United Grain Growers Case - HBR

1. United Grain Growers
Limited (A)
Group 1:
ABM11023 Arpit Vinayak

2. Background
• United Grain Growers (UGG) is one of the Canada oldest grain distributors
in Canada.
• The agriculture business was risky. Anything that affected the quantity of
grain shipped had a material impact on the firm’s revenues, profits and cash
flow.
• UGG was still faced with the problem of how to deal with the biggest risk:
the weather
• UGG has to identify the principal risks of the corporation’s business and
ensuring the implementation of appropriate systems to manage these risks.

3. The industry is quite volatile,
characterizes by boom and
bust cycles, and its roots in
the forces of supply and
demand in the global market
Agriculture and in
particular industry was
one of civilization’s
oldest industries
Grain supplies were
variable due to natural
forces such as pests,
disease and weather.
Grain Distribution
Three largest distributor in
1998 were Saskatchewan
Wheat Pool, Agricore, and
UGG

4. To reduce volatility, many countries
create policies in Canada for wheat
(barley and oats/board gain)
regulated by Canadian Wheat Board
(CWB) that mandated monopsony
Grain distributor like UGG
were important
intermediateries between the
farmer and the end market.
Case Facts
In 1995, goverment repealed legislation that
kept gain transportation cost fixed (and
low) for many years, and reviewing other
grain transpotation and distribution
systems.
The Canadian agriculture industry was
under pressure from several directions, and
many farmers disagreed with CWB policies
and its monopsony power.

5. Established
in 1906
1993
restructured
itself as a
public
corporation
Issued limited voting
common shares on
Toronto Stock
Exchange
Strategy:
To modernize its grain
handling business
To provide farmers with
services beyond grain
handling
Core Division
Grain
Handling
Merchandising
Since 1993, derive about 70%
of its income from grain
operation
UGG spent about $65
million on acquiring and
building its non-grain
handling business
Build new HTP elevators,
upgrade existing elevator,
funding activities
Initial Public Offering
United Grain Growers- Trajectory

6. 1955
- New Industry regulation
- Poor harvest contribution
- Railroads began consolidating routes
- Distributors can set their own tariffs
- Higher grain prices
- Four out of the five major competitors lost money in the handling business
- UGG had to take $12.5 million charge to close 93 country elevators
The Industry Climate

7. Alberta Pool
Manitoba Pool
ElevatorsTakeover UGG
Rather than suffer substantial
dilution of their existing investment,
the bidders withdrew their offer
Two bidders merged from
Agricore
The Industry Climate

8. • UGG formed a strategic
alliance with Archer
Daniels Midland Company
• UGG also formalized a partnership
with Marubeni Corporation
 ADM would gain “a secure grain supply
for its processing operations”
 UGG could “plan more efficiently for
future transportation and grain handling
demands, and increase market shares
The Industry Climate

9. • 1992, shareholders successfully sued their directors
because the firm did not hedge it's grain risk when prices
were falling
• Emerging interest in risk management prompted UGG to
participate in a benchmarking review of best risk
management practices in its Treasury department
The Willis Report

10. On site Risk Brainstorming
February 11, 1997, twenty UGG senior managers and
other employees met for an on site risk brainstorming,
with task :
1. to identify the risk the firm faced
2. to rank them, by polling the group, in relative
importance to the firm

11. Willis Attention
Willis focused its attention on the first
group of six which included :
A. commodity price risk
B. inventory management risk
C. customer and supplier counterparts risk
D. account receivable and credit risk
E. environmental risk
F. weather risk

12. Earnings at Risk (EaR)
• Which had been developed by
the financial community, to
describe aggregate risk.
• EaR expressed a "worst-case"
loss, set against a benchmark
of expected profit, within a
specified confidence or
probability level.

13. CHARM
• CHARM (Comprehensive Holistic All Risk Model) generated graphical
output in several formats to highlight the various aspect of each risk.
• The most general format was a probability distribution showing the
probability of incurring a loss as a function of the size of the dollar loss .
• Cox had the information to do something to improve the firm's risk
management performance and potentially reduce UGG's long term cost of
risk

14. • Five of the six risk could be managed through traditional
methods.
• But about the weather risk ?
• No financial products that would effectively mitigate the weather risk
• Innovation to mitigate : weather derivatives  pay a specified amount of
money as a function of a particular weather characteristic
What to do about the weather ?

15. Risk Instance(s) Earning at Risk Possible Alternatives
Weather Impact on harvested
yields
11.5 Weather Derivatives and
Insurance
Environment Toxic waste 2.5 Insurance and control
Counterparty Failure of Supplier 4.3 Diversification/Due
diligence/Contract
Credit Payment Failure 1.6 Diversification/Due
diligence/Contract
Inventory Spoilage of Inventory,
UnderStock/OverStock
2.2 Operational Control, and
Insurance
Commodity Price Fluctuation 11.9 Futures and Options
Six Major Risk

16. Risk Analysis

17. Business interruption
Cargo/marine exposure
Civil disturbance
Commodity basis/ price
Competition
Consumer preferences
Contractual no-performance
Credit/receivables
Counterparty
Directors & officers exposure
Data accuracy
Disease/spoilage
Computer system failure
Employee injury
Employee liability
Employee performance /fidelity
environmental
Foreign exchange
Head office catastrophe
Industrial espionage
Intellectual property
Interest rates
Inventory
Labor strike
Leverage (too much or too little)
Loss of key personnel
Mergers and acquisition
Major property exposure
Pension plan performance
Process compliance/execution
Product liability
Product performance
Quebec separates from Canada
R&D ventures
Regulatory (CWB, transportation)
Stock market crash
Strategic planning
Technology (choice, use of)
transportation
unionization
weather
List Of Risk

18. 41
Risks
The Major Risks are
1 Weather
2 Environment Liability
3 Counterparty
4 Credit
5 Inventory
6 Commodity
Willis Group Assessment

19. The modeled yields, in turn, explained approximately 94% of the variability of UGG’s
grain handling earning. The yield depends on the rain according to the regression equation
Yield=15.5+0.0577*Rain, R-squared = 43%.
All-Wheat yield in Saskatchewan and the July
precipitation for 1960 through 1992

20. Comprehensive Holistic All Risk Model
CHARM
CHARM plot showing the probability distribution of
earning with and without the impact of the weather.
When the weather risk is removed, the variation in
EBIT is smaller, as shown by the lighter curve,
though expected value is the same. The probability
showing incurring a loss as a function of the size of
the dollar loss.

21. Definition: What is Value at Risk?
• Summary statistic that quantifies the exposure across many assets/liabilities classes to
market risk.
• Identifies ‘How Much’ one can loses if adverse market conditions prevail.
• Captures diversification or Portfolio Effect.
• Measurisk Approach
• Full Monte-Carlo Valuation-based without approximations
• Risk calculation based on evaluation of log changes in market instruments
• Method allows modeling of entire distribution of expected profits and losses and shape of risk
surface over time and tail risk
Nasdaq Drop 95% VaRAsian Flu
Nasdaq Drop
Euro Rally

22. Earnings at Risk and Corporate Treasury
• Longer time horizon than traditional asset management
• Multi-Step Monte Carlo
• More data needed to define covariance matrix
• View of multiple time horizons (I.e. Each quarter of the
fiscal year)
• Quantify risk across business lines
• Ability to optimize trading activities - view impact of
different hedging strategies

23. Earnings at Risk
• Measure of earnings volatility
• Income Statement Perspective
• Used to define risk appetite
• Can help answer “What should be hedged?”
• Focus on market moves to:
• FX Rates
• Interest Rates
• Commodity Prices
• Perspective: Basket of Exposures (“Portfolio Effect”)

24. The Estimation of the 6 Major Risks
Risk Instance(s) Earning at Risk Possible Alternatives
Weather Impact on harvested
yields
11.5 None
Environtment
Liability
Toxic waste 2.5 Insurance
Counterparty Faliure of Supplier 4.3 Diversivicaiton/DD/Co
ntract
Credit Payment Failure 1.6 Diversivicaiton/DD/Co
ntract
Inventory Spoilage of Inventory,
UnderStock/OverStock
2.2 Operational Control
Commodity Price Fluctuation 11.9 Insurance/ Futures

25. 1. Weather
• Its effect on grain volume
would disturb the Business
2. Environmental
Liabilities
• The Toxic waste released
to external environment
could raise social risk and
could raise penalty from
government
3. Credit
• The Failure of UGG
Partner to pay their Debt
to UGG would Disturb
UGG Cash Flow
4. Commodity
• The Fluctiation of Commodity
Price could result a severe
disturbance to UGG business
5. Couterparty
Exposure
• The Probability of UGG
Suppliers (Upstream and
Downstream) not to meet
their contract obligation
6. Inventory
• The Understock condition
might result the loss of market
opportunity
• The Overstock inventory
would result higher risk since
the grain price are very
fluctuative
The top 6 Risk based on its severe risk

26. • First, UGG had been and planned to continue making large investments in
storage facilities (grain elevators).
• Second, the variability in its cash flows caused UGG to hold extra equity
capital as a cushion against unexpected low cash flows in any given year.
• Third, although much of UGG’s current business could be characterized as a
commodity business, UGG tried to distinguish itself from competitors by
creating products 7 with brand names and by providing on- going services to
customers
Retention

27. • Weather derivatives were a relatively new risk management tool.
• A contract could be tailored on a number of dimensions to meet the specific needs
of the buyer.
• For simplicity, the illustration assumes that the relationship between gross profit and
the weather index is linear. Since low values of the weather index correspond to low
expected profits for UGG, a derivative contract that would pay UGG money when
the index is low would provide a hedge.
• Hedging their weather risk with derivatives was feasible, but it suffered from several
difficulties. Although Willis had performed a sophisticated analysis of the effect of
weather on UGG’s gross profit, the results of this analysis had to be converted into
a desired contract structure.
Weather Derivatives

28. Illustration of a Weather Derivative

29. The Insurance Contract Idea
• UGG knew that the primary reason weather was important was because weather
affected UGG’s grain shipments.
• The obvious problem with such a contract is the moral hazard problem – UGG’s
pricing and service also influences its grain shipments.
• One solution to this problem was to use industry-wide grain shipments as the
variable that would trigger payments to UGG.
• UGG also considered the possibility of integrating grain volume coverage with
UGG’s other insurance co
• Willis then contacted several major commercial insurers, including a division of the
large reinsurer Swiss Re, called Swiss Re New Markets. Located in New York, this
group structured innovative risk financing deals for commercial entities.

30. Risk Assessment to the weather problem
 Estimate probability distribution of and correlation among losses
 Measure the expected loss individually and in combination on ROE,
EVA, EBIT
 Changes in weather was ranked the highest source of risk
 Grain volume and lagged crop yields highly positively correlated
 Relationship between weather and gross profit
 Weather >>> Crop Yields >>>> Grain Volume >>>> Gross
Profit

31. 1
Environment Liabilities
-Insurance
- Increase Control 2
Credit
- Diversivication of parnership to avoid
depedency with limited number of partners
- Be more selective to choose partner
3
Commodity
-Futures
- Options
4
Counterpart
- Diversivication of parnership to avoid
depedency with limited number of partners
- Be more selective to choose partner5
Inventory
-Increase Control
- Insurance
Environment Liabilities, Credit, Commodity, Conterparty
and Inventory Risk Exposure

32. Suggestion and Conclusion
We propose the use of insurance for the weather
uncertainty (option 3) due :
1. Broader Loss Coverage, not only weather risk
2. The premium of insurance cost can be reduced
3. Company would much more safe

33. Thank You