WEATHER PUBLICATION 2016
DOES GEOGRAPHIC
DIVERSIFICATION
DECREASE WEATHER RISK?
APRIL 2016
JARDINE LLOYD THOMPSON CAPITAL MARKETS, INC.
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WEATHER PUBLICATION 2016
EXECUTIVE SUMMARY
Given our forecast-oriented society, managers are under intense
pressure to meet (and exceed) business forecasts. Much attention
is given to dramatic, sudden events—catastrophic events—as
the primary driver of missed forecasts. However, little attention
is given to a seemingly innocuous driver of missed forecasts:
non-catastrophic weather events. Often it is an unpredictable and
gradual series of events that send forecasts awry.
Furthermore, too many businesses retain excess noncatastrophic weather risk and mistakenly believe that geographic
diversification reduces this risk—when in fact it amplifies it. We
believe a bespoke weather product offers corporates a solution to
transfer their non-catastrophic weather risk.
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WEATHER PUBLICATION 2016
SECTION I: SHATTERED EXPECTATIONS
Today, our communication channels are relentlessly inundated with forecasts—
forecasts about revenue, competitors’ revenue, market share, and profit margin.
The list is exhaustive. All is well when such forecasts align with reality.
However, the problem with our excessively forecasted society is once one is made,
it no longer retains its ephemeral feel. It becomes crystalized into expectation—and
crystalized expectations are held onto tightly. Unsurprisingly, market participants
have trouble grappling with today’s forecasts turning out to be incorrect. When
your business grows at 4%, instead of 20%, all sense of grip is lost and the end
result is usually picked up in pieces.
SECTION II: DAVID & GOLIATH
Many corporates fail to keep a watchful
eye on their non-cat weather risk due to
the belief that geographic diversification
decreases their non-cat weather risk.
While diversification is an excellent risk
management strategy that decreases
exposure to idiosyncratic risk, we
believe there are weaknesses that
overshadow. Geographic diversification
can increase exposure to weather risk.
Let us walk through how:
Consider the predictable value of a
small auto shop in Southern California,
which generates $100k in profit
annually. To oversimplify, the value
of the business is derived from the
present value of one set of future
cash flows (forecasts are built into
the discount rate around seasonality,
growth, etc.).
If the owner opens up a second shop
on the east coast, which also generates
$100k in profit annually, the value of the
business is derived from the present
value of two sets of future cash flows.
The owner is geographical diversified,
but has increased his probability
of disappointing expectations: that
is, the value of the business is now
dependent upon the present value
of two sets of future cash flows. Any
cash flow disruption—i.e., a significant
divergence from expectations (revenue
expectations)—that occurs is likely
engender adverse effects on the
balance sheet, as well as the income
statement.
What’s more, the expectation is those
cash flows will not only continue, but
also grow. The plight of a successful
business is that it is expected to remain
a successful business and continue to
expand at the same rate. Unfortunately,
the law of large numbers dictates a
smaller rate of growth the larger your
enterprise. How long can you have
consecutive record years before the
inevitable disappointing year—when
is the last time Coca Cola® grew
revenues by 20%? (To be clear, we
are not advising against diversification:
we are advising against unhedged
diversification.)
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WEATHER PUBLICATION 2016
SECTION III: GOLIATH
Even Company ABC, a well-known beverage company with a market capitalization of $190B, and sales in more than 200
countries, retains too much non-cat weather risk. In fact, size amplifies non-cat weather risk: the greater the cash flow, the
greater the expectations, the greater the probability of cash flow disruptions and the greater the chance of disappointing
expectations. A review of Company ABC’s 10k filings reveals the adverse impact of mundane weather.
UK
SPAIN
SOUTH AFRICA
RUSSIA
NORTHWEST
EUROPE & NORDICS
NORTH AMERICA
MEXICO
JAPAN
INDIA
IBERIA
GERMANY
EU
CHINA
CENTRAL &
SOUTHERN EUROPE
BRAZIL
FAVORABLE WEATHER
REGION MENTIONED
SOURCE: SEC’s EDGAR DATABASE
POOR WEATHER
UK
SPAIN
SOUTH AFRICA
RUSSIA
NORTHWEST
EUROPE & NORDICS
NORTH AMERICA
MEXICO
JAPAN
INDIA
IBERIA
GERMANY
EU
CHINA
CENTRAL &
SOUTHERN EUROPE
BRAZIL
2006 Q1
2008 Q1
2010 Q1
2012 Q1
2014 Q1
QUARTER
Company ABC’s revenue (X) is largely derived from the present value of hundreds of sets of future cash flows. When outcome
(Y) occurs, and it is less than (X), there are negative consequences. A bespoke weather product can offer revenue smoothing
characteristics and help to bridge the gap between expectation X and outcome Y.
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CONTACTS
Ryan Fitzpatrick
Chief Operating Officer
Jardine Lloyd Thompson Capital Markets
+1 646 362 4654
[email protected]
Rick Miller
Managing Director
Co-head of Insurance-Linked Securities
Jardine Lloyd Thompson Capital Markets
+1 646 362 4653
[email protected]
Michael Popkin
Managing Director
Co-head of Insurance-Linked Securities
Jardine Lloyd Thompson Capital Markets
+1 646 362 4652
[email protected]
SECTION IV: BESPOKE
WEATHER SOLUTIONS
It is no longer adequate to rely on geographic diversification as an
appropriate hedge, irrespective of size. We believe it is an opportune
time to transfer non-cat weather risk through the use of bespoke weather
solutions—especially as the supply of investor capital has swelled and
is ready to be deployed. Going forward, corporates will continue to be
assessed on their ability to meet forecasts. A bespoke weather solution can
assist corporates in creating predictable sources of cash flow and avoid the
process of picking up the pieces after falling short of expectations. Typically,
the product can be structured in a variety of mediums: such as options,
swaps, bonds, or paper. The flexibility gives corporates a way to better
predict revenue and ensure non-cat weather risk does not affect revenue.
If you would like to further discuss non-cat weather risk, please contact
Jardine Lloyd Thompson Capital Markets, Inc.
James Bradley
Associate
Jardine Lloyd Thompson Capital Markets
+1 646 362 4656
[email protected]
Jeffrey Daddario
Analyst
Jardine Lloyd Thompson Capital Markets
+1 646 362 5720
[email protected]
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