Pension Plans May Slow Utility Growth in 2003

 

 

The economic downturn is increasing utility pension plan costs and liabilities.

While 401(k) stock option plans have increasingly displaced traditional pension plans in corporate America, many mature firms like electric utilities are still administering sizeable pension plans that in the recent economic downturn could compromise future earnings, according to a report by investment bank CIBC World Markets (CIBC).

William D. Hyler, utilities analyst at CIBC, finds that, "With a majority of companies targeting mid-single-digit growth rates, changes in pension-related expense items can meaningfully impact growth rates, hence dividend discount models. [Barring a major market recover], with payout ratios for many companies already rising in the wake of the earnings shortfalls, pension-related issues could affect the impact on future dividend growth." He adds that even FASB accounting rules that smooth out performance swings may not help some companies in the current market climate.

Utilities that have witnessed the largest positive swing in pension credits function of the growth in overfunded positions through 2000) are seen most vulnerable moving forward (see Table 1), the report says.

"We note that many utilities have benefited to the point that the pension line has contributed a meaningful percentage of reported earnings per share in recent years. However, even companies that continued to generate net pension expense will likely be negatively affected as the level of expenses rise," Hyler writes.

In addition, companies with significant underfunded positions (liabilities) could face rising future cash flows to fund plans in the future (see Table 2).

CIBC has developed a modeling spreadsheet it has e-mailed to fund managers that can identify utilities that warrant attention from the income standpoint (i.e., have generated a meaningful percentage of reported "earnings per share" from pension income) and from the funding (balance sheet) standpoint, i.e., have underfunded plans. (The graphs in this article were generated using CIBC's modeling spreadsheet.)

Of course, Hyler emphasizes that if equity markets were to experience a sustained recovery, pension-related concerns could abate. But at press time, economists still predicted continued weakness in the U.S. economy.

For example, Kevin Logan, an economist at Dresdner Kleinwort Wasserstein, said in early December, "We think GDP in the fourth quarter will be between zero and 1 percent."

Of course, U.S. economic growth was brisker than first thought in the third quarter, while consumer confidence broke a five-month downtrend in November, but within these apparently upbeat reports in early December lurked signs the recovery was still not on solid ground, according to Reuters press reports.

Gross domestic product, a measure of all output within U.S. borders, rose at a revised 4 percent annual rate in the July-September period after an anemic 1.3 percent gain in the preceding quarter, accord-ing to a Commerce Department report.

The latest figure, up from an originally reported 3.1 percent, came in a bit stronger than economists had expected, but did nothing to alter forecasts for sharply slower growth in the current quarter.

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