Norcros: Pension problems?
I am having a look at Norcros. What struck me after 2 minutes is that despite consistently making a profit, the BV per share is broadly declining.
Usually, this means that something is going on in the statement of comprehensive income. Stockopedia does not provide the statement of comprehensive income (as far as I know), so I had a look on Norcros website to download their financial reports for the past 4 years. I can indeed see that in many years, the "actuarial losses on benefit retirement obligations" are very significant, and sometimes larger that the profit for that year.
Is there a cause for concern here? Pension obligations always seemed a headache to understand to me...
Thanks for any comment on that front!
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27 comments
Norcros put out an interesting data point in the latest presentation where they said that the average age in the scheme was 77.
Add 2 on the PER?
Paul means he adjusts the P/E ratio, price earnings ratio, upwards by 2 to allow for the proportion of earnings that are needed to deal with the pension deficit and thus are not available to shareholders.
Rough and ready but very sensible and a lot clearer than asking an actuary.
Norcros (LON:NXR) issued a trading update today that contains details of a ten-year agreement with the pensio trustee. Paul Scott thinks that has removed any concerns about the deficit. (See today's SCVR)
The SA business seems to be doing well, too.
Hi FREng,
I'm not saying it has removed all worries about the pension deficit. More that a 10-year deal of agreed cash over-payments certainly helps investors do the sums on this important issue - a big uncertainty seems to have been removed. That's good, I think.
I chatted this through with the FD of Norcros a while ago, and I recall him saying that their schemes are mature - i.e. pensioners are something like 80 now, average age. So, nature being what it is, the schemes will inevitably shrink over the next 15 years.
As with all pension schemes, they're a long-term liability.
The company is growing. The pension schemes will shrink. So it looks entirely manageable to me.
In terms of valuation, I just knock off about 2 from the PER.
Regards, Paul.
Seems the SA government have done a rapid U turn on the Finance Minister appointment and Rand is going back up again in response.
http://www.bloomberg.com/news/articles/2015-12-14/old-hand-gordhan-back-at-national-treasury-after-zuma-climbdown
One point to bear in mind is that the increasingly inept economic mismanagement in South Africa that has put the rand on the skids could very we'll force the SA government to introduce exchange controls that just might leave Norcros unable to repatriate any SA profits that it continues to make. Argentina and Venezuela are two examples;
http://www.americasquarterly.org/content/capital-controlsinvestment-flows-latin-america
Up until now few thought this likely but the recent ministerial reshuffle has caused a rapid rethink of just how bad things could get for business in South Africa.
I don't hold Norcros because of the South African exposure representing such a large part of their recent improved trading.
Well all this talk about Norcros pension deficit made me feel uneasy, so I sold my small holding the other day. I was never that happy about the South Africa exposure.
Thanks pooledaniel for the informative post.
This bit in particular is quite revealing:
"From my point of view, if you are trying to analyse a pensions deficit - the accounting position is close to irrelevant. It isn't used for anything other than accounts. The things that 'matter' are the Scheme funding position, as this drives the deficit reduction contributions that the company will have to pay, and potentially the 'buyout' position if the company is looking to 'get rid' of the scheme.
These figures can be VERY different to accounting. It wouldn't be atypical for the buyout liabilities to be 50% or more above the accounting liability."
That 50%-plus may prove a useful yardstick for assessing the real-life value of pension liabilities.
I haven't had chance to dig into the details of the case you mentioned, but I can give some general info on the cost of securing an annuity (i.e. buyin) or the buyout of a pension scheme vs the liabilities shown in the accounts.
The discount rate used for the accounting position shown will be driven by corporate bond yields. The other assumptions used to value the liabilities will generally be close to 'best estimate', i.e. have no prudence baked in (e.g. no intention to overstate how long people will live etc).
The assumptions used for a 'Scheme funding valuation' will be different. The discount rate is driven by gilt yields plus some margin (varies depending on the approach taken). This discount rate will typically be lower than that used for accounting. The other assumptions (mortality, commutation, proportion married etc etc) are likely to have prudence built in (as per the example above - e.g. intentionally overstating how long people will live). These act to increase the liabilities versus the accounting position. As the assets are valued at market prices, the deficit therefore increases.
Finally the 'buyout' position, also referred to as 'solvency'. The basis used for calculating liabilities is more prudent again. Typically there will be little to no margin applied on top of gilts when deriving a discount rate. Other assumptions will have even greater prudence built in (as per the insurers own house views). Also, 'cost saving' assumptions such as commutation for deferred members will be excluded, which further pushes liabilities up.
There are, of course, other factors at play but this is a very high level explanation of why things can look so different.
From my point of view, if you are trying to analyse a pensions deficit - the accounting position is close to irrelevant. It isn't used for anything other than accounts. The things that 'matter' are the Scheme funding position, as this drives the deficit reduction contributions that the company will have to pay, and potentially the 'buyout' position if the company is looking to 'get rid' of the scheme.
These figures can be VERY different to accounting. It wouldn't be atypical for the buyout liabilities to be 50% or more above the accounting liability.
"The way I read it is that they will ultimately buy an annuity worth approx 9.5m (funded from 3.7m of scheme assets to be liquidated and the 5.5-6m company contribution). This implies a hole between pension liabilities and their market value (the cost of a replacement annuity) of 60% which sounds in the right ballpark given how optimistic the regulatory methodology is."
This is pretty much it. The annuity to cover the scheme liabilities is worth 9.5m, which is equal to the value of the scheme liabilities on a buyout basis (vs c. 6m on scheme funding, even less on accounting). This shows the magnitude of the difference.
As a purely made up, but very plausible example:
Accounting liabilities - £1,000m
Assets - £1,000m
Acc deficit - £Nil
Scheme funding liabilities - £1,300m
SF deficit - £300m
Buyout liabilities - £1,500m
BO deficit - £500m
The accounting position suggests everything is fine. In reality, there is a £300m 'hole' that must be filled under legislation via deficit reduction payments / asset outperformance. This will require a recovery plan being agreed.
If the company wanted to 'get rid' of the risk by purchasing an annuity / transferring to an insurer - an upfront contribution of £500m (the BO deficit) would be needed.
I appreciate this a long, and not particularly well written post - but hopefully makes some sense. I've written it in a bit of a rush but would be more than happy to help people understand these bits more if it's of any use.
(Worth noting I guess - I'm a pensions Actuary so this is pretty much what I do!)
Thanks for the summary.
Unless I'm valuing a company as a liquidation asset play (where it seems the even more cautious method is warranted) then I tend to take the level of contributions to the scheme above those charged to the income statement and adjust the earnings accordingly.
Makes much more sense to me to use actual cash out of the door for adjustments vs an absolute value calcualted based on varying assumptions at a single point in time.
Problem though is that the cash out can be volatile, e.g. if the current payments are about filling a hole that's 1% of gross liabilities and that hole grows to 10% of liabilities in the next valuation round, you'll get something like 10x the amount to pay out on the next review... (and conversely).
Yes something wrong with the voting, asks me to sign in even though I'm already signed in, then to subscribe.
Interesting comment about a pension deficit from Ensor (ESR) this morning:
http://www.investegate.co.uk/ensor-holdings-plc--e...
Our balance sheet carries a gross liability of £2.0m in respect of retirement benefit obligations under the Ensor Group Pension Fund. This liability is currently financed by a schedule of contributions agreed with the scheme trustee, and paid by the Company to the scheme. Given the expected outcome of the Group sale process, we have now decided, in principle, to purchase an annuity which will secure all future liabilities of the Ensor Group Pension Fund, as a precursor to a buyout and wind-up of the scheme. The cost of this exercise, which will be payable in cash, is expected to be in the region of £5.5m to £6m and will be financed through short-term borrowings, to bridge the shortfall until further asset sales are realised.
I read this as ESR having to stump up £5.5m - £6m to get shot completely of pension liabilities in the books at only £2m.
£5.5m represents 18p per share and is equivalent to twice ESR's 2015 reported earnings, so quite significant.
Mayn
Ensor Holdings (LON:ESR) pension liabilities. I think the company has badly worded the position with the pension liabilities and obligations.
To understand what they have done and propose to do, you need to go back to the full year end accounts 31/3/15 and digest the details.
The actuarial valuation in 2014 resulted in defined benefits obligation of £5.9m, scheme assets of £3.7m giving a deficit of £2.2m. Based on this, the agreement with the scheme trustees was to make contributions of £300k (rising to £348K) over 7 years starting 2014.
So my understanding now is that they have (or intend to) purchase a bulk annuity costing £5.5m - £6.0m to de-risk the benefits obligations part only of £5.9m (as calculated in 2014).
The scheme assets will still remain the responsibility of the company. As asset sales progress, the assets backing the pension fund will be realised as cash which will then lead to a full buy-out. (hence their wording "... as a pre cursor to a buyout"...)
Could be wrong so all IMO and please DYOR.
I understand this company has put itself up for sale?
HI Ramridge
Thanks for the reply.
Yes, the text is not clear. But from my reading, and my suspicion of pension deficits in general, I think the following is what is happening.
* The sale process has prompted ESR to plug the pension deficit once and for all.
* ESR has decided/been told to stump up an extra £5.5m/£6m to plug the shortfall via an annuity, a product with defined future returns that can match the projected liabilities of the scheme.
* The last accounts showed scheme obligations of £5.9m and scheme assets of £3.7m. Clearly the assets are not enough to cover the liabilities, and it seems the obligations at £5.9m may be understated. Otherwise, why bother purchasing an extra £5.5m/£6m annuity to shore up the scheme's assets?
* The 2015 annual report confirms the scheme's assets are held in trust separate from the group and are managed independently of the group's finances. Essentially once paid into the scheme, this £5.5m/£6m becomes the property of the scheme and its members.
* To fund the purchase of the annuity, ESR will take on short-term borrowings and will then repay these borrowings through asset sales.
* The annuity and equities within the pension scheme are unlikely to be sold, as they are currently funding (or expected to fund) the liabilities. If they are ever sold, the proceeds will remain the property of the pension scheme. Only through an agreement with the Trustees will such scheme assets be handed back to the company. Such handbacks generally occur after years of a scheme surplus being recorded, and I have only ever found one case of such a handback among quoted companies.
What I should have written in my original post was that the declared £2m scheme deficit has in reality proved to require almost three times that sum to clear the obligations. Such adverse discrepancies underline why we ought to be wary of pension deficits in general -- they are just something to go wrong.
That's how I see it, but I may be completely mistaken!
Mayn
I've checked with the company. The £5.5m-6m payment is in addition to the scheme's assets. i.e. it only covers the £2m actuarial shortfall. So Maynard is right to be wary about pension deficits.
The way I read it is that they will ultimately buy an annuity worth approx 9.5m (funded from 3.7m of scheme assets to be liquidated and the 5.5-6m company contribution). This implies a hole between pension liabilities and their market value (the cost of a replacement annuity) of 60% which sounds in the right ballpark given how optimistic the regulatory methodology is.
Just looking at this again, The £5.5m takes out the £2m shortfall? So is not in addition to, therefore it should be £3.5m additional, so about 11p per share.
One cause for concern here could be assessing the group's valuation.
The recovery deficit payment of £2.1m referred to in a comment above is not charged against P&L earnings. So you could argue reported profits are flattered somewhat if such payments are likely to be a regular feature of the accounts. With this share, I don't think you can ignore such a large liability and it has to be factored into your valuation sums -- perhaps either by adding it on to the market cap as you would debt to get an enterprise value, or reducing reported profits by the likely level of deficit payments.
The other cause for concern generally are that these pension schemes are simply something to go wrong for your investment. There is generally no operational upside for shareholders to these schemes, but plenty of downside if/when the liabilities increase and the company has to find extra cash.
If you look at the likes of BAE, BT etc, their pension deficits are larger now than they were 10 years ago, despite all the £££ pumped into the schemes. These deficits never seem to go away on a permanent basis -- (although they will of course disappear when the last member of the scheme dies).
You see, if it is not a market crash hitting the scheme's asset value, then it is increased life-expectancy projections or decreasing interest-rate forecasts or rising salary predictions that increase the liabilities. Us ordinary shareholders never seem to win -- something always comes along to hit the scheme and give the now-quite-powerful Trustees every excuse to extract more of the company's cash that could be paid to us as dividends.
Personally I would never bother with any share that has a substantial deficit in relation to annual profits. Such shares may often appear cheap, but your valuation sums are at the whim of complex pension accounting, actuarial valuations and the associated long-term forecasts. Best in my view if you look at other cheap shares without such headaches!
Agree it is a problem especially for smaller more cyclical companies such as Norcros. Obviously the likes of BA and BT should be able to manage it more easily. However interesting to note that some UK stocks such as AGA have still be bid for despite large pension deficits, although maybe that reflects more the intangible value of the AGA and other brands etc. Not sure how valuable the Triton brand would be to an acquirer?
On adjusting for these numbers, they do seem to be in their cash flow statements etc. but they strip them out when they talk about adjusted / underlying earnings etc. Interestingly there was another sponsored note out from Edison yesterday which does adjust for this ongoing cost and therefore takes next years earnings down from the Co.s 24p to more like 21p which puts it closer to 10x on the adjusted basis which is worth bearing in mind when looking at this one - which obviously you won't be!
Hope this helps the original poster and other readers.
Jamie
Compoundincome.org
Right now there may be an opportunity in stocks like these.
Pension deficits are very sensitive to interest rates.
If interest rates go up, at the next actuarial valuation, the liabilities will fall
- there will be a long lag here between the market rate change, the actuarial valuation and the accounts that valuation is placed in.
The pension liabilities of £441.3m and an IAS19R deficit of £44.3m at the end of FY15 is significant in the group context given the market cap. is £125m. However in a recent sponsored note from Edison they said:
"Changing assumptions affect the balance sheet though inflation and interest rates are at historically low levels and a higher discount rate in due course would have a favourable impact on the deficit. The latest triennial review is underway and no material change in funding (FY15 recovery plan cash of £2.1m, linked to CPI) is anticipated. We see no impact on normal business operations as a result of the scheme position."
Hope this helps
Jamie
Compoundincome.org
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I don't want to change my password.
Actually, in the 2015 annual report, note 23, shows clearly a pension deficit, which more than double since 2014.
Earlier in the report, it says Norcros has no employee... I wonder why they have to report pension obligation stuff if that's indeed the case?