The Billion-Dollar Pension Shortfall Of Colgate-Palmolive

| About: Colgate-Palmolive Co. (CL)
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As is too often the case, Colgate-Palmolive (NYSE:CL) is yet another American corporation that currently has an underfunded pension. As of September 2012, Colgate-Palmolive had $2.79 billion in pension obligations but only $1.86 billion in pension assets.

While there are probably many reasons that contribute to this underfunding, I believe there are two main culprits that can help explain why there is about a $1 billion shortfall in the company's pension funding.

1. The first cause is that Colgate-Palmolive has generally used quite optimistic predictions in forecasting the future performance of the pension's total assets. Throughout most of the 1990s and through 2007 (before the financial crisis hit), the company predicted total returns on pension assets of between 9-10.5% during that time period. While I would consider those predictions to be particularly cheery for the performance of the American stock market as a whole, I find Colgate's pension assumptions to be particularly egregious given that the company maintained a fixed income allocation of between 30-45% during that time period, making the prediction of 9-10.5% seem particularly far-reaching.

Since the financial crisis, the company's predictions about the pension assets have been growing slightly more conservative. Since the financial crisis, the company lowered its long-term pension assumptions to 8% in 2009 and 2010, and lowered them yet again in 2011 to 7.75%. While I'd like to see a more conservative estimate of 6.5-7% (I'd rather deal with the chance of an overfunded pension than an underfunded pension), I welcome the company's move to use more conservative assumptions in funding their pensions. As the assumptions have grown more realistic, hopefully the billion-dollar shortfall will continue to shrink with time, both for the sake of Colgate-Palmolive shareholders and the firm's employees as well.

2. Also, the company's asset allocation within the pension has been slightly questionable as well. When the stock market hit the lows of 2008/2009, Colgate-Palmolive was shifting assets from the side of American and international index funds to fixed income investments. As the crisis has cleared somewhat, Colgate-Palmolive is now shifting more pension assets to the equity index side at the expense of fixed income as stock prices have inched higher. For instance, the company put $312 million into US equity funds in 2010, but as of September 2012, that number has inched upward to $403 million. Meanwhile, the company is cutting back on its international equity investments ($47 million) and increasing its American real estate investments ($62 million). The company also has about 20% of its plan assets in American bonds, which may complicate the company's overall pension assumptions of earning 7.75% on the plan's assets.

Of course, the question facing investors is what to do with the information that a company is underfunding a pension, paying executives handsomely, or doing something else that negatively affects the company. After all, Colgate-Palmolive is an excellent, stable company, and is the type of firm that many conservative investors can hold for the long-term while sleeping well at night.

When I write about something like the underfunded pension of an excellent company, I'm not writing with the intent to scare someone off from investing in Colgate-Palmolive. Rather, I write an article like this with the intention that the knowledge of an underfunded pension may affect the price that an investor might be willing to pay for a share of the firm. Right now, the company is trading at 21x trailing earnings. Maybe knowing that the company has a $1 billion pension shortfall means you'll only pay 20x earnings for a share of the company, or 19x earnings. Or maybe it won't factor into your analysis at all. The good news with the Colgate-Palmolive pension is that the company is getting more realistic with its forecast of long-term pension returns, but the bad news is that the company has a pretty high allocation of fixed-income assets that perhaps makes the pursuit of 7.75% annual returns a difficult feat to accomplish.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.