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Summary

  • AT&T has a market cap of $183 billion and is responsible for $56 billion in pension assets (at FYE 12/31/13).
  • AT&T faces an issue many older companies do: providing benefits to workers who are not currently productive.
  • Newer companies can be more nimble and focused without having to concern themselves with discount rates and investment returns.
  • In FY 13, a change in the discount rate and the strong stock market added about $7 billion to income, although this was a non-cash item.

This article continues my theme of analyzing large multinational firms with major pension obligations. See this recent article on Disney (NYSE:DIS) and General Electric (NYSE:GE) for comparisons with other employers.

Employee Base

As of 1/31/14, AT&T (NYSE:T) employed approximately 243,000 persons.

Approximately 55 percent of employees are represented by the Communications Workers of America (CWA), the International Brotherhood of Electrical Workers or other unions. In February 2014, AT&T reached a tentative agreement with the CWA and employees hired after 2014, AT&T will increase its matching contributions to a 401(k) plan rather than provide a pension plan.

In October 2013, as part of the 2014 annual benefits enrollment process, AT&T communicated an amendment to Medicare-eligible retirees that beginning in 2015 AT&T will provide access to retiree health insurance coverage that supplements government-sponsored Medicare through a private insurance marketplace. This new approach will allow retirees to choose insurance with the terms, cost and coverage that best fits their needs, while still receiving financial support as determined by AT&T.

AT&T expects that the cost to AT&T for retiree medical coverage in 2015 will be comparable to 2014.

Pension Benefits and Postretirement Benefits

Substantially all AT&T U.S. employees are covered by a noncontributory pension plan. The majority of newly hired employees, longer-service management and some non-management employees participate in cash balance pension programs that include annual or monthly credits based on salary as well as an interest credit.

Other longer-service management employees participate in pension programs that have a traditional pension formula (i.e., a stated percentage of employees' adjusted career income).

How Does the Pension Plan Affect the Balance Sheet?

Amounts recognized on the AT&T balance sheet at 12/31 are as follows:

Billions of $

Pension Benefits

Postretirement Benefits

2013

2012

2013

2012

Current portion of employee benefit obligation*

$0

$0

$2

$2

Employee benefit obligation**

9

14

19

26

Net amount recognized

9

14

21

28

* Included in Accounts Payable and Accruals.

** Included in Postemployment benefit obligation.

The accumulated benefit obligation for AT&T pension plans represents the actuarial present value of benefits based on employee service and compensation as of a certain date and does not include an assumption about future compensation levels. The accumulated benefit obligation for the pension plans was $55 billion at 12/31/13 and $57 billion at 12/31/12.

However, a weakness in the equity or fixed income markets could require AT&T in future years to make contributions to the pension plans in order to maintain minimum funding requirements as established by law.

The Strong Stock Market Has Helped AT&T

In 2013, AT&T income was boosted by $7.4 billion due to an increase of its assumed discount rate to 5.0 percent and higher-than-expected asset returns. This wasn't the case in prior years. The combined net pension and post-retirement (credit) cost recognized on the consolidated statements of income was $(7.4 billion), $10.3 billion and $7.3 billion for years ended December 31, 2013, 2012 and 2011, respectively.

The Low Interest Rate Environment Hurts AT&T

Readers of my other works have seen how the low interest rate environment hurt GE's pension plan. AT&T is in the same boat. When a company lowers its assumed discount rate, this increases the obligation (in present value).

AT&T assumed a discount rate of 5.00% at December 31, 2013. This reflects the hypothetical rate at which the projected benefit obligations could be effectively settled or paid out to participants.

The company determines the rate based on a range of factors, including the yield on high-quality, fixed income corporate bonds (typically bonds rated AA-).

AT&T assumes an expected long-term rate of return on plan assets of 7.75% for the year ended December 31, 2013. In 2013, the actual return on the combined pension and post-retirement plan assets was 14.1%, resulting in an actuarial gain of $3.2 billion.

How are the $56 Billion in Assets Invested?

Principal pension

Plans

Other pension

plans

Equity securities

41%

45%

Debt securities

(including cash)

33

24

Private equities

12

4

Real assets

11

1

Other

3

26

The Total Plan Assets of the Pension Plan at 12/31/13 was $47 billion and the Total Plan Assets for Post-retirement Accounts was $9 billion.

Conclusion

I conclude that AT&T is at a disadvantage given that management must focus their time on pension acrobatics. AT&T trades at a large discount to the S&P 500. The trailing P/E ratio is about 10x compared to an S&P 500 index trading at almost 18x. Also, note that AT&T has an above market dividend yield of 5% compared to an S&P 500 dividend yield of 1.7%. Regardless of the risk around the pension plan, I rate this stock a Buy. In the modern world, it is nearly impossible to be without a cell phone, and AT&T has found numerous ways to sell many plans.

This article does not describe the current drivers of the AT&T business, which are critical to valuing the stock. These issues include the demand for wireless, the demand for spectrum and the ability to support innovation on a broad geographic area. The company launched new service plans including Mobile Share and AT&T Next (sale of devices on installment) to serve an already mature marketplace. The company is also looking at a merger or acquisition of DirecTV (NASDAQ:DTV), according to recent news reports. Lastly, I am a Financial Analyst, and not an actuary. The above article is an opinion, and not investment counsel.

Disclosure: I am long DIS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: AT&T And The $56 Billion Pension