3 stocks with terrifying pension deficits

Paul Summers — Wed, 30 Aug 2017 06:00:14 +0000

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.

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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.

3 problems BT Group plc has that are bigger than fraud

Zach Coffell — Tue, 31 Jan 2017 12:12:40 +0000

Opportunistic value investors sensed a trading opportunity in BT (LSE: BT-A) after a £530m financial fraud write-off coupled with a profit warning sent its shares into a 20% free fall earlier this month. The shares are now trading on a P/E of 10,, with a yield of more than 4%, indicating there could be a value opportunity in the short-term.

I reckon the company may not beat the market over the next decade or so, however, due to some other underlying issues in the business that could hamper performance.

A Competitive and Expensive Commodity

A lot of the services offered by BT are becoming commoditised, meaning there are often offerings of equal quality and value available to consumers elsewhere. A quick visit to moneysupermarket.com reveals a number of viable options for Internet or TV services. This intense competition is unlikely to dissipate in my view and could result in a “race to the bottom” on prices.

In recent years, BT has turned to buying sports TV rights to gain an advantage over competitors like Sky. BT paid a whopping £960m for three years of Premier League TV rights, which equates to around £7.6m per game, and another £897m for exclusive Champions League and Europa League rights. There is no guarantee that BT will win the next bidding war, which could see the appeal of their broadband and TV offerings significantly reduce for a number of customers.

On top of that, another one of BT’s key competitive advantages is currently facing some uncertainty. Openreach, which is a part of BT Group, develops and maintains the countries main telecoms network, which is used by providers like Sky, TalkTalk and Vodafone. BT has been accused of running Openreach in a biased fashion, favouring its own operations.

Pension Payments and Cash Flow

Competitors want Openreach to be spun-off into a completely separate entity. This looks pretty unlikely, but Openreach is the company’s biggest source of cash-flow and any complications here could put pressure on the payments to cover its £10bn pension deficit. BT also faces accusations of under-investing in our country’s infrastructure. Only 2% of premises have access to fast fibre connections — the remainder are stuck on old-fashioned copper connections.

It seems likely that Openreach will be forced to increase capital expenditure above and beyond the £6bn planned over the next three years. This, combined with the aforementioned £530m write-off, potentially increased pension payments, and increasing competition, could place pressure on free-cash-flow and thus the dividend.

There’s also a significant debt-pile alongside the pension deficit for the company to worry about. If cash-flow is seriously crimped by the above factors the company would have to either cut the dividend or take on more debt to pay it, which could dent its credit rating, thus increasing the costs of financing its £10.9bn net-debt pile.

BT is one of the world’s premier telecommunications companies and has an enviable competitive position in a number of its businesses. That said, there’s too much uncertainty hanging over the balance sheet and the sustainability of these advantages for me to consider buying the shares.

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