Pension Hole Deepening in Europe Adds Pressure to Bruised Stocksby
Germany among European countries with largest pension assets
Issues started to bite at Lufthansa, E.ON, Commerzbank
Mario Draghi’s efforts to stimulate Europe’s economy is claiming unintended victims: companies with ballooning pension deficits.
Record-low interest rates propagated by the European Central Bank are making it harder for firms to fund the asset pools set up to provide for retired workers, potentially jeopardizing dividends and other spending. Investors have taken note. A Citigroup Inc. gauge of the companies with the biggest gaps is trailing the benchmark Stoxx Europe 600 Index by 14 percent since its inception at the start of 2014.
“It’s an enormous problem,” Alexander Altmann, a director at Citigroup’s equity-trading strategy unit, said by phone from New York. “Something’s got to give. The pensions need to be topped up, and that will inevitably eat into the companies’ cash flow, which can inhibit capital expenditure opportunities or shareholder returns.”
As Draghi’s asset-buying binge continues, firms have to set aside more money to ensure they’ll have enough to pay retired workers. Among those hit: Deutsche Lufthansa AG, which last month emphasized the need to reduce its pension liability. Falling bond yields can reduce future investment income and spur accountants to raise estimates of the value of payments to come.
The Citigroup index of European companies tracks 13 stocks with the largest pension liabilities and deficits as a percentage of market value. While the gauge started in 2014, Altmann said its members outperformed the Stoxx 600 in 2013, when bond yields rose. In 2015, as Draghi began his asset-buying program, the basket trailed the benchmark index by 11 percent.
In countries such as Germany, where 10-year bond yields turned negative this year, the deficits have already started to bite. In addition to Lufthansa, E.ON SE reported an increase in pension provisions, and its chief executive officer said in August he’s critical of ECB policy. Commerzbank AG posted a lower capital ratio in July, which the lender said reflects higher pension liabilities, among other things. The stocks are down more than 12 percent this year.
Germany is one of the European countries with the largest pension pool, and liabilities are a growing issue there, according to Norman Dreger, the head of Mercer’s multinational client group in central Europe. Through July this year, the funding ratio of assets to obligations for companies on the national benchmark DAX Index was on track to finish 2016 as the lowest in at least a decade, data from the consulting firm showed.
“As the liabilities increase, the company equity decreases and that has an unfavorable impact on certain key financial ratios,” Dreger said by phone from Frankfurt. “Equity analysts or rating agencies might have a less favorable view of the company, which would then potentially be reflected in the company’s cost of borrowing, valuation or stock price. It’s not something that can be ignored.”
Guillermo Hernandez Sampere, head of trading at MPPM EK in Eppstein, Germany, says he has recently been paying more attention to pension deficits when making stock picks. Jon Hatchett, head of corporate consulting at Hymans Robertson, says the firm’s clients have been getting more questions from investors about the state of their pension plans in the past few months.
“It’s definitely got more attention in our spreadsheet models,” Hernandez Sampere said. His firm oversees $260 million. “We didn’t ask very much about that during company meetings in the past, but now we do ask specifically if a company has a pension fund.”
In the U.K., which Mercer says is the European country with the most pension assets, the problem has already weighed on the share prices of companies with large retirement plans, including BT Group Plc and Tesco Plc. Carclo Plc, a maker of plastic components for technical and consumer products, said it’s unlikely to pay a planned dividend next month, projecting a “significant increase” in its pension deficit unless corporate bond yields recover by the end of September.
Greater risks from uncovered pension liabilities require supervisory attention where profitability and capital levels are in jeopardy, the Joint Committee of the European Supervisory Authorities said in a Sept. 7 release. The report showed that defined-benefit pension plans across the European Union were on average only 75 percent covered by assets at the end of 2014. According to Bloomberg Intelligence, many schemes will likely have deteriorated since then.
“There is more than circumstantial evidence that this is becoming an issue with a series of companies in Europe,” according to Citigroup’s Altmann. “Their propensity to grow the dividend will be somewhat limited, and they’ll struggle to generate surplus cash, both of which have been favored strategies among investors in recent years.”