Plunging Pension Income Seen Threatening Stocks

0

Plunging Pension Income Seen Threatening Stocks

By CONOR DOUGHERTY

Staff Reporter

An accounting tactic that’s allowed some companies to pad their earnings with pension-plan income is beginning to backfire.

With stock markets in reverse the past two years, pension income at Fortune 500 companies has fallen dramatically. Some analysts are concerned that falling pension income could hamper a stock market recovery.

“I don’t know how many (investors) take pension income out of earnings per share,” said Yogi Thambiah, a vice president at Credit Suisse Asset Management. “If EPS goes down in a weak market, for some people that has an impact.”

In 2000, for instance, Northrop Grumman Corp. reported pension income of $538 million, accounting for 49 percent of its $1.1 billion in pretax operating income. In 2001, pension income fell to $337 million, and this year the company projects the number to be $95 million.

During the good times, Northrop like many other companies didn’t break out its pension income from the rest of its earnings. But the company came under pressure from shareholders, and for the past five quarters it has separated pension income from what it calls “economic” earnings.

Companies are becoming more attentive to disclosure now, said Domenick Fumai, a fixed income analyst with BNP Paribas. But there’s also a self-serving element to the shift. “People tend to change their arguments to suit them,” he said. “They’re probably emphasizing it more than they had when the pension income was higher.”

Northrop officials declined to comment.

Pension income is derived from an arcane set of calculations based on contributions a company makes to its pension plan, its past earnings and assumptions about future returns and pay-outs to workers that haven’t yet retired.

Generally speaking, pension-plan income in one period reflects fluctuations in returns from the year-earlier period. So when markets began to tank in 2000, pension income remained high, reflecting 1999’s strong performance.

According to a study conducted by Bear Stearns & Co., pension income accounted for 1.4 percent of aggregate operating income for companies in the S & P; 500 in 2000, up from 1 percent in 1999.

Companies are likely to feel income pressure from the bear market until at least one year into the recovery.

“When the value of the plan assets decline the dollar amount of pension cost will go up, or in the case of Northrop Grumman, pension income will go down,” said Patricia McConnell, a senior managing director at Bear Stearns.

In recent years, many companies have switched to less-risky defined-contribution 401(k) plans from traditional pension plans, which must pay a fixed benefit no matter what their performance. Older companies are more likely to have defined-benefit plans.

In a worst-case scenario, companies could be forced to reach into operating earnings to fund their pension plans.

At the end of 1993, General Motors Corp. faced an underfunded pension liability of $22.3 billion. GM was ultimately forced to contribute more than $18 billion in cash and stock to replenish the plan and clean up its balance sheet. While GM was healthy by early 1996, the diversion of cash prevented GM from keeping up with the new-product roll-outs of its competitors. These days the company’s pension fund is once again underfunded.

Earlier this month, Tampa, Fla.-based Anchor Glass Container Corp. filed for Chapter 11 bankruptcy protection because of its heavy debt load, part of which was due to the liabilities of the company pension plan.

Northrop is nowhere near having to fund its pension plan. Its fund took in millions during the boom years, and rules allow the company to set some of that income aside for later recognition.

“There’s definitely a decline in the fund assets, but it’s still recognized as an asset (rather than a liability) on the books,” Fumai said.

In the first quarter, Northrop reported net income of $149 million, or $1.27 a diluted share, compared with $132 million ($1.81) in the like year-earlier period. Pension-fund income accounted for $24 million of that, on a pre-tax basis, down from $69 million in the first quarter of 2001.

Analysts say they don’t typically pay close attention to pension-fund income, because it’s in a separate pot from the company’s general funds, and can’t be put to immediate use for such items as acquisitions.

“It’s been a distraction more than anything else,” said Paul Nisbet, an aerospace analyst at JSA Research Inc.

However, it does have an impact on the bottom line.

In an extended bear market, pension income could dry up completely. “It’s possible, if the stock market continues to decline, (Northrop) could see it as an expense,” Fumai said.

There’s a difference, however, between earnings fluctuations and actually having to write a check to fund a pension plan.

The matter is complex, and can be confusing. “The company’s income or expense from its pension plan could be very different in any given period than the amount that they have to fund,” McConnell said. “It is entirely possible that a company could report income on a pension plan and still have to write a check.”

No posts to display