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| | Company Focus
Who's been playing stupid pension tricks?
Underfunded pensions still arent factored into many stock prices. We took a new look at the problem and identified more than three dozen stocks that could get hit.
By Michael Brush
Over the next few months, most large companies will be forced by law to tidy up their shaky pension plans. What they discover in the process, and reveal to the markets, may shave more than a few points off many leading stocks.
The problem is simple. Like friends swapping tall tales about stock market victories, companies such as Lockheed Martin (LMT, news, msgs) and Weyerhaeuser (WY, news, msgs) have been exaggerating pension investment gains to boost their earnings. At others, such as Avon (AVP, news, msgs), puffed-up retirement fund returns divert attention from growing pension shortfalls.
Now that its time to square pension accounts for annual reports due in the spring, many will have to lower earnings guidance as they divert profits to shore up pension plans. Others will rob cash from important capital investments and debt-reduction or share-buyback programs. They have no choice, as federal regulations require that retirees futures not be jeopardized by companies past sins.
"This is going to be a significant use of cash for a lot of companies, because for the past three years pension funds have underperformed significantly," predicts Donn Vickrey, of Camelback Research Alliance, a Scottsdale, Ariz.-based firm that performs earnings quality analysis for professional investors.
Time bomb
"If the market does not turn around in the next couple years in a very big way, this could be a real time bomb," says Robert Friedman, an aerospace and accounting analyst at Standard & Poors, which ruffled feathers recently by adopting a stricter approach to accounting for pension obligations.
If you're employed at any of these companies, however, dont be alarmed. Uncle Sam would protect you if things got really bad. Besides, a strong market during the next few years could even come to the rescue before you hit your golden years.
To find which companies look most vulnerable on the pension front, we asked analysts at Camelback Research Alliance to crunch the numbers and find the ones that top the list in the biggest possible problem areas.
First, we looked for companies with a high percentage of reported earnings because of unrealistic pension assumptions. By reported earnings, we mean the earnings that are prepared according to standard accounting rules and presented in quarterly and annual filings -- as opposed to the earnings used by Wall Street analysts. Camelback, aiming to smooth out the effect of one-year anomalies, looked at three-year time frames. Next, we looked for the largest pension fund shortfalls, and the most unrealistic expected returns on pension investments. The results are contained in the accompanying tables.
| Companies with largest percentage of income from pensions, past 3 years | | Company | Symbol | 3-year trailing
net income ($ million) | Gains from pension
returns ($ million)* | Percent of income or loss
from pension assets | | United States Steel | X | -195.0 | 627.0 | 321% | | A. M. Castle | CAS | 2.0 | 5.4 | 269% | | Standard Register | SR | -7.6 | 17.8 | 234% | | Raytheon | RTN | -218.0 | 487.0 | 223% | | Friendly Ice Cream | FRN | -6.7 | 11.1 | 164% | | McDermott International | MDR | -41.7 | 64.0 | 154% | | Northeast Utilities | NU | 293.3 | 344.0 | 117% | | P. H. Glatfelter | GLT | 92.4 | 91.1 | 99% | | Northrop Grumman | NOC | 1,502.0 | 1,150.0 | 77% | | Owens-Illinois | OI | 385.2 | 276.8 | 72% | | Allegheny Technologies | ATI | 407.5 | 290.8 | 71% | | Lufkin Industries | LUFK | 25.2 | 17.8 | 71% | | Green Mountain Power | GMP | 2.7 | 1.7 | 64% | | Lockheed Martin | LMT | -1,183.0 | 745.0 | 63% | | United Industrial | UIC | 19.4 | 12.0 | 62% | | EDO Corp. | EDO | 18.3 | 9.2 | 50% |
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*Figures include real and assumed returns
| Large companies with the most underfunded pension plans, past three years | | Company | Symbol | Amount underfunded
($ million) | Amount underfunded
as percentage of assets | | Avon Products | AVP | -282.8 | 9% | | United Technologies | UTX | -2,329.0 | 9% | | Imperial Oil Limited | IMO | -538.7 | 8% | | 3M | MMM | -990.0 | 7% | | FedEx | FDX | -717.0 | 5% | | Exxon Mobil | XOM | -7,249.0 | 5% | | Harley-Davidson | HDI | -160.6 | 5% |
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| Smaller firms with most underfunded pension plans, past 3 years | | Company | Symbol | Amount underfunded
($ million) | Amount underfunded
as percentage of assets | | Timken | TKR | -530.4 | 21% | | Northwest Airlines | NWAC | -2,275.0 | 18% | | Joy Global | JOYG | -215.2 | 16% | | Maytag | MYG | -452.7 | 14% | | EDO Corp. | EDO | -38.4 | 14% | | Delphi | DPH | -2,367.0 | 13% | | Delta Air Lines | DAL | -2,353.0 | 10% | | Engineered Support Systems | EASI | -23.9 | 10% | | Airborne | ABF | -163.6 | 9% | | Solutia | SOI | -322.0 | 9% | | Cummins | CUM | -380.0 | 9% | | ITT Industries | ITT | -383.5 | 8% | | AK Steel Holding | AKS | -399.7 | 8% | | Adolph Coors | RKY | -132.1 | 8% |
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The first thing you notice about companies with the biggest potential problems is that theyre the older, bigger industrial companies in sectors such as car and steel production, utilities, aerospace, paper, energy and basic metals.
Companies that started long ago tended to use traditional pension plans based on generous retirement promises made to workers up front. But now, as mature companies in lower-growth sectors with fewer younger workers, they may have a harder time supporting their shortfalls, says David Myers, a Lehigh University finance professor. Many of these companies also promised generous medical benefits in retirement.
In contrast, newer companies use pension plans that make payouts based on how much employees contribute. Think of the 401(k). This system limits the exposure to big pension shortfalls at companies. Thats why you dont see many tech companies turning up on the list of companies with potential problems, says Linda Shore, a retirement fund attorney at Buchanan Ingersoll.
Companies with the highest assumed returns on their pension investments were UTi Worldwide (UTIW, news, msgs) at 14%, Amkor Technology (AMKR, news, msgs) at 12%, Weyerhaeuser at 11%, PPG Industries (PPG, news, msgs) at 10.9%, and Lehman Brothers (LEH, news, msgs) at 10.8%.
To the defense
The next thing you notice is plenty of defense contractors such as United Industrial (UIC, news, msgs), Northrop Grumman (NOC, news, msgs), EDO Corp. (EDO, news, msgs), Lockheed, Raytheon (RTN, news, msgs) and Engineered Support Systems (EASI, news, msgs). In a separate analysis, Standard & Poors calculated that Northrop and Lockheed, for example, would have reported losses of $3.51 and $2.50 per share in the past 12 months instead of gains of $4.99 and 83 cents, were it not for starry-eyed pension gains.
Acknowledging that the chickens are soon coming home to roost, sell-side analysts recently tacked on $300 million extra in expected pension expenses at Raytheon and Lockheed for next year.
Defense shares will surely suffer as more of this kind of news trickles out in the group. On the other hand, its an attractive sector because of the 35% defense budget increases expected over the next five years. What to do? Keep in mind that Uncle Sam subsidizes a big part of the pension obligations at these companies, says Bear Stearns analyst Steve Binder. Exactly how much, and when, is still not clear, though. Regardless of what the government kicks in, General Dynamics (GD, news, msgs) is on solid ground with its pension obligations, says Binder.
Dont forget that no one is accusing any of the companies in the tables above of outright lying. The pension shortfalls and unrealistic investment returns are fully disclosed in corporate filings. But does that mean the potential problems are priced in to the market? Perhaps not, thanks to those updates you can expect over the next two quarters as companies go through their year-end house cleaning. Besides, pension accounting is complex, and many companies and analysts use assumptions that let offenders off the hook -- with the hopes that a rising market will save the day.
Pension experts also defend the companies in the tables above by pointing out that even though assumed returns of 10% may look idiotic in a bear market, those assumptions are meant to estimate long-term annual returns in models built to predict pension payouts many years from now. And over the long-term, returns of 10% arent unrealistic, at least if history is any guide. In light of what happened in the last two years, you would say that 10% looks outrageous, says Myers. But over the last 20 years, many of these companies have done pretty well in the market.
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