Thursday morning and the biggest FTSE 100 faller is BT Group:
The reason can be traced to a downgrade and report from Morgan Stanley, which suggests the UK’s pension regulator might propose a quicker deficit reduction scheme for the giant BT pension fund:
We are concerned that the Pensions Regulator could make a further statement on his “substantial concerns” this autumn. Though he has given no date for this, it is now over 7 months since this became public – long enough to expect an update, in our view. Were the Regulator to propose a quicker deficit reduction schedule of 10 years rather than 17 years, this would imply no spare FCF beyond pension top-ups and dividend – even though changes to the cash paid in by BT would likely need to wait until the next actuarial review in December 2011.
So far, so bearish.
But have traders and investors actually read the whole report? Probably not, because Morgan Stanley analyst Nick Delfas is actually quite positive on the pension deficit.
Regardless of what the pensions regulator says, Delfas reckons that by the time of BT’s next actuarial review, the deficit could look a whole lot better. Here’s why:
1 Assets. Assets have risen in value from £31bn in December 2008 to £33.9bn as at June 30, 2010. This £2.9bn benefit would not all flow to a reduced deficit, as the discount rate would be adjusted down. We estimate a ballpark £1bn improvement from asset prices.
2. Reduced benefits. In April 2009 BT agreed reduced benefits with its employees, including later retirement and average rather than final salary for future service. This was not included in the December 2008 actuarial review. We estimate this is worth £1bn.
3. CPI / RPI. In our September 2 note we estimated this could be worth around £3bn, though the difference between the two measures over time is uncertain. For the purposes of this analysis we reduce this by half to £1.5bn.
4. Crown Guarantee. A portion of the pension fund, still to be defined exactly in court, is covered by a government guarantee. This could potentially alter the deficit. In February BT wrote: “If the valuation had used a “median estimate” approach, BT estimate that the deficit would have been c.£3bn. The “median estimate” approach reflects how investments might on average be expected to perform over time and the expected impact of the pensions review changes implemented on 1 April 2009. This implies the funding valuation includes a margin for prudence of c.£6bn or 15% of the scheme liabilities.” This double counts the reduced benefits above, but again we allow half the remaining benefit, or £2.5bn.
Adding all that up gives a deficit reduction of £6bn, or a pre-tax deficit of £3bn, reckons Delfas. So, even if the pension regulator demands a shorter funding period, it’s unlikely that cash contributions will rise.
As such Delfas says he would be a buyer into any pensions-driven downdraft, which err, he seems to have helped fan.
How about that for a circular (commission-generating) argument.
Very neat.
Update: Sept 17, 10.42am (BST). We have probably been a bit harsh on Delfas with out jibe about circular arguments.
The other reason he “pressed pause” and cut his rating on BT is because of the looming Comprehensive Spending review.
A secondary concern is BT’s exposure to UK government contracts (government spending review October 20). We estimate an EBITDA drag of around £45m in FY12 and £60m in FY13 – manageable, but challenging both the recent upward trend in estimates and BT’s top line growth strategy for FY13.
Which is certainly reason to worry.