Healthcare Reform Consequences: Valuations Taking Hits

Includes: CAT, DE, T
by: Karl Denninger

Yeah, I know, Obama has said that there would be no "material" impact to finances until 2014.

Truth: Caterpillar (NYSE:CAT) and John Deere (NYSE:DE) already announced non-cash charges of $100 and $150 million, respectively, for this year based upon the impact of this bill on forward retiree health care costs.

The law says you must account for such changes when you become aware of them, and that would be now.

But today a 100-kiloton device landed on AT&T's (NYSE:T) balance sheet - they announced a one billion dollar non-cash charge:

On March 23, 2010, the President signed into law comprehensive health care reform legislation under the Patient Protection and Affordable Care Act (HR 3590). Included among the major provisions of the law is a change in the tax treatment of the Medicare Part D subsidy. AT&T Inc. ("AT&T") intends to take a non-cash charge of approximately $1 billion in the first quarter of 2010 to reflect the impact of this change. As a result of this legislation, including the additional tax burden, AT&T will be evaluating prospective changes to the active and retiree health care benefits offered by the company.

Oh, there won't be any material impacts until 2014, eh?

I told you that was BS, and now you're seeing it. If you're wondering how this stacks up, AT&T had revenue of $123 billion and a reported profit margin of 10.19%, for a net profit of $12.54 billion.

This represents about 8% - for this quarter.

Caterpillar reported $32.4 billion in revenue and a 2.76% profit margin, with a net income attributed to common of $895 million. Their $100 million charge amounts to 11% of that income.

John Deere reported $22.8 billion in revenue, a 4% profit margin and $912.80 million in net profit; their $150 million charge amounts to 16% of net income.

Still think this is no big deal?

I will note that "EPS", or Earnings Per Share, is how we value stocks. These valuation "hits", if they are somewhat representative, imply that stocks instantly became overvalued by somewhere between 10-15% when President Obama's pen hit the paper.

I hope (1) you have enjoyed the market rally and (2) have hedged yourself, as the efficient market hypothesis says that this new information will shortly appear directly in stock prices.

PS: The impact gets worse as current employee costs ratchet upward - these charges are only against retiree obligations for existing retired workers that remain as liabilities to the firm. To expect that the total impact could easily reach 20% or more of net profits over the next couple of years is not at all farfetched, and the market should soon start discounting that too.