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| | Company Focus
40 companies sitting on pension time bombs
United Airlines' struggles have put a new focus on a pension guaranty system that is near collapse. Reform could take a huge chunk out of the bottom line on big offenders.
By Michael Brush
Thanks to robust stock returns since the lows of mid-2002, a serious problem weighing on many companies has simply vanished from public debate: Their massively underfunded pension plans.
Over the past two years, pension portfolios inside companies have risen sharply along with the market, sweeping under the rug concerns about looming retirement-plan shortfalls.
But severe turbulence in the airline sector may soon change all that, moving the menace of bankrupt pension plans squarely back into the spotlight.
If so, many of your stock holdings could be at risk as companies are forced to shore up pension plans. Well get to potential problem companies in a moment, and the best ways to spot them. But first, a little background on whats brewing.
The domino effect
To find the culprit that could bring things to a head near term, look no further than bankrupt UAL Corp. (UALAQ, news, msgs), the parent of United Airlines. As part of its recent flight into bankruptcy, the troubled airline decided to hoard cash by temporarily suspending contributions to its pension plans.
But heres the rub. Many corporate-debt analysts -- like those at CreditSights, an independent credit research group -- think the move looks like the first step in a scenario that will see United Airlines walk away from its pension obligations altogether at some point. United Airlines suggested as much in court filings last week.
United Airlines workers wont spend their golden years in the poorhouse if this happens. Aside from the pilots, they would still get most, if not all, of their pensions -- because those pensions are guaranteed by our countrys Pension Benefit Guaranty Corp. (PBGC).
Thats a government body funded by premiums from companies that operate defined-benefit pension plans. (As a quick refresher: Defined-benefit plans are the ones where workers get a pension based on how long they worked for a company and how much they got paid. These workers dont make direct contributions, unlike people in defined-contribution plans, such as 401(k) plans.)
However, if United Airlines bails on its pension obligations and leaves the PBGC to clean up the mess, that could set off a chain reaction at other airlines -- most likely Delta Air Lines (DAL, news, msgs) and US Airways Group (UAIR, news, msgs), for starters. They, too, would plead that they need to bail from their pension obligations to stay competitive, says Glenn Reynolds, chief executive of CreditSights, because they will have an inherent cost-structure disadvantage.
The link to your stock portfolio
But how could the mess hit stocks in your portfolio that have nothing to do with the airline industry? To find the nexus, look no further than the PBGC itself -- and the heap of problems it faces.
Thanks in part to a sharp decline in the number of defined-benefits plans (from 112,000 in the mid-1980s to just over 31,000 today), the PBGC now collects much less in premiums. Thats one reason its at risk of bankruptcy itself -- or rather, of the need to go to the government for a taxpayer bailout if it hits the wall, which looks more and more likely.
Look at the bill PBGC would get stuck with if United Airlines bailed on its pension obligations. The airline has contributed just $50 million in premiums to PBGC. But PBGC says it would be saddled with claims worth $6.4 billion. This kind of mismatch provides a powerful incentive for companies like United Airlines to walk away from their pension obligations. Its a good deal -- for them, at least.
Even before United Airlines went into bankruptcy, problems were mounting at PBGC. It had an $11.2 billion deficit at the end of 2003. Now, its potentially exposed to bills for as much as $85 billion from possible pension-plan terminations -- about $23 billion from the airline sector alone. In total, private defined-benefit plans had a massive $400 billion gap between assets and liabilities as of the end of 2003, suggesting bigger headaches down the road. PBGC is basically going to go bankrupt if you look at it from a purely actuarial basis, because it cant handle the influx of bankrupt pension plans, says Roger King, a senior analyst at CreditSights.
Before that begins to play out, you can bet PBGC will make lots of noise in Washington, D.C. It will try to get politicians to do something to crack down on companies that threaten to take down the whole system because they are too far behind in funding their pension plans. The PBGC insures the pensions of 44 million workers and retirees, so a lot of votes and potential political pressure hang in the balance if it goes on a campaign to paint a dire picture.
Right now, PBGC doesnt tend to go out and pound the table a lot, says Reynolds. But if they get activist, there could be hell to pay for some of these companies out there. If Congress takes steps to make sure the gaps are filled, it could affect any of the most exposed companies because they will be asked to accelerate their payments to their pension funds.
Already PBGC executive director Bradley Belt is laying the groundwork for reform. In a recent speech, he called for changes that would toughen rules and raise premiums for companies that are at high risk of running into trouble with their pension plans. That could lower profits, and maybe stock prices.
Who will get hit?
To be sure, the government gave deadbeat companies a reprieve of sorts in April. Thats when Congress agreed to increase the interest rate used to discount future pension obligations back to the present. That makes them look smaller, right now -- even if it doesnt reduce the bill further down the road.
So now, when you are determining your funding requirement, your pension plan is going to look healthier, says David Zion, an accounting expert with Credit Suisse First Boston. I viewed it as a bit of a gift.
Zion estimates that pension-plan contributions by S&P 500 ($INX) companies will drop to $21 billion in 2004, from $39 billion in 2003 because of the gift alone. Even so, he thinks 32 companies in the S&P 500 will be required to contribute more than $200 million to their pension plans in 2004 or in 2005.
Outside of the airline group, predicts Zion, some of the biggest amounts will be forked over next year by Ford Motor (F, news, msgs), $1.3 billion; Exxon Mobil (XOM, news, msgs), $1 billion; Hewlett-Packard (HPQ, news, msgs), $472 million; ChevronTexaco (CVX, news, msgs), $450 million; and Altria Group (MO, news, msgs), $392 million.
But things could get worse if airlines run from their pension obligations and threaten to put PBGC on the path to bankruptcy, setting off a crackdown on deadbeat corporations by Washington, D.C.
Are investors worried? Sean Reidy, co-manager of the Olstein Financial Alert Fund (OFALX), says his fund group backs out unfunded pension obligations when valuing companies as standard practice. But we are probably a lot more conservative than most people.
Zachary Shannon, an analyst with Camelback Research Alliance, which tracks earnings-quality issues and unfunded pension burdens for clients, agrees that investors seem a lot less concerned about pension issues than they were a year or two ago. We think it is still really relevant though, he says.
How to spot trouble
For a simple way to spot companies most likely to run into trouble, investors should look for at least two types of weaknesses, according to experts such as Zion and Shannon:- Companies that have the biggest proportion of unfunded pension obligations compared to market capitalization. Unfunded pension obligations at Delta Air Lines, for example, are 8.7 times the size of its market cap. (Another way is to compare the obligations to net assets.)
- Companies that get the biggest chunk of their net income (excluding unusual items) from assumed returns on their pension investments. Oddly, companies are allowed to include returns on pension investments in their net income -- even though they owe the money to retirees, and those returns are based on assumed rates of return of 8% to 12% that are far bigger than real market returns in many years. Income from pension plans should be backed out to get a real net income number, says Shannon. Over the past three years, for example, the portion of net income that came from pension gains was four times regular income at TRW Automotive (TRW, news, msgs).
We asked Shannon to screen for the top 20 offenders in both categories. The results are in the tables below.
| The 20 most underfunded pension plans | | Company | Market cap | Underfunded amount
at 12/31/03 | Ratio of amount
underfunded to market cap | | Delta Air Lines (DAL, news, msgs) | 645 million | 5.65 billion | 8.77 | | Northwest Airlines (NWAC, news, msgs) | 746 million | 3.74 billion | 5.03 | | AMR Corp. (AMR, news, msgs) | 1.35 billion | 2.66 billion | 1.97 | | Continental Airlines (CAL, news, msgs) | 595 million | 1.07 billion | 1.81 | | AK Steel Holding (AKS, news, msgs) | 721 million | 1.18 billion | 1.65 | | Goodyear Tire & Rubber (GT, news, msgs) | 1.92 billion | 2.75 billion | 1.44 | | W.R. Grace (GRA, news, msgs) | 381 million | 361 million | 0.95 | | Delphi (DPH, news, msgs) | 5.3 billion | 3.97 billion | 0.75 | | Visteon (VC, news, msgs) | 1.3 billion | 870 million | 0.65 | | McDermott International (MDR, news, msgs) | 708 million | 410 million | 0.58 | | Alaska Air Group (ALK, news, msgs) | 558 million | 311 million | 0.56 | | British Airways (BAB, news, msgs) | 4.54 billion | 2.4 billion | 0.53 | | Crompton (CK, news, msgs) | 684 million | 337 million | 0.49 | | Ispat International (IST, news, msgs) | 2.17 billion | 965 million | 0.44 | | Vitro (VTO, news, msgs) | 292 million | 127 million | 0.44 | | Ford Motor (F, news, msgs) | 26.9 billion | 11.68 billion | 0.43 | | ArvinMeritor (ARM, news, msgs) | 1.37 billion | 561 million | 0.41 | | Navistar International (NAV, news, msgs) | 2.5 billion | 994 million | 0.40 | | Standard Register (SR, news, msgs) | 313 million | 123 million | 0.39 | | Olin (OLN, news, msgs) | 1.2 billion | 457 million | 0.38 |
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Source: Camelback Research Alliance
| 20 companies with largest percentage of income from assumed returns on pension funds | | Company | Market cap | Income from pension
plan in last 3 yrs* | Income before items
in last 3 yrs** | Improvement to net
income from pension
income in last 3 yrs *** | | TRW Automotive (TRW, news, msgs) | 2.05 billion | 261 million | 58 million | 449% | | MeadWestvaco (MWV, news, msgs) | 6.01 billion | 186 million | 83 million | 223% | | Glatfelter (GLT, news, msgs) | 584 million | 57 million | 58 million | 99% | | Longview Fibre (LFB, news, msgs) | 659 million | 29 million | 35 million | 83% | | Duquesne Light (DQE, news, msgs) | 1.45 billion | 26 million | -33 million | 76% | | CTS Corp. (CTS, news, msgs) | 414 million | 28 million | -51 million | 55% | | Tredegar (TG, news, msgs) | 633 million | 17 million | 34 million | 51% | | Unisys (UIS, news, msgs) | 3.42 billion | 218 million | 432 million | 51% | | Prudential Financial (PRU, news, msgs) | 24.7 billion | 664 million | 1.39 billion | 48% | | Hecla Mining (HL, news, msgs) | 639 million | 3 million | -6 million | 44% | | Xcel Energy (XEL, news, msgs) | 6.83 billion | 150 million | -367 million | 41% | | Potlatch (PCH, news, msgs) | 1.18 billion | 29 million | -77 million | 38% | | Tecumseh Products (TECUA, news, msgs) | 755 million | 36 million | 97 million | 37% | | Pactiv (PTV, news, msgs) | 3.54 billion | 186 million | 580 million | 32% | | Northeast Utilities System (NU, news, msgs) | 2.39 billion | 169 million | 558 million | 30% | | Kerr-McGee (KMG, news, msgs) | 7.89 billion | 43 million | 149 million | 29% | | A.O. Smith (AOS, news, msgs) | 844 million | 32 million | 118 million | 27% | | Vector Group (VGR, news, msgs) | 617 million | 7 million | -26 million | 26% | | GenCorp (GY, news, msgs) | 523 million | 47 million | 180 million | 26% | | Samsonite (SAMC, news, msgs) | 281 million | 7 million | -28 million | 25% |
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Source: Camelback Research Alliance
*Reported pension income minus assumed corporate tax rate of 35%
**Income excluding unusual items
***For companies reporting losses, the loss would be lower by this percentage, without pension income
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