QUALIPORT
Companies With A Pension Problem

By Maynard Paton (TMFMayn)
January 13, 2003

Much has been said about a looming pension crisis hitting corporate Britain. Low investment returns and an aging population could leave many a business weighed down with a long-term pension burden. However, Financial Reporting Standard 17, a relatively new accounting standard, can help identify those firms that have onerous pension responsibilities.

An in-depth review of FRS17 was published last year. In short, FRS17 reveals the extent of retirement benefits an employer is committed to providing in the future. As such, FRS17 affects the disclosure of defined benefit, rather than defined contribution, pension schemes.

Unfortunately, the formal adoption of FRS17 has been postponed until 2005 at the earliest. But the transitional reporting arrangements still require listed companies to produce a FRS17 accounting note, which reveals:

* A forecast of all future pension liabilities, alongside the actuarial assumptions used in the calculation;
* The current market value of the pension fund, plus the estimated growth rates of the underlying asset classes, and;
* The overall net pension surplus or deficit position.

The main warning signs of companies heading for pension trouble are:

1. Large pension deficits: A big pension shortfall could indicate additional costs ahead. Unless the pension fund produces great returns, significant increases in future contributions may depress future profit growth.

2. Aggressive assumptions: A number of estimates and forecasts have to be used to calculate a pension surplus or deficit, including stock market growth, salary inflation and a liability discount rate. Needless to say, directors are at liberty to use unduly optimistic figures.

To provide a practical angle to the investigative theory, the fifteen shares on the Qualiport's watch list will be put to the test. However, DFS Furniture (LSE: DFS) and Games Workshop (LSE: GAW) escape the review as neither firm operates a defined benefit pension scheme and are thus unaffected by FRS17.

Surplus or deficit?

The following table compares the pension surplus (or deficit) with earnings of the remaining thirteen watch list companies:

Company             Year to      Pension         Surplus/   Post-tax
                              Assets Liabilities  (Deficit)   Profit
                                (£m)    (£m)       (£m)       (£m)

Assoc Brit Ports     Dec 01      424    (320)       104        98
Carpetright          Apr 02        4      (5)        (1)       36
Emap                 Mar 02       77     (90)       (13)      104
Gallaher             Dec 01      856    (853)         3       289
Halma                Mar 02       55     (68)       (13)       33
Imperial Tobacco     Sep 02    2,121  (2,390)      (269)      454
Johnston Press       Mar 02      139    (152)       (13)       53
Lloyds TSB           Dec 01   11,126 (10,618)       508     2,500
London Stock Exch    Mar 02      148    (167)       (19)       54
Metal Bulletin       Dec 01       10     (12)        (2)        6
Renishaw             Jun 02       27     (34)        (7)       15
Scottish Radio       Sep 02        6     (13)        (7)       10
Ulster Television    Dec 01       46     (40)         6        10

Of the fifteen companies on the watch list, just four showed a pension surplus in their latest annual report. Of those with deficits, probably Imperial Tobacco (LSE: IMT) and Scottish Radio (LSE: SRH) give the most concern. Imperial's shortfall runs to £269m, some 60% of pre-exceptional earnings. Although Scottish Radio's deficit is just £7m, annual earnings only amount to £10m.

Others at risk of greater contributions having some impact on profits include Halma (LSE: HLMA), Johnston Press (LSE: JPR), London Stock Exchange (LSE: LSE) and Metal Bulletin (LSE: MTLB).

Assumptions

But what of the predictions used to calculate the surpluses and deficits?

The table below highlights...

* The split of equities and bonds within the pension fund;
* Estimates of future investment growth (the lower the better), and;
* The discount rate of future liabilities (the lower the better).

... for the watch list thirteen:

Company             Year to     Allocation     Est. Growth      Disc.
                             Equities  Bonds  Equities  Bonds   Rate
                                (%)      (%)     (%)     (%)     (%)

Assoc Brit Ports     Dec 01     55       43     7.00     5.40    5.75
Carpetright          Apr 02     83       10     8.00     6.00    6.00
Emap                 Mar 02     51       49     8.30     5.30    6.00
Gallaher             Dec 01     64       29     7.30     5.30    5.85
Halma                Mar 02     82       15     8.25     5.25    6.00
Imperial Tobacco     Sep 02     57       29     7.56     5.25    5.15
Johnston Press       Mar 02     65       32     7.50     5.00    6.00
Lloyds TSB           Dec 01     70       16     8.00     5.10    6.00
London Stock Exch    Mar 02     28       72     7.75     5.57    6.00
Metal Bulletin       Dec 01     12        2     7.00     5.50    5.90
Renishaw             Jun 02     98        2     8.00     5.00    5.80
Scottish Radio       Sep 02     77       16     9.00     5.00    5.50
Ulster Television    Dec 01     85       14     7.00     5.50    5.90

Compared to the others, Carpetright (LSE: CPR) has applied some relatively upbeat forecasts. Although the retailer uses the highest liability discount rate (6%), the highest bond growth rate (6%) and a relatively high equity growth rate (8%), any downward revision to these projections on what is just a £1m pension deficit is unlikely to cause major profit problems (Carpetright's earnings were £36m in fiscal 2002).

The 9% equity growth assumption (the highest of the thirteen) used by Scottish Radio is also interesting. The media group had shares worth £4.6m in its pension fund at 30th September 2002. Over twenty years, 9% annual growth will turn that sum into £25.8m; 7% growth per annum generates £17.8m. The £8m difference could more than double Scottish Radio's current deficit.

Also worth a mention is the London Stock Exchange (LSE: LSE). Save for Metal Bulletin (LSE: MTLB), whose pension fund is largely invested in a with-profits policy (!), the LSE's pension scheme has the lowest percentage allocation to equities. A somewhat bizarre situation, given the LSE's promotion of (and obvious interest in) greater share ownership!

Of those shares on the watch list, Scottish Radio is probably the only one that requires any further investigation. That said, following a disastrous 2002 for the stock market, the next round of annual reports could throw up a few other firms whose pension obligations could look rather alarming.

The author owns shares in Carpetright, DFS Furniture, Games Workshop, Halma, Johnston Press and London Stock Exchange