Hi DJ, <<subsidies>> no need to worry about the big picture when there is still so much to worry about the fine prints ...
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GM's Pension Fund Keeps on Sputtering
By Odette Galli
Columnist ? thestreet.com
10/15/2002 05:17 PM EDT
It seems that General Motors wasn't kidding around when it labeled its latest round of incentives "Overdrive." With zero-percent financing and zero down until 2003 on most 2002 and 2003 models, how could it get any better?
That's the problem: It probably can't. As a result, this year's overdrive will likely produce next year's breakdown. Anyone who listened to the third-quarter conference call looking for clarity on next year's outlook would have come away disappointed. If anything, the call raised more questions, not only about industry sales for next year, but also about the
status of GM's hugely underfunded pension liability. After today's bounce, this stock looks like dead money at best for a while. It jumped $3.44, or 10%, to close at $36.70 Tuesday.
A Look at the Numbers
The news on the pension fund was particularly grim. GM ended last year with an underfunded pension liability of $9 billion. At midyear, the return on pension-fund assets was a negative 3%. At that time, the company assumed that a zero-percent return on its assets for full-year 2002 was a reasonable forecast. Accordingly, GM expected to end this year with an underfunded liability of $12.7 billion and to incur, after taxes, about $500 million, or 90 cents a share, in higher pension expenses in 2003 compared to 2002. On the second-quarter conference call, CFO John Devine said, "Any increase in pension expense next year is expected to be offset by other structural cost reductions."
But now GM's not so sure. Through the end of the third quarter, the return on its plan assets plummeted to a negative 10%, still better than the market averages overall, but a dismal performance in the context of the plan's assumed long-term return of positive 10%. Clearly, GM's assumptions need some adjustments: both the discount rate used to compute the net present value of future pension obligations, as well as the sustainable return on the plan's assets. Assuming no change in either, and assuming that the plan ends this year with a negative 10% return, Devine now says next year's pension expense could rise by $1 billion after tax, or more like $1.80 per share.
As a result, he's changed his tune dramatically on what kind of impact that will have on the bottom line. "It is unlikely that GM North American operations will be able to offset the increase in 2003 pension expense in other areas of structural cost," Devine concluded. But that $1 billion impact will likely be even higher, considering that every 1% change in the return on plan assets translates into an earnings impact of about 85 to 90 cents per share.
A Perfect Storm?
That's not the half of it. Poor returns on plan assets, combined with lower bond yields (which lower the discount rate used to compute the net present value of future pension obligations, causing it to rise), both conspired to produce what will likely be a hugely underfunded pension liability by the end of this year. Assuming the plan ends this year with a negative 10% return, and the discount rate used is the prevailing AA corporate bond yield of 6.75% (compared to 7.25% last year), the pension's underfunded status would mushroom to $23 billion, Devine said.
Every 100 basis-point decrease in the discount rate increases the pension obligation by $7 billion. That's more than GM's market capitalization of $19.6 billion and its shareholders' equity of $19 billion. Last year, GM took a $9.5 billion hit to shareholders' equity because of a deterioration in its funding status. A similar number could flow through this year as well.
This means GM will have an even bigger demand on its cash flow than previously expected. Here's one bleak scenario Devine provided on the call: If, after this year's negative 10% return, the pension plan assets earn a positive 10% return yearly in the following years, GM would still have to pony up $14 billion in cash contributions to the pension between 2004 and 2007 in order to avoid $200 million in penalties. But if the annual return assumptions are lowered to a more realistic 8%, the cash requirement rises to $17 billion. So even though GM is boasting about the $6 billion-plus in cash generated from the auto business this year, shareholders will likely see none of it.
In the meantime, the auto business is clearly not getting easier. GM's executives were loath to admit that the U.S. vehicle market is softening and that next year may not be as strong. But in its press release, the company clearly changed its tune from a quarter ago. For example, in the second-quarter's "looking ahead" section, GM said it saw U.S. vehicle sales in 2003 at the same level as 2002, or in the high 16 million-unit range. But the third-quarter release says that while 2002 could come in higher, at around 17 million units, 2003 would be lower, or in the mid- to high 16 million-unit range.
This is creating other serious hurdles. Pricing isn't getting any better. In fact, it worsened in the third quarter to negative 2.2%, vs. negative 1.5% in the first half of the year. The company wouldn't give pricing guidance for the fourth quarter or next year for "competitive reasons," but Devine said, "The run rate is a reasonable indicator of future expectations," adding, "we have been competitive and we will keep that up."
Sure, GM is having a great year in 2002. But it looks like it'll wake up with a mean hangover in 2003.
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