(The comment below does not constitute an opinion as to the valuation of Honeywell (HON) common stock—only its pension accounting.)
For investors who make buy/sell decisions on the basis of P/Es or other accounting conventions, the news out of Honeywell (HON) was certainly good. For 2011, the firm, based on information released yesterday, expects to accrue a $200MM expense on its P&L, despite an actual cash contribution into its pension plans of $1 billion. Its shift to mark-to-market helps during periods of rising asset values.
Obviously, this will pump up earnings despite its obvious negative impact on free cash flows, with Honeywell needing to borrow when all aspects of the business are considered. Honeywell is a strong credit with low cost of capital and open access to the commercial paper markets.
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Source: Honeywell, ‘Investor Update – Pension’, November 16, 2010
During the period 2005-2008, Honeywell contributed, on average, $269MM into its pension and retirement plans, far short of what was really needed; thus, starting in 2009, the company began to make contributions in excess of $1 billion, which will continue through at least next year. If interest rates remain low or market values decline, Honeywell’s ultimate obligation will be much larger than currently recognized. If interest rates rise, Honeywell will most likely further match its liabilities or completely close out it plans with annuities.
Taking advantage of accounting rules, $2 billion is now in a funding “corridor” from which, if a shortfall to Honeywell’s actuarial assumptions occur, will not need to be reflected in earnings as reported to shareholders, but in a section of the balance sheet, titled “Accumulated Other Comprehensive Income.” As CT Capital’s invested approach focuses on cash flows, the reality is, shortfalls will eventually need to be made up.
Other firms, because of their higher cost of capital, will not be as lucky as Honeywell, and CT Capital currently penalize such firms for their real cash flows, adjusted for the actual contributions that need to be made.
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Disclosure: No positions