Pension Costs-It’s Real Money Which Impacts Stock Prices-Alcoa (AA)
Example: At the beginning of this year Alcoa (AA) transfered $600MM in stock to a master trust, which can later be sold, but will still be outstanding. This is stock (44.3 MM extra shares) which will reduce all financial measures-earnings per share, cash flow per share, return on invested capital…… And what’s more, Alcoa needs to place more cash into its still underfunded plans!
But Alcoa is not the only firm with such a need. There are many thousands like Alcoa, and at least 20 public firms have announced in-kind contributions over the past year, according to a search on EDGAR, the SEC database.
A couple of weeks ago there was a story of a U.K company which put whiskey futures into its pension plan to shore up funding. I would remind you this was not the first of its kind. Public firms have placed non-cash (in-kind) assets onto its plans for a long time—for instance, a number of years ago US Steel placed timberland into its plan and many firms have contributed stock of its publicly traded subsidiary companies. Years ago, some firms placed company stock into pension plans as a takeover defense. Is it possible Alcoa was doing the same?
Department of Labor approval is required for in-kind transactions in order to protect the interests of the participants.
It’s all part of cash flow analysis. Why? Because when firms understate their pension contribution, as Alcoa has been doing, they are overstating their cash flows. Stock contributions could also aid prospective free cash flows as the contribution is a tax-deductible expense and, by preserving cash, could be a value-enhancing and accretive transaction. For firms operating at a loss, the tax-deduction, if a loss-carryover credit remains, could be entitled to an additional refund.
Stay tuned! Alcoa had negative free cash flow during its first fiscal quarter and was only able to show positive cash flow from operating activities for its last fiscal year from “working” its balance sheet. On the positive side, they have been aggressive at reducing its corporate and downline overhead. They used derivatives and swaps, but as hedges. Also, their cost of sales was somewhat artificially bloated last year due to a halt to a tax benefit in Italy. Alcoa still has a ways to go in streamlining, which will aid free cash flow, as its growth rate in key areas is still high in relation to its growth in cash flows, as normalized and adjusted. Alcoa can easily free up several hundred million dollars in free cash flow from additional expense cutting, according to the proprietary data of our firm CT Capital LLC.
If you’d like to learn more about cash flow and risk: Pre-order “Security Valuation and Risk Analysis” McGraw-Hill, on Amazon or other online book stores.
