Those words of warning come from a recent UBS Paine Webber study of how pension fund performance and accounting affects the earnings of the Standard and Poors' 500 Index and different industries and companies in that index.
Basically, the report tells us that in some industries and in some companies, the pension tail is wagging the company dog. Here, culled from the 66-page report, are some of the things investors should note.
• Broadly Measured, Pensions Aren't A Gigantic Problem. As recently as 1999 S&P 500 index company pension funds had a surplus over obligations of $252 billion. By the end of 2001 the surplus was down to $1.2 billion. At the end of August the report estimates a deficit of $126 billion or about 11 percent of pension benefit obligations. That's a large shift. The UBS Paine Webber analysts found, however, that adjusting reported earnings for pension effects didn't have a major impact on earnings or Price/Earnings multiples. That's the good news.
• Measured by Industry, It's Another Story. Of the 500 companies in the S&P 500 Index, 145 don't have defined benefit pension plans so they are unaffected by the issues surrounding the performance of pension funds and accounting for pension funds. Of the 355 companies in the index with defined benefit pensions, however, they report 118 with "false assets"--- reported pension surpluses when the plan is actually in deficit. One way to gauge the potential impact of pension plans is to compare pension plan assets to the total market value of the company. Pension fund assets in the automobile industry, for instance, were 170 percent of total market capitalization while they were negligible to non-existent for younger industries. Since pension fund assets are a rough proxy for pension obligations and pension obligations must be funded from company earnings, the larger the pension assets the greater the influence the pension has on the value of the shares. (See table below)
|The Ten Industries Most and Least Affected By Pension Fund Problems|
|Note the older, heavy industries dominate the most affected list while newer industries predominate in the least affected list.|
|Industry||Pension Assets as % Market Cap.|
|… The Ten Most Affected|
|Aerospace & Defense||70.4|
|Construction & Engineering||61.9|
|Metals & Mining||50.4|
|Leisure Equipment & Products||43.8|
|Paper & Forest Products||41.2|
|Containers & Packaging||36.6|
|… The Ten Least Affected|
|Wireless Telecommunication Services||0.0%|
|Internet Software & Services||0.0|
|Internet & Catalog Retail||0.0|
|Semiconductor Equipment & Products||0.30|
|Hotels Restaurants & Leisure||0.89|
|Healthcare Equipment & Supplies||2.06|
|Source: UBS Paine Webber|
• In Some Companies, The Workers May Be The Defacto Owners. While most corporate obligations are reflected quite directly on corporate balance sheets, the calculation of pension obligations is based on a murky stew of assumptions. As a consequence, worker claims on future corporate earnings may "crowd out" the shareholders interest. The pension assets of U.S. Steel Corp., for instance, are $8.6 billion. This is more than 5 times the total market value of the company shares. Whatever happens to the pension plan will have a very large effect on corporate earnings. The table below lists the ten most impacted S&P 500 Index companies.
|The Top Ten Company Dogs Being Wagged By Long Pension Tails|
|Rank ordered list of S&P 500 index companies with major pension assets relative to their total market capitalization.|
|Company||Pension Assets (mils)||As % Mkt. Cap|
|United States Steel||$ 8,583||531%|
|Allegheny Technologies||$ 5,242||390|
|General Motors||$ 73,662||271|
|McDermott International||$ 1,822||241|
|Delta Air Lines||$ 8,304||230|
|Lucent Technologies||$ 35,359||182|
|Ford Motor||$ 48,754||171|
|Navistar International||$ 2,872||161|
|Source: UBS Paine Webber|
Bottom line: Collapse of the fabled "new economy" notwithstanding, the "old economy" has problems of its own. That's why a stock market recovery is likely to lag an economic recovery.
Earlier Pension Related Columns:
April 4, 2002: Is A Pension Plan Time Bomb Ticking?
September 22, 2002: The Next Big Shoe: Pension Plans
September 24, 2002: How IBM Pulled a FAS One on Pensions