Something I always enjoy looking at when I'm going through a company's annual report is the pension portion to see if they have a Defined Benefit (NYSE:DB) pension plan or Defined Contribution (DC) pension plan. There's more company liability when they operate a DB plan, and I always make sure to look at the funded status of the plan for a surplus or deficit. Based on my experience, surpluses are extremely rare, and deficits can be a cause for concern if too large.
Generally, I am less confident when a company runs a deficit because you need to account for it as essentially being debt owed to the employees, which reduces the value of the company. It's not always that straight forward because, as I learned this past week, companies may need to take charges to earnings when the value of their pension assets falls. I focus on cash flows and thus non-cash earnings charges aren’t the end of world. Sometimes I’ll add the charges back to earnings if I don’t believe they’ll occur again – everything is case-by-case.
I was reading through Silgan Holdings Inc. (SLGN)’s end of year earnings announcement, and they mentioned a "non-cash pension headwind as a result of significant market declines in investment values at the end of 2018". The charge will reduce 2019 EPS by $0.13USD, or approximately $20 million. This is equivalent to about 9% of 2018 earnings. (As an aside, I actually think SLGN is a great business, and the only reason I never invested was because I didn't understand pension accounting well enough yet - the CFA level 2 helped solve that problem).
After going through (SLGN)'s earnings announcement, I read an article in the WSJ talking about potential pension adjustment charges at (T) and (VZ) ( and others) because they mark-to-market the gains and losses on their pensions. Three days later, VZ reports an "annual mark-to-market for pension and OPEB (other post-employment benefits) charges of $165 million", according to their earnings announcement. This makes up about 8% of their fourth quarter earnings. ((T) did not report any adjustments to its earnings due to the pension losses).
I don't actually believe this is a threat to earnings moving forward because these are generally treated as one off charges or are smoothed out over a period of time. (The three examples above are all one off chargers). I actually expect (VZ) to reverse its charge due to the recent rally. I follow many companies that have yet to report earnings with large DB pension plans, and should have a better idea of what companies are reporting. The contingency on the “moving forward” assumption is dependent on the performance of the capital markets.
Presently seeing and continuing to see what companies are reporting from the impacts of pension adjustments in the fourth quarter, it will prove valuable as a stress testing scenario on their pension plans for future pullbacks. Especially considering almost 90% of assets were down on in 2018, it seems like a fitting sample for an extremely negative scenario.
I may update this post as I see fit, if I notice more pension adjusts.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: This does not constitute investment advice, and should not be taken in isolation. Use proper judgment when making investment decisions, and ask your licensed Investment Advisor about anything mentioned in this article as I am not licensed to provide investment advice.