Avoiding Pension Plan Time Bombs

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Avoiding Pension Plan Time Bombs

By Fei Mei Chan, Forbes

June 16, 2003

NEW YORK - For America's workers, pension plans are a lifeline; for corporations, they are a way to attract and retain talented individuals. But in a bear market, with interest rates at 45-year lows and profit margins under severe pressure, pension obligations are just another problem for corporate management.

The two main flavors of pension plans are defined benefit and defined contribution. Defined benefit plans promise to pay a specified amount to retirees. With defined contribution plans the proceeds can vary, depending on the return from the investments made in the plan.

Of the S&P 500 companies, 360 have defined benefit pension plans. Such plans pose the biggest headache for management because companies are locked into paying out specified amounts--no matter what the return is on the pension assets.

A recent Credit Suisse First Boston report tallied up the erosion in pension assets. In 1999 the pension plans of the S&P 500 were overfunded by $252 billion, but last year underfunded obligations totaled $216 billion. The report's author, David Zion, notes that 322 companies with defined benefit pension plans were underfunded at the end of 2002 making it the highest level in 10 years.

For the S&P 500 the number of overfunded pension plans has steadily dwindled--from 254 in 1999 to 38 companies as of year-end 2002.

Among companies with a pension surplus is McKesson health care supplies and services firm. For 2002 McKesson showed a pension benefit obligation (PBO) of $332 million and overfunding of $15 million. In its latest fiscal year, which ended in March, McKesson reported a 14% jump in revenue, to $57 billion, and a 32% increase in earnings per share.

The table below lists seven S&P 500 companies with overfunded pension plans for 2002. In addition, estimated PBO represents less than 20% of their current market capitalizations. All are expected to post annualized-earnings-per-share growth of at least 10% over the next three to five years.

Leggett & Platt, which manufactures store fixtures and furniture components, has a PBO of $134 million, which is equal to only 3% of its total market value. In 2002 its plan was overfunded by $8 million.

Per-share profits at Leggett & Platt fell 11% in the first quarter of 2003 versus the same quarter last year. The prime culprit: higher energy prices. Lower energy prices, cost cuts and an expected pickup in demand should help Leggett's prospects in the second half of the year.

Leggett & Platt is expected to squeeze out a 3% gain in earnings in 2003. It trades at 19 times estimated 2003 profits of $1.20 per share.

If the stock market continues to rebound, companies will get some relief on funding their pension plans. But be on the lookout for businesses that transfer some of their overfunded pension assets to the income statement in order to smooth out profits during rough times. Such an accounting gimmick can mask a weakness in ongoing operations.

Companies With Pension Surplus
Company	Price	Overfunded ($mil)	Long-Term Growth*	2003 Estimated P/E	Market Value ($mil)
Bank One	$39.10	$62	10%	13	$ 44,666
Leggett & Platt	22.16	8	15	19	4,274
Manor Care	25.03	11	15	18	2,253
McGraw Hill	63.94	103	12	20	12,193
McKesson	34.55	15	18	15	10,003
North Fork Bancorporation	33.30	4	11	12	5,217
Sallie Mae	124.49	8	15	23	18,765
*Annualized; projected over the next three to five years. P/E: Price-to-earnings ratio. Prices as of June 13. Sources: FT Interactive, Multex and Thomson First Call via FactSet Research Systems; Credit Suisse First Boston