Computer Sciences Corp. ("CSC"): Pension Analysis (Part 1)

Jun. 29, 2010 8:05 PM ETDXC
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 Chain Bridge Investing’s (“CB” or “we” or “our”) evaluation of the Computer Sciences Corporation (“CSC”, “Computer Sciences Corp.” or the “Company”) is based primarily on fundamental factors such as past, current and potential operating performance, as well as the Company’s current competitive environment.  There is no guarantee that the market price of the Company will eventually reflect its implied value as derived from fundamental factors.  This post, along with the others in this series, does not analyze the technical aspects of the Company’s stock price and its volume patterns.  Furthermore, the reader should note that this post is the first of multiple posts by Chain Bridge Investing regarding CSC.  For a more complete analysis, we recommend that one read the other posts in this series as they become available.

Brief Statement of Interest in CSC

Chain Bridge Investing evaluated CSC as a potential investment due to the following factors:

  1. Historically, CSC has consistently generated high levels of free cash flow relative to its market value.
  2. As the Company continues to move a significant portion of its operations to Asia,  its operating margins will most likely increase, thus improving overall operating results, free cash flow, and providing a possible catalyst for an increase in market value.
  3. CSC has a strong balance sheet that shows a Company with great liquidity and  manageable debt levels.
  4. During the past couple of years the Company has demonstrated strong bookings to revenue.  The new bookings have been driven by both new customers and existing customers, thus growing and diversifying its revenue stream.
  5. CSC  is well positioned to serve both commercial and public-sector clients, thus providing it with a degree of protection if one sector were to take a hit.
  6. In recent years, the Company has actively repurchased a portion of its outstanding shares.

Unfunded Pension Plans

During our analysis of CSC's financial statements, we discovered that the Company sponsors several different pension plans and other post retirement benefit plans for its employees.   These employer sponsored plans include both defined contribution plans and defined benefit plans.  The Company organizes the figures detailing the defined benefit plans into two categories: (1) U.S. plans and (2) non-U.S. plans.  At present, as seen in Exhibit 1,  when the defined benefit plans are consolidated they have an unfunded status of $1.4 billion, which is consider an off-balance sheet liability.  One can see that the funding status of CSC's defined benefit plans has deteriorated tremendously since fiscal year 2006.  If such a deterioration were to continue, then the unfunded liability would most likely drain cash away from CSC's operations  and could threaten the well being of the Company.  Fortunately, CSC's management froze the primary U.S. plan in July 2009 and will freeze the primary non-U.S. plan in July 2010.  These freezes will limit the growth of CSC's projected benefit obligation and thus limit the unfunded liability.  Nevertheless, even with the freezes on the primary defined benefit plans, CSC must continue to make the benefit payments to its retired employees and resolve the unfunded liability.  As explained below, the Company's operations appear strong enough to cover these pension plan cash outflows with little difficulty.

Expected Benefit Payments & Employer Contributions

As seen in Exhibit 2, the estimated benefit payments along with estimated employer contributions appear to be very manageable with the highest figure estimated to be $367 million.  From fiscal year 2006 to fiscal year 2010, CSC has managed to average a cash flow from operations of $1.6 billion.  When one considers this $1.6 billion average cash flow from operations combined with CSC's current cash balance of $2.8 billion, CSC appears able to cover the existing obligations of the frozen defined benefit plans with ease - unless it were to face a collapse in demand for its services.  However, given CSC's diversity of revenue sources, its handling of the 2008 crisis, its strong bookings of future contracts, and its preference for clients with high credit quality the probability of the Company witnessing a large collapse of demand is small.

To further explore this matter we should consider the effects of the estimated benefit payments, estimated employer contributions, along with the maturities of CSC's outstanding debt.  In that situation, the only two years that could pose a threat to CSC are 2012 and 2013 when $1.5 billion and $1 billion of debt mature, respectively.  Yet, the Company's current cash balance could cover the combined maturities in both of those years,  thus allowing the Company more than enough cash from operations to cover the benefit payments and employer contributions.

Moreover, the following may further aid the Company in dealing with the estimated employer contributions and estimated benefit payments:

  1. The retirement of a portion of CSC's outstanding debt will probably reduce interest expense and result in higher cash flow.
  2. The ability to refinance its debt will allow CSC the ability to delay maturities if it has no other choice.
  3. Improved returns on the plans' assets would reduce the unfunded liability and decrease contribution amounts.

CSC's cash flow combined with the existing cash balance appears to be more than enough to cover the Company's estimated benefit payments, estimated employer contributions, and debt maturities.  As a result , we do not believe that the unfunded liability of $1.4 billion presents a viable threat to the Company or its operations.

Disclosure:  Author did not have a position at time of writing, but is contemplating one. 

Disclosure: No Position

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