The Motley Fool

3 stocks with terrifying pension deficits

Thanks to a combination of increased life expectancy and changes in economic conditions, there’s been much chatter about the pension deficits of some of the UK’s biggest companies recently. Only yesterday, adviser JLT Employee Benefits highlighted how 10 FTSE 100 companies have liabilities greater than their market value. BAE Systems and British Airways owner IAG both make the list of those whose schemes represent a “material risk” to their businesses.

What’s less discussed is the similar situation unraveling at some firms in the market’s second tier.

Hidden threat

Perhaps the best (or worst?) example of a company facing a significant pension deficit is bus and rail operator First Group (LSE: FGP). A similar study by JLT earlier this year found that it had the largest pension liability of any company in the FTSE 250 (just over £4bn) relative to its market cap (£1.2bn). Although the value of First Group has increased very slightly (to £1.4bn) since the report was published, that’s still hugely worrying. With the shares trading at less than nine times forward earnings, it strikes me as a value trap of the highest order.

Infrastructure group Balfour Beatty (LSE: BBY) is the second of our trio with terrifying deficits. Its pension liability may not be as great as First Group’s but, at £3.4bn back in March, this was still more than double the value of the entire company at the time. Facts like these make its recent return to profit appear somewhat less impressive. To make matters worse, a predicted 56% decline in earnings per share in the current financial year leaves the shares trading on a forecast price-to-earnings (P/E) ratio of 23.

Despite more than doubling in price since the shock EU referendum result, package holiday operator Thomas Cook (LSE: TCG) remains another risky buy, in my opinion. Not only must it contend with the threat from more nimble online-only operators, the company’s total pension liabilities hit £1.4bn earlier in 2017. Given that almost 90% of FTSE 250 businesses have liabilities of less than this amount (if any at all), it’ll take more than a surge in summer bookings to make me look twice at the stock. 

So what could happen?

Clearly, the situation at some mid-caps can’t go on forever. With high pension burdens come the possibility of dividend cuts to help plug these holes, if they haven’t happened already. Trustees may also need to consider reducing benefits or increasing member contributions. Understandably, the first of these has the most impact on investor sentiment. Why buy a troubled company’s shares if you aren’t being rewarded for your patience?

Of course, some might argue that those with low valuations indicate a lot of bad news is already priced-in. Surely investors will be rewarded eventually?

While I’ve sympathy for this view (and buying for the long term is very much part of the philosophy espoused by the Fool), it’s worth mentioning that all three of the above could also see trading suffer — at least temporarily — thanks to our forthcoming exit from the EU.

With so much still unknown about how Brexit will work in practice, a tremendous leap of faith is surely required to back any of these businesses at the current time, regardless of their problematic pension schemes. As such, I think there are far better opportunities elsewhere in the market.

Conserve your wealth

Buying a slice of a company without checking for hidden nasties (such as a burdensome pension deficit) would be a huge mistake.

If you're looking to avoid making expensive errors during your time in the stock market, I strongly encourage you to download a special report from the Motley Fool's analysts. Reading their thoughts on the worst mistakes investors make could save you many thousands of pounds over the course of your investing career.

Better still, this wealth-preserving report is completely FREE to read and comes with absolutely no obligation.

Just click here and it's yours.

Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro.