Tuesday, March 1, 2011

Pensions Become Unrecognized Assets

What a difference a couple of years makes! In 2009, as the market set low after low, investors were cautioned to be aware of companies with defined benefit pension plans. Since shareholders are on the hook for the pension obligations, any drop in pension plan assets (as a result of the market declines) should result in a drop to a company's valuation.

Over the last little while, however, the opposite effect has taken place. As companies with fiscal years ending on December 31st will release their annual reports in the coming weeks, companies with defined benefit plans will likely see improved financial positions! Since pension asset values are only reported once a year, investors using 3rd quarter reports are likely underestimating the value of their companies under study. In other words, companies with defined benefit plans are likely worth more than investors are giving them credit for!

As an example, consider Twin Disc (TWIN), a company that has been previously discussed as a potential value investment. In 2009, the value of the company's pension assets fell by $24 million, pushing the company to cease accruing pension benefits for employees. For a company with a market cap (at the time) of just $100 million, this change in the value of its pension assets is clearly material to the value of the stock.

Since the broad market has gained significantly since that period, Twin's pension assets likely experienced a material gain as well. Unfortunately, until the 10-K comes out (and for TWIN, that is not for several months, as their fiscal year-end is not the same as the calendar year-end), all the investor can do is estimate the gains. (The pension assets gained $7 million in the last 10-K.)

Unfortunately, estimating gains is not easy. While companies do disclose their planned asset allocations, determining the rise in values of private equity or real-estate investments is not an easy task. Furthermore, in the interests of conservatism, investors are cautioned from being overly optimistic when estimating returns. However, in cases where pension assets are material, recognition of this issue can help the investor improve the accuracy of his valuation.

Disclosure: None


Anonymous said...

Do shareholders really have access to the assets of an overfunded pension plan?

Paul said...

I don't know if shareholders have access to over funded pension plans anymore, but didn't they have access in the 80s? It seems like that was part of all those LBOs back then.

Saj Karsan said...

Hi guys,

They have some access in theory, but rarely is this ever done. However, I argue that these are still assets, as they reduce future cash outflows the company would have to make had the pension assets not appreciated.