Recent news articles on Honeywell, UPS, and General Motors have served as a reminder to pay attention to pension obligations and their corresponding impact on cashflow. Before establishing a new position I attempt to make sure that I've factored into my decision making the potential negative impact of a defined benefit pension plan. Occasionally I'll take a shortcut and that aspect is missed. Annually I scour my portfolio to make sure I'm aware of pension issues. Many multi-national industrial and consumer product companies are saddled with underfunded plans that must be addressed.
The impact on earnings isn't always negative, as in HON's case, as they may be able to change accounting treatment and lessen the impact on net profit. But they can't change the impact on cashflow. Less cashflow, less balance sheet cash, or more debt are the only real ways for a company to bring their pension plan up to snuff. None of which are positive for the cautious investor.
While the stock market's rebound is beneficial to pension funding, the bond component of pension assets remains dismal. Plan assumptions have been too optimistic, for too long and companies are addressing the issue. But the timing is far from perfect.
Not only are we in a global slowdown, commodity input prices are raging. Any company that makes a product is facing significant pressure on margins. Now, after several years of poor performance in equities and low bond yields, companies are needing to start a more aggressive refunding of their defined benefit pension plans. Unfortunately it is at the same time as sales growth is difficult to capture and input costs are soaring. Difficult headwinds.
QE2 and emerging market growth may continue to lift all stocks, but my suggestion is to cull portfolios of the weakest firms with underfunded pension plans. Battling rising costs in a tough sales environment is difficult enough.
About the author:
Ravi Nagarajan is a private investor and Editor of The Rational Walk website. Ravi focuses on applying value investing techniques to find securities trading well below intrinsic business value. Ravi has over 15 years of experience in the financial markets and started investing on a full time basis in 2009. From 1996 to 2009, Ravi held a number of technical and executive level positions in the commercial software industry. Ravi graduated Summa Cum Laude from Santa Clara University with a degree in finance. Visit his website The Rational Walk
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