Grant's: Pension Predicament

The modern financial epoch is defined by a few common threads, not least a collective corporate inclination toward buybacks and/or dividends over reinvesting in their businesses.  The Financial Times noted on August 29 that capex across global listed companies has fallen in every calendar year since 2012.   

 

Capital investment is not the only expense that has been at least partially neglected in this long bull cycle. The July 21 issue of Barron’s made note of plainly inadequate funding levels for corporate pension plans:

 

At midyear, the average corporate defined-benefit pension plan was only 83% funded, according to Goldman Sachs Asset Management. That’s up from 81% at the start of the year, but it’s still a big shortfall. General Electric (GE), Lockheed Martin (LMT), and Exxon Mobil (XOM) all had plans funded at just around 70% of assets at the end of last year. The shortfalls are ‘despite very benign equity markets,’ notes Kevin McLaughlin, who heads liability risk management in North America at Insight Investment. ‘The need to make contributions to close these deficits is real.’

 

Some companies are heeding McLaughlin’s advice, albeit in ways that might raise an eyebrow or two.  Bloomberg today broke the story that Boeing Co. opted to partially plug its $20 billion pension shortfall (the plan’s total size is $57 billion) through a $3.5 billion infusion of its own shares, including those it had acquired from the public in prior company share buybacks.

 

Boeing stock has been as good as gold this year.  Actually better than gold:  its 58% share price appreciation soundly trumps the yellow metal’s 14% advance.  Still, some observers are less than impressed with a move that seemingly embeds a type of leverage that can’t be readily spotted on Boeing’s balance sheet. 

 

‘It’s an irresponsible thing to do certainly from the perspective of the plan participants,’ said Daniel Bergstresser, a finance professor at the Brandeis International Business School. ‘Ideally, you would like to put assets in the pension plan that won’t fall in value at exactly the same time that the company is suffering.’

 

Others have turned elsewhere for a remedy. Kroger Corp. recently announced a $1 billion contribution into its own pension plan, substantially closing the plan’s $1.3 billion shortfall.  The Cincinnati-based supermarket chain is taking the more conventional route to plug the gap: it tapped the bond market through a $1.5 billion offering of senior unsecured debt in July.  

 

The move was cheered by some. John Meyer of Meyer Capital Management told the Cincinnati Business Courier that “this strikes me as a move only a really good business would make. Kroger views this as not managing for the next 12 weeks but looking at it over the long term.” Matt Brill, a bond fund manager at Invesco, was quoted in the aforementioned Barron’s story as saying, “We don’t feel negative about it at all.  At the end of the day, they owe the money anyway.”

 

As to the efficaciousness of the plan, we aren’t so sure.  Beset by corporate T-1000 Jeff Bezos and Amazon’s splashy cost-cutting foray into the grocery business via the Whole Foods deal, Kroger has seen its share price shaved by more than 37% year-to-date.  Part of the problem is that debt issuance is not the only liquidity-draining initiative undertaken by management of late. The company announced on June 22 a $1 billion share buyback, the fifth such repurchase program initiated by the company since March of last year (the prior four took place at much higher prices). Yesterday, Kroger declared a regular quarterly cash dividend of $0.125 per-share, up by 4.2% from its September 2016 payout and 19% north of its 2015 disbursement.  

 

These maneuvers, in tandem with its contracting valuation, have added some strain to Kroger’s balance sheet. Its long term debt footed to $13.1 billion as of the quarter ended August 12, up by 36% year-on-year.  Shareholder equity of $6.14 billion was down 7% year-over-year.  Dividend payments have accounted for 34.2% of net income through the first two quarters of the year, compared to an average of just under 24% last fiscal year and just under 20% in fiscal 2016. 

 

So far, the ratings agencies have registered no public protest.  Kroger maintains a triple-B rating at S&P and Baa1 at Moody’s, both one notch above the lowest rung of investment grade.  Both agencies have deemed Kroger’s outlook to be “stable”.

 

File these items in the bourgeoning category of: not-early bull market sightings.

From Grant's Interest Rate Observer