

volume and the price level for UPM. Also competitor behaviour influences the market price development.

UPM performance is also impacted by the performance of substitute or alternative products. Most

notably, the demand in graphical papers in the mature markets is forecasted to continue to decline,

due to the shift away from print media to electronic media. Similarly, several raw materials used by UPM

have competing end uses.

Consumers’ environmental awareness has also increased, and this may have either a positive or

negative impact on the consumption of UPM’s products, depending on the product area. UPM sells a

proportion of its products to several major customers. The largest customer in terms of sales represented

approximately 3% of UPM’s sales in 2016, and the ten largest customers represented approximately 16%

of such sales.

M&A and changes in the business portfolio UPM’s strategic direction is to increase the share of growing businesses with positive long-term

fundamentals. This may require acquisitions of new businesses or divestments of existing businesses.

Participation in M&A involves risks such as successful implementation of a divestment and the ability

to integrate and manage acquired operations and personnel successfully, as well as to achieve the

economic targets set for an acquisition/divestment.

Regulation

UPM is exposed to a wide range of laws and regulations. The performance of UPM businesses, for

example the biofuels business, the paper businesses and the energy business, are to a high degree

dependent on the current regulatory framework, and changes to regulation, direct and indirect taxation

or subsidies would have a direct impact on the performance of UPM. In addition, regulation may

structurally restrict or exacerbate UPM’s ability to compete for raw material.

UPM’s environment related processes and management are based on full compliance with such

laws and regulations, and environmental investments, audits and measurements are carried out on a

continuous basis. UPM is currently not involved in any major proceeding concerning environmental

matters, but the risk of substantial environmental costs and liabilities is inherent in industrial operations.

Political and economical risks

UPM has major manufacturing locations in Finland, Germany, the UK, France and the US. In these

countries, the slow development of the individual economies and/or of Europe as a whole influences

adversely UPM’s performance. Furthermore, policies (on European and/or national level) that hamper

economic growth or lower the competitiveness of UPM (for example through adverse regulation or

increase in direct or indirect taxation) may have an adverse impact on UPM’s performance. In the

developed countries, the unpredictability of regulation may lead to an increasing uncertainty and risk

level when investing in or operating in these countries.

UPM has manufacturing operations in a number of emerging market countries, such as China,

Uruguay and Russia. In the emerging market countries, the lack of transparency and predictability of the

political, economic and legal systems may lead to an increasing uncertainty and risk level when investing

in, or operating in these countries. These uncertainties may materialize as unfavourable taxation

treatment, trade restrictions, inflation, currency fluctuations and nationalisation of assets.

Risks

Risk management

UPM regards risk management as a systematic and proactive means

to analyse and manage the opportunities and threats related to its

business operations. This includes also risks avoided by careful

planning and evaluation of future projects and business environment.

UPM seeks to transfer insurable risks through insurance

arrangements if the risks exceed the defined tolerance. The insurance

cover is always subject to the applicable insurance conditions.

The main risk factors that can materially affect the company’s

business and financial results are set out below. They have been

classified as strategic risks, operational risks, financial risks and

hazard risks. Risks may also arise from legal proceedings incidental

to UPM’s operations.

TYPE OF RISK

RISK DESCRIPTION

Earnings uncertainty

The main short-term uncertainties in UPM’s earnings relate to sales prices and delivery volumes of the

group’s products, as well as to changes in the main input cost items and exchange rates. Most of these

items are dependent on general economic developments.

Availability and price of major inputs

In 2016, third-party suppliers accounted for approximately 83% of UPM’s wood requirements. Other

production inputs, such as chemicals, fillers and recovered paper, are obtained from third-party

suppliers. Disruptions in the supply of key inputs would impact upon manufacturing operations, for

example, by interrupting or resulting in the downscaling of production or a change in the product mix.

They could also cause price increases for critical inputs or shifts in the availability and price of wood.

It is also uncertain how the EU energy policies may impact upon the availability and costs of fibre and

energy.

Project execution

Investment projects in UPM businesses such as energy, pulp, paper or biofuels are often large and take

one or more years to complete. UPM has experience in such projects in various businesses and locations

around the world, and applies vigorous planning, project management and follow-up processes.

Participation in large projects involves risks such as cost overruns or delays, as well as achievement of the

economic targets set for the investment.

Partnerships

UPM currently works together with many partners without control over strategic direction and operational

output. The highly competitive market situation and, for example, new developments in biofuels or

bioenergy are likely to increase the importance of partnerships in the search for higher efficiency or new

products and businesses. Partnerships, however, may create risks to the profitability, for example, through

changes occurring within the partner entity or changes in how the partnership operates.

Ability to recruit and retain skilled employees To meet the challenges of sustaining growth and improving the effectiveness of operations, a skilled

workforce is necessary. UPM is continuously evaluating its recruitment, compensation and career

development policies and taking measures to attract and retain skilled personnel, thereby seeking to

avoid shortages of appropriately skilled personnel in the future.

Availability and security of information

systems

UPM business operations depend on the availability of supporting information system and network

services. Unplanned interruptions in critical information services can potentially cause a major

interruption of UPM business areas. UPM has implemented numerous technical, physical and process

improvements to mitigate the availability and security risks and to reduce the service interruption related

recovery time to acceptable level.

Risks related to non-compliance

The UPM Code of Conduct sets the standards of responsible behaviour towards UPM stakeholders.

They apply to every employee. The code covers topics relating to legal compliance and disclosure,

conflicts of interest, gifts and bribes, HR practices, human rights questions and environmental matters.

UPM’s environmental performance and social responsibility play a significant role in UPM’s ability to

operate and influence the long-term success of its businesses. Negligence or breach of Code of Conduct

may lead to legal processes or serious reputational damages impacting the value of the company.

UPM ensures that employees are aware of the Code by regular trainings, the company maintains a

report misconduct channel and carries out regular audits in its supply chain.

Financial risks

Financial risks are described in consolidated financial statements 2016.

TYPE OF RISK

CONSOLIDATED FINANCIAL STATEMENT NOTE

Credit risk

4.6 Working capital

Liquidity and refinancing risk

5.1 Capital management

Interest rate risk

6.1 Financial risk management

Foreign exchange risk

6.1 Financial risk management

Electricity price risk

6.1 Financial risk management

Hazard risks

UPM operates a significant number of manufacturing facilities globally, mostly UPM-

owned, and is also the largest private owner of forestland in Finland. UPM is exposed

to risks in areas such as occupational health and safety, environment, fire, natural events

and site security. These risks are managed through established management procedures

and loss prevention programmes. UPM’s insurance programme also provides coverage

for insurable hazard risks, subject to terms and conditions.

Operational risks