Changes in operating assets and liabilities:

[Spekulatius]

"The reality is that working capital is not predictable. We CAN model it based on past behaviour, but a predicted number +/- 20% is not particulary useful. For ratio purposes treat it as negative debt at money market rates, & common size the historic financials. Most of the working capital distortion will disappear."

 

Agree. Would only add that, in certain selected instances when the going concern assumption becomes a topic of discussion, the working capital distortion may reappear.

 

"Pension and postretirement benefit plan contributions. It's an indicator of a DB pension plan, is the sponsors contribution, & is based primarily upon payroll. To predict, you must know how the DB plan works, and how demographics affect these plans. About once every 10-20 years DB plans will become 'overfunded' relative to their obligations, and the 'overfunding' will be shared equitably amongst plan participants as contribution holidays, discounted service buybacks, etc."

 

Again agree mostly but my understanding is that sometimes (often?), firms may use the surplus as sort of cookie-jar reserve. The once invincible behemoth GE who used to be masters at financial engineering were reported to "fatten" earnings when certain numbers needed to be met. Let the good times roll.

 

If you like to think in terms 10-20 year time-spans, in the early 1980's, many corporate pension plans were overfunded (some by a lot). A relatively popular way to "share" was to terminate the overfunded plan and starting a new one, with the surplus being dstributed to...

https://fraser.stlouisfed.org/files/docs/publications/frbnyreview/rev_frbny_1984_v09n01.pdf

 

See section on pensions, p.19-27.

The first part is also interesting as the Federal Reserve candidly admits that there are still unresolved issues in monetary policy. :)

 

Just to link to what happens to an asset that becomes a liability (and then what?), GE is now facing some headwinds on how to "manage" a certain level of uncomfortable underfunding.

 

http://money.cnn.com/2018/01/18/investing/ge-pension-immelt-breakup/index.html

 

From the article:

2001:        14,6 billion surplus

end 2008:  6,8 billion deficit

end 2016:  31,1 billion deficit

 

In the article, it is said that the massive shortfall should be discounted in a way as the problem, if there is one, may show up only in the distant future. Just in case though, they will borrow a few billion to contribute to the pension plan. It is hard to see scenarios where the future free cash flows will not be impacted.

 

Pensions are like debt, just worse, since the assumed returns are often lofty and most likely not achievable. It’s clear why - it is more convenient to kick the can down the road, than to deal with it right away. It also helps that analysts tend to ignore it and because they can’t model it well and the expenses are too lumpy to fit in their neat spreadsheet models.

 

Just look at GE and UPS or UPS. UPS has spent more on pensions during the few years than on buybacks and dividends. GE does not even have the money to fix their pensions right now.

[Uccmal]

Awesome thread.  Thankyou all for your thoughts.  It gave me lots to think about.

[SharperDingaan]

"The reality is that working capital is not predictable. We CAN model it based on past behaviour, but a predicted number +/- 20% is not particulary useful. For ratio purposes treat it as negative debt at money market rates, & common size the historic financials. Most of the working capital distortion will disappear."

 

Agree. Would only add that, in certain selected instances when the going concern assumption becomes a topic of discussion, the working capital distortion may reappear.

 

"Pension and postretirement benefit plan contributions. It's an indicator of a DB pension plan, is the sponsors contribution, & is based primarily upon payroll. To predict, you must know how the DB plan works, and how demographics affect these plans. About once every 10-20 years DB plans will become 'overfunded' relative to their obligations, and the 'overfunding' will be shared equitably amongst plan participants as contribution holidays, discounted service buybacks, etc."

 

Again agree mostly but my understanding is that sometimes (often?), firms may use the surplus as sort of cookie-jar reserve. The once invincible behemoth GE who used to be masters at financial engineering were reported to "fatten" earnings when certain numbers needed to be met. Let the good times roll.

 

If you like to think in terms 10-20 year time-spans, in the early 1980's, many corporate pension plans were overfunded (some by a lot). A relatively popular way to "share" was to terminate the overfunded plan and starting a new one, with the surplus being dstributed to...

https://fraser.stlouisfed.org/files/docs/publications/frbnyreview/rev_frbny_1984_v09n01.pdf

 

See section on pensions, p.19-27.

The first part is also interesting as the Federal Reserve candidly admits that there are still unresolved issues in monetary policy. :)

 

Just to link to what happens to an asset that becomes a liability (and then what?), GE is now facing some headwinds on how to "manage" a certain level of uncomfortable underfunding.

 

http://money.cnn.com/2018/01/18/investing/ge-pension-immelt-breakup/index.html

 

From the article:

2001:        14,6 billion surplus

end 2008:  6,8 billion deficit

end 2016:  31,1 billion deficit

 

In the article, it is said that the massive shortfall should be discounted in a way as the problem, if there is one, may show up only in the distant future. Just in case though, they will borrow a few billion to contribute to the pension plan. It is hard to see scenarios where the future free cash flows will not be impacted.

 

Pensions are like debt, just worse, since the assumed returns are often lofty and most likely not achievable. It’s clear why - it is more convenient to kick the can down the road, than to deal with it right away. It also helps that analysts teend to ignore it and because they can’t model it well and the expenses are too lump to fit in their neat spreadsheet models.

 

Just look at GE and UPS or UPS. UPS has spent more on pensions during the few years than on buybacks and dividends. GE does not even have the money to fix their pensions right now.

 

You might want to rethink this statement.

 

PVBO is determined by the discount rate and the length of the benefit obligation (BO). The DB pension is fully funded when the existing pension assets + assumed annual return + sponsor/contributor contribution = PVBO. The sponsor has incentive to push for high returns - to both lower the PVBO as much as possible, and the amount they will have to contribute this year. The contributor has incentive to 'go along' as it also reduces how much they will have to contribute this year.

 

The employer has incentive to hire the youngest workforce possible, and pay them as little as possible; to both maximize the length of the BO, and minimize the PVBO itself. To restore an 'underfunded' pension, a sponsor need simply fire everyone > 50, and outsource the work to somewhere else where the workforce is decades younger, and a lot cheaper. The PVBO drops like a brick, but the assets remain unchanged - problem fixed. Precisely what you see happening.

 

DB plans also go a long way to hiding management incompetence; it's convenient to blame the DB plan when earnings are less than expected, and easy to use the complexity to confuse investors. The reality is that they actualy LOWER the current wage bill by defering comp into the future, & structurally INFLATE earnings, to produce a higher share price. Why do you think the original management set them up? - it wasn't out of the goodness of their hearts.

 

Sponsors get into trouble because they offset the long term liability against a one year asset (existing plan assets + current contribution) WITHOUT CONSIDERING THE DURATION MISMATCH. And it's this duration mismatch that causes the wide swings as interest rates and economic conditions (driven by interest rate) change.

 

SD

 

 

 

 

 

[Spekulatius]

Firing anybody above 50 is not  possible in a Union outfit nor anywhere else for that  matter. the fired worker also still would have the pension claim, he would just stop accumulating new ones.

 

Stopping elganility for a pension plan doesn’t do much either. If a a 30 year old worker in a pension plan, I can still accumulate claims for my entire work forthright next 35 years and then can get claims payed out for the rest of his life, it could be 60 years from now hen the buck stops, after they closed the plan for new employees.

[SharperDingaan]

Firing anybody above 50 is not  possible in a Union outfit nor anywhere else for that  matter. the fired worker also still would have the pension claim, he would just stop accumulating new ones.

 

Stopping elganility for a pension plan doesn’t do much either. If a a 30 year old worker in a pension plan, I can still accumulate claims for my entire work forthright next 35 years and then can get claims payed out for the rest of his life, it could be 60 years from now hen the buck stops, after they closed the plan for new employees.

 

You just fire the old and pay the severance. The worker cannot collect pension untll they turn 65, and they stop accruing benefits at the highest possible costs for a good 10-15 years. Its a staight forward NPV calculation, that sadly just equates people as 'costs'.

 

A eligible 30 year old wil not collect until 65; 35 years of discounting reduces the NPV of that BO to low cents in the dollar. The worker will also not go to 65 as you'll fire him/her at 55 (25 years from today - if they haven't moved on themselves before then)

 

A union environment also cannot prevent you from firing - they can only make you pay for it.

If the NPV isn't positive you aren't going to initiate firing the old early.

 

Agreed it's brutal mathematics, but this is part of what we pay managers to do.

Maximize EPS to drive the share price as high as possible.

 

SD