Europe Special report

20 April 2009

SRI an0 gle

Pension funds
What’s the risk that companies use cash to shore up their pension funds?
Markets underestimate the extra funding needs for companies’ pension obligations. This should put further pressure on indebted companies and particularly on those largely invested in equities. We expect a negative impact on British Airways and BT Group.

Claudia Panseri (33) 1 58 98 53 35

Sarbjit Nahal (33) 1 58 98 12 55

and SG’s analysts

Tristan Paviot


Pension funds


20 April 2009

Pension funds

3 4 7 9 10 11 14 15 17 18 19 23 23 25 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 What’s the risk that companies use cash to shore up their pension funds? The implications of the financial crisis for pensions Different pension scheme concepts explained Discounting future liabilities Pension discount rate components Plan assets – companies with high exposure to equities Change in discounting rate: companies at risk Financial market declines: companies at risk Companies with large pension deficit vs market cap Companies with large pension deficit vs Enterprise Value Sensitivity of pension deficit to market variables Pension Deficits/Ageing Workforce From baby boom to ageing workforce Sectors with ageing workforces Company Profiles Akzo Nobel Nv Alcatel-Lucent BAE Systems Bayer Ag British Airways BT Group Daimler Deutsche Lufthansa Deutsche Post AG GKN Invensys Meggitt Michelin Peugeot Citroen PSA ThyssenKrupp Valeo Appendices – Definitions

20 April 2009

Pe nsio n funds

20 April 2009


Pension funds

What’s the risk that companies use cash to shore up their pension funds?
In line with our previous debt-linked reports “Capital raising: who is at risk?” published on 22 December 2008 and “2009: year of shareholder dilution?” published on 5 February, this report focuses on another factor that we believe should be treated as a debt (or financial assets): the pension deficit. SG analysts have already published some notes on the subject (British Airways, BT group, Alcatel-Lucent), however, we now apply our approach to the entire SG coverage universe. In this note we discuss a number of issues relating to pensions deficits (or surpluses) considering the current difficult environment for asset performance and the likely fall in the discount rate for pension liabilities. With the publication of annual reports, many companies have communicated on their pension deficit figures. Although the value of pension assets has generally fallen substantially, in many cases the value of pension liabilities has fallen too, due to higher discount rates last year (widening spreads) and a lower inflation rate. However, the macro picture is worrying, particularly in the US and in the UK where the number of companies reporting rising pension deficits is increasing and where pension fund assets exceed 100% of national income.
Estimated deficit for UK pension schemes (£bn)
150 100 50 0 Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09 -50 -100 -150 -200 -250 -300
Source: PPF, The Pensions Regulator

Some companies have warned that pensions will have an adverse effect on 2009 earnings or require additional contributions. The companies most exposed are those largely invested in equities and with large pension schemes. Unless the equity markets rebound significantly
during 2009, pension funds will remain significantly under funded, which will result in high contribution requirements in 2010e and 2011e, in our view. All of the companies with larger

schemes are at risk of increased contributions being needed.
Main risks for defined benefit plans
Liabilities-related risks Assets-related risks

Fall in corporate bond spreads (fall in discount rate) Increase in life expectancy Hikes in salaries and health care costs Higher inflation rate
Source: SG Cross Asset Research

Negative performance of financial markets Rise in volatility of assets


20 April 2009

Pension funds

Assuming that government action will restore confidence, corporate bonds spreads should fall leading to a decline in the discount rates for pension liabilities, and thus wider deficits. Companies with large gross liabilities clearly face greater risks than their peers, and we would expect the share prices of the former to be more volatile. As suggested by IAS 19, pension liabilities are discounted using high quality corporate bond yields, of appropriate currency and duration.
Stock conclusions In SG’s coverage universe, few companies are likely to disappoint the market in the first quarter of the year, on our estimates. British Airways and BT Group are the most at risk. Negative surprises may come from BAE Systems, ThyssenKrupp and Akzo Nobel. There should also be some pleasant surprises: Alcatel-Lucent will switch from a deficit to surplus thanks to the rise in the discount rate. Risk of using cash to shore up pension deficits (3 High risk; 1 Low risk)
Pension liabilities risk Asset plans risk Pension deficit risk Global Risk (sum of the previous columns)

British Airways BT Group BAE Systems ThyssenKrupp Akzo Nobel Continental Michelin Deutsche Lufthansa GKN Meggitt Peugeot Daimler Deutsche Post Invensys Valeo Alcatel-Lucent Bayer BMW
Source: SG Cross Asset Research

3 3 3 3 2 2 2 1 1 1 1 1 1 1 1 1 1 1

3 3 3 2 3 2 2 3 2 2 2 2 2 1 1 1 1 1

3 3 2 2 2 1 1 1 1 1 1 1 1 1 1 1 1 1

9 9 8 7 7 5 5 5 4 4 4 4 4 3 3 3 3 3

20 April 2009


the higher volatility of returns on equities versus bonds largely penalised those funds with a bias towards equities. We decided to publish this note to highlight the controversial position of the private pension system and the rising possibility that policymakers may take advantage of current turmoil to shrink private components of the pension system. Global pensions assets ($ trillion) 35 30 25 20 15 10 5 0 2001 2002 2003 2004 2005 2006 2007 2008 est.3trillion in the United States alone. Australia and Japan. Such opportunistic messages should be countered with a long-term outlook. and the Netherlands. IFSL estimates Last year. often with a large proportion invested in bonds which carry yields that are lower but more stable than those of equities. at least temporarily. the purchase of annuities at retirement is not mandatory.Pension funds The implications of the financial crisis for pensions Over the last few months. Pension funds have benefited from having diversified investment portfolios. investors have started to worry about pensions.4 trillion at end-2007. But. we will focus on both asset depreciation due to the financial crises and increases in asset liabilities due to the age pyramid thanks to the contribution of our SRI Equity Research team. based on independent financial projections for both the public and private systems. each with 3%. Global pension environment faces higher asset volatility Detailed figures for global pension assets were published by the OECD in December 2008. in the defined contribution systems of Australia and the United States. followed by the UK with 11% of assets. These losses are smaller than the decline in equity values. which accounts for 64% of assets. Canada 5%. 4 20 April 2009 . The total value of pension assets managed globally rose by 10% to $30. As a consequence. Even if these people maintain their savings in equities in the expectation of a recovery. Source: OECD. In this report. The situation is different in other countries. retirement income will be lower. investors are now worried that the sharp decline in equity values may cause some pension surpluses from 2008 to move into deficit this year or send those in negative territory deeper into deficit. Investment losses on all OECD private pension plans (including individual retirement accounts and pension insurance contracts) are estimated at $5trillion. IMF. The global market is dominated by the US. with $3. For example. Some governments may also point to the temporary weakness of private pensions to justify delaying necessary reforms of the public pension system. but then fell by some 18% to $25 trillion at end-2008. the default investment option for older workers may often have as much as 50 to 60% of assets invested in equities.

the major risk this year may occur if spreads narrow ahead of any significant recovery in equity markets. and for around 19%in the UK. the financial position of pension funds would deteriorate and further capital injections may be required. Therefore. Canada and the Netherlands. France and Italy. in that case.9 billion.7bn at end-February 2009. The credit crunch has resulted in falling equity markets and sent interest rates lower. we obtained some figures showing that many developed countries have extensive funding pension arrangements. pension fund assets exceeded 100% of national income in Denmark. Australia. with the largest deficit at £109.9bn in June 2007. In the last update of the IFSL (International Financial Services London) report. 20 April 2009 5 . The aggregate funding position is estimated to have worsened over the month to a deficit of £242. the UK. fears are linked to the belief that companies may use cash to shore up their pension funds in the event of spread tightening during 2009 and at the same time further negative performance of equities. Pension assets as % of national income 180 160 140 120 100 80 60 40 20 0 Germany New Zealand Hong Kong Russian Fed South Africa Netherlands Switzerland Denmark Norway Mexico Sweden UK France Portugal Canada Japan Korea Israel Italy Poland Ireland Spain Brazil Australia Chile Finland US Source: IFSL estimates based on OECD and World Bank data The number of UK under-funded schemes is increasing Calculations made by the Pension Protection Fund show how changes in market conditions since last year have caused considerable variations in aggregate funding positions of pension schemes. Sweden and Ireland. the US. the Netherlands.2bn in February 2003 and the greatest surplus at £148. the UK. from a deficit of £204.Pension funds Although a decrease in estimated liabilities as a result of rising corporate bond yields (AA corporate bonds are set as the benchmark in IAS19 accounting regulations for discounting the net present value of future liabilities) has partially offsetted the decline in assets. so that the deficit by end-October 2008 had widened to £80. Pension insurance policies and personal pensions are also an important source of provisions: accounting for the majority of pension assets in Denmark and Sweden. Assets between 50% and 100% of GDP have been accumulated in Finland. At end-2007. Assets in retirement products other than pension funds and pension insurance make up 42% f assets in Canada and 35% in the US. While autonomous pension funds remain the primary focus of investment in the US. The aggregate funding position varied significantly. Chile. Canada and Switzerland.0bn at end-March 2009. they remain scarce in other large western European countries: Germany.

Canada recently decided to give pension funds and their sponsoring employers more time to allow funding levels to return to their targets levels in order to avoid putting further strain on employers when the general economic situation is deteriorating. 6 20 April 2009 . for example. Employers may then have to make up the shortfall caused by lower asset values.000 6. Policymakers seek to protect pension fund participants by setting funding levels sufficiently high. The Pensions Regulator Companies have to cover the shortfall in asset values To keep up with their pension funding requirements after disappointing investment returns. from 2.000 4. A lowering in the funding level targets is less likely as this would weaken benefit security over the long term.500 5. In Switzerland. which is the original cost minus depreciation). many companies may be forced to increase their contributions to pension funds which were already quite high as a result of recovery plans implemented after the 2000 stock market declines.500 6. Pension funds in Ireland and the Netherlands have been given more time to prepare their recovery plans also. On the other hand.000 3. Questions are also being raised about the suitability of mark-to-market valuations for pension funds (an accounting practice that values assets and liabilities at current market prices rather than their book value.75% in 2008 to 2% in 2009.000 5. The Pensions Regulator Source: PPF.500 4.Pension funds Pension deficit in UK schemes (£bn) 150 100 50 0 -50 -100 -150 -200 -250 -300 03 04 05 06 07 08 09 Estimated number of schemes in deficit 7. the government is considering a reduction in the minimum return that pension funds must guarantee. there could be much debate on the suitability of statutory investment performance requirements on pension funds and the valuation standards for assets and liabilities.500 3.000 03 04 05 06 07 08 09 Source: PPF.

Pension plans. − Funded pension plans accumulate dedicated assets to cover the plan’s liabilities.Employee Benefits on the amount of the surplus that can be recognised as an asset. fiscal and economic conditions of each country in which the company operates. Defined contribution plans. The Consolidated Balance Sheets include the following significant components related to pension plans: 20 April 2009 7 . Prudently the company makes discretionary contributions in addition to the funding requirements. either directly or by contributing to independently administered funds (private pension plans). Minimum funding requirements On 5 July 2007 IFRIC issued the interpretation IFRIC 14 – IAS 19 – The Limit on a Defined Benefit Asset. no assets are set aside. It also explains how the pension asset or liability may be affected when there is a statutory or contractual minimum funding requirement in the Consolidated Financial Statement. or they may be wholly or partly funded by contributions by an entity. or fund. Most OECD countries do not allow unfunded private pension plans. the company has no further payment obligations. Post-employment benefits are provided under defined contribution and/or defined benefit plans. and sometimes by its employees. Health care plans and Other. If the unfunded pension fund plans present a surplus compared to the requirements of law. Once the contributions have been paid. contractual or voluntary basis. the companies concerned may not be required to contribute to the plan in respect of the minimum performance requirement as long as the fund is in surplus. Minimum Funding Requirements and their Interaction effective retrospectively from 1 January 2008. Unfunded pension plans are said to be paid on a current disbursement method (also known as the Pay-As-You-Go method). with benefits paid directly from current workers' contributions and taxes. The plans are classified by the company on the basis of the type of benefit provided as follows: Reserve for employee severance indemnity. Benefits are generally payable under these plans after the completion of employment. The interpretation provides general guidance on how to assess the limit in IAS 19 . Unfunded plans may still have associated reserves to cover immediate expenses or smooth contributions within given time periods. that is legally separate from the employer and from which the employee benefits are paid. The way these benefits are provided varies according to the legal. the benefits generally being based on the employees’ remuneration and years of service. Defined benefit plans may be unfunded. Under these plans a contribution is generally made to a separate fund (trust) which independently administers the plan assets. into an entity. the company pays contributions to publicly or privately administered pension insurance plans on a mandatory. All the details are usually reported in the Company Annual Report in the Notes to Consolidated Financial Statements. − Unfunded pension funds plans are financed directly from contributions from the plan sponsor or provider and/or the plan participant. Pension arrangements provided by the state in most countries in the world are unfunded. The company’s funding policy is to contribute amounts to the plan equal to the amounts required to satisfy the minimum funding requirements prescribed by the laws and regulations of each individual country.Pension funds Different pension scheme concepts explained Some companies provide post-employment benefits for their active employees and for retirees.

These valuations incorporate both financial assumptions (discount rate. This sets out requirements on the calculation of pension liabilities. In the event that the sponsor company does not make payments.460) (70) (2.194 22. retirement age and life expectancy.361 99 (1. However. In 2003 the Pensions Directive EU (2003) was enacted. former employees with vested rights and of retirees and their surviving dependents with consideration of future compensation and pension increases. The European Directive requires appropriate assets to cover provisions for pension schemes meaning that large deficits will translate into cash payments. 8 20 April 2009 . The effects of differences between previous actuarial assumptions and what has actually occurred (experience adjustments) and the effect of changes in actuarial assumptions (assumption adjustments) give rise to actuarial gains and losses. 654 (2. Deficit treatment European law provides protection to the beneficiaries of company sponsored defined benefit schemes.530) 50 (2. the Pensions Act 2005 effectively gives Trustees the power to impose higher contributions. for example. actuarial gains and losses on post-employment benefits are taken directly to equity in the year in which they arise.142 4. and the funding of those liabilities. or trustees and the sponsor cannot agree on a contribution schedule. including rates of employee turnover.361m is the amount recognised in the Consolidated Balance Sheet under the line ‘pension plans and similar commitments’ *Principal pension benefit plans (1) The surplus (deficit) of the defined benefit obligations (DBO) relative to the plan assets as of the balance sheet date.Pension funds Accounting for defined benefit plans – the case of Siemens €m September 2008 Principal pension benefit plans (1) Principal other post-employment benefits plans (2) Other (3) Liabilities for pension plans (1)+(2)+(3) Prepaid costs for post-employment benefits Actuarial (losses)/gains (4) Income Tax effect (5) Net amount recognised in the Consolidated Statements of Income Source: SG Equity Research 2.591) (16) (1. the fair value of plan assets in funds allocated to finance such benefits. The calculation of this provision is based on valuations performed by independent actuaries using the projected unit credit method and final salaries.607) €4. The DBO is calculated based on the projected unit credit method and reflects the net present value as of the balance sheet date of the accumulated pension entitlements of active employees. €m September Fair value of plan assets (1) Total defined benefit obligations (funded + unfunded) (2) Surplus/(Deficit) = (1) + (2) Unrecognized past service cost Net amount recognized Pension Asset Pension Liability Source: SG Equity Research 20. In the UK.580* 639 1. where appropriate. there is recourse to the pensions regulator which can direct the company to make payments to eliminate the deficit. expected rate of return on plan assets.580) The provision for pensions and other employee benefits (including long-term benefits) is equal to the present value of the company’s future benefit obligation less. and increases in salaries and medical costs) and demographic assumptions. Actuarial gains and losses arising on long-term benefits payable during employment are recognized in full in the income statement for the financial year in which they were incurred.

this has left corporate pension plans with funding gaps as large as or larger than the market capitalisation of the plan sponsor. iBoxx AA bond yield (%) 7. However. Datastream The risk arising from pension obligations does not produce immediate cash costs. which allows us to estimate the impact of asset volatility. salary increases. bond yields among other things. The funded status of a defined-benefit pension plan represents the value of the plan's assets less the projected benefit obligations. the company needs cash. There are two forms of defined-benefit obligations: funded and unfunded. Funds are required to disclose how they are invested (% in equities.5 7 6.5 5 4. For companies that have funded defined-benefit plans. negative returns on assets have been offset by lower present values of liabilities. Negative equity market returns have eroded plan assets at the same time as declining interest rates have increased the market-to-market value of benefit obligations and contributions.5 4 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 MSCI European index (rebased to 100) 114 104 94 84 74 64 54 44 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 Source: SG Cross Asset Research. requiring actuaries to estimate the value by analysing the retiree population. Some investors are not concerned as they mention that the liabilities durations is long. Companies with unfunded obligations. When the funds become underfunded. bonds etc).Pension funds Discounting future liabilities Recent difficulties have drawn attention to the risk management practices of institutional investors in general and defined benefit pension plans in particular. This last part makes it difficult to see the real value of a pension fund at a given moment. a company can decrease its future obligations by increasing its discount rate or lowering the salary increase assumptions. have not set assets aside to fund the future pension payments. While the first part is simple to value. Adverse market conditions over the past two years have negative impacted many corporate defined benefit pension plans. As IAS 19 requires that future pension payments are discounted back to the present day using discount rates based on the yields available on ‘high-quality’ corporate bonds (and corporate bond yields went higher in 2008). to discount the future benefit streams back to a present value. the second is more complicated. mainly in Germany and Italy. Of great importance are the assumptions used for the fair value of invested assets and the present value of the future obligations. a pension obligation is a form of long debt financing. In extreme cases. the burden of the pension obligation is mitigated by having pension assets to pay out the pension payments. This unfunded nature of the pension obligation explains why German companies have high pension deficits as a percentage of market capitalisation. given that it relates to payments to be made in the future. For example. we believe that the problem is real and that regulators are investing a lot of time to 20 April 2009 9 . However.5 6 5.

in the UK. The two main components have moved in different directions. which provides additional protection. Falling credit spreads for a given 5 200 150 level of Treasury yields will cause pension 4 100 liabilities to increase. As a result. Pension discount rate components To calculate their pension liabilities many plan sponsors use the AA-rated yield curve which is calculated by adding the spreads of AA-rated corporate bonds at several maturity points to the Treasury curve. The impact of interest rate changes can be hedged with bonds and/or derivatives but there is also a lack of liquidity that could potentially make hedging more difficult. AA credit spreads are very high and could fall as the economy starts Liabilities discount rate’s components 400 350 300 250 6 AA-corporate bond spread 30y Treasury yield (rhs) 8 7 recovering. 10 20 April 2009 . Many companies in this situation have BBB ratings and could be downgraded to junk status. This pension discount rate index can be broken down into its two main components: the 30-year Treasury yield and a credit spread. almost offsetting each other.Pension funds find a better ALM system. Datastream (International Accounting Standard) rules for the timing of contributions. All of the companies with larger schemes are at risk of having to increase contributions. the pension fund is seen as a creditor like others and has to ask for increased cash contributions in the event of widening deficits. This could cause credit rating agencies to downgrade companies with material underfunded pension plans. required 3 50 pension contributions could be very high in 2 0 99 00 01 02 03 04 05 06 07 08 09 both 2010e and 2011e based on IAS Source: SG Cross Asset Research. For example. However. While 30-year Treasury yields could still fall from now until year-end despite their current low levels. some schemes benefit from special status.

while the US also saw a decrease in bonds from 34% to 30%. from 15% to 30%. Of course. private equity and derivatives. while schemes in the Netherlands also increased holdings from 40% to 43%. following a fall in the share of domestic equities in pension portfolios. Net pension liabilities as a % of mkt cap 60% 173% 50% 40% 30% 20% 10% 0% Emerson Tomkins Alstom Invensys Areva SKF Siemens Tognum Nexans GKN Rockwell Legrand Sandvik Atlas Copco Assa Abloy Vallourec Schneider -10% -6% Philips ABB 4% 5% 5% 2% 2% 2% 3% 3% 8% 8% 20% 14%15% 10%12% 46% Fair value of plan assets as a % of mkt cap 200% 180% 160% 140% 32% 417% 339% 158% 120% 100% 80% 78% 50%54% 60% 38% 29%29% 40% 20%20% 12%18% 20% 0% 3% 3% 7% 9% 9% 0% Alstom SKF Tognum Areva Emerson Siemens Tomkins Legrand Nexans Philips Vallourec Schneider Atlas Copco Assa Abloy Rockwell Invensys Sandvik ABB GKN Source: SG Equity Research (Capital Goods Team) Source: SG Equity Research (Capital Goods Team) 20 April 2009 11 . despite Sandvik’s extensive exposure to equities we are not concerned about its pension deficit as it represents no more than 5% of market capitalisation. compared to a 7% allocation to both cash and real estate in the UK. those companies largerly exposed to equities and with significant pension scheme could suffer. This is particularly true since the beginning of the year as stability of corporate bond spreads is no longer acting as a support to offset the falling value of (equity) assets. we highlight those companies largerly invested in equities (more than 50% of the global allocation) and therefore more exposed to declines in the value of the assets. while the equity allocation remained stable in the US. Below. real estate and other investments varied between the five countries. In contrast. the global size of the pension liabilities versus market cap or versus the entreprise value remains key. On the other hand. Figures showing the allocation of assets to cash. SG Capital Goods analysts calculate that another 10% decline in the value of plan assets would reduce the equity value of GKN by 29%. Equity allocations dropped in the UK from 67% in 2003 on average to 56% in 2007. Bond allocations fell sharply in Japan from 45% to 32%. with Australia holding around 25% in other investments. including 10% in both cash and real estate. initially.Pension funds Plan assets – companies with high exposure to equities Taking a look at the allocation between asset classes helps. although investment by Australian schemes remained stable at 21%. GKN has lower exposure to equities than Sandvik but the risk borne by the company is higher as pension liabilities represent about 170% of the market capitalisation. Australia and the Netherlands but increased from 44% to 51% in Japan over the same four-year period. As we mention above. while Japan has 12% in assets such as hedge funds. This is why. in assessing the risk exposure of companies with high levels of investment in stock markets and then the impact that declines in equity values may have on the pension deficit/surplus. primarily as a result of reductions in domestic bond holdings. investment in bonds doubled in the UK over 2003-2007.

Pension funds Pension asset allocation – companies with equity exposure above 50% Year end date Bonds (%) Equities (%) Property (%) Other (%) Expected LT Return Rate On Pension Assets (%) Pirelli Gazprom Delhaize Lindt & Sprüngli Norbert Dentressangle Aegis Group plc Centrica Ryanair Safran BP Vodafone Home Retail Group Groupe Eurotunnel Aegon Signet Jewelers Limited Software AG BG Group Emerson Valeo Rio Tinto Anheuser-Busch InBev Liberty International DSG International AXA Delachaux Bic Fiat British Land Co Diageo Reckitt Benckiser Belgacom Tomkins Publicis Groupe Cobham Whitbread IMI A.0 33.0 39.1 6.0 53.0 7.5 54.0 60.6 3.2 79.0 27.0 30.7 na 18.4 21.0 4.0 7.0 7.8 54.2 29.0 27.0 5.0 51.0 28.2 6.0 39.0 na na na 3.6 4.0 30.7 na 7.5 15.4 6.8 4.9 5.0 19.2 6.6 1.0 22.0 0.1 52.8 9.5 2.8 na 6.6 9.9 53.5 57.1 3.0 24.9 41.8 5.6 40.0 15.4 40.2 7.0 7.2 5.2 7.6 5.4 4.0 43.0 4.0 11.7 na 2.4 63.9 na 6.0 4.0 10.0 64. Moller-Maersk B SAP STMicroelectronics Tesco Wm Morrison Meggitt Lloyds Banking Group Debenhams CRH Atos Origin Unilever NV Christian Dior KBC Legal & General Land Securities 31/12/2008 31/12/2007 31/12/2008 31/12/2008 31/12/2007 31/12/2008 31/12/2008 31/03/2008 31/12/2007 31/12/2008 31/03/2008 01/03/2008 31/12/2007 31/12/2008 02/02/2008 31/12/2008 31/12/2008 30/09/2008 31/12/2008 31/12/2007 31/12/2008 31/12/2008 03/05/2008 31/12/2008 31/12/2007 31/12/2008 31/12/2007 31/03/2008 30/06/2008 31/12/2008 31/12/2008 03/01/2009 31/12/2008 31/12/2008 28/02/2008 31/12/2008 31/12/2007 31/12/2008 31/12/2008 23/02/2008 01/02/2009 31/12/2008 31/12/2008 30/08/2008 31/12/2008 31/12/2007 31/12/2008 31/12/2007 31/12/2007 31/12/2007 31/03/2008 15.0 77.5 6.4 59.0 1.0 6.5 70.0 5.5 6.1 22.0 31.0 7.9 na 9.0 4.5 29.0 50.0 27.0 9.7 68.9 22.0 54.4 33.8 6.0 na 10.9 38.9 18.5 10.9 3.0 63.1 Source: FactSet and Company releases (Annual reports published in March 2009) 12 20 April 2009 .0 68.5 7.1 7.7 31.9 10.5 6.0 56.6 54.0 na na na na 7.4 na na na 9.0 2.7 6.0 4.0 59.0 23.8 52.3 3.0 2.0 5.0 52.8 6.0 2.0 59.8 7.0 1.0 6.2 8.0 6.2 2.4 4.0 8.8 75.0 9.0 33.7 54.5 1.7 4.0 22.5 1.0 62.1 5.0 4.0 55.0 na na 1.0 na na 1.6 73.0 4.7 72.2 3.0 39.7 44.2 60.0 39.2 4.1 2.3 na na na 5.0 53.8 4.3 7.1 30.0 5.4 2.6 51.5 2.6 41.1 48.2 22.5 5.0 78.0 36.0 10.0 5.7 5.7 1.0 9.1 21.9 80.8 50.9 4.0 5.7 6.0 65.6 53.0 37.5 4.0 36.7 6.3 2.3 0.8 27.4 5.4 28.0 6.0 30.0 4.4 7.1 6.1 na 7.4 34.0 54.0 58.5 4.0 40.0 56.4 7.0 57.P.0 8.0 51.4 54.2 4.2 60.4 7.0 1.9 33.4 7.7 7.9 17.9 14.4 0.1 18.6 6.0 58.0 11.1 13.0 30.1 7.6 5.3 5.0 68.0 10.0 74.2 5.7 6.5 68.0 78.

Of course.%). the loss in asset value is higher when the percentage invested in equities is above 50% and is around 30% for companies with more than 80% of investments in equities.6% for the companies in our selection. portfolios 50% invested in equity and 50% in bonds generated realized returns of about -13%. This is the average loss caused by the drop in equities and it’s the percentage we should apply in estimating the pension surplus/deficit for companies half invested in equity and half in government bonds. Secondly. Over the last 20 years the realized average is about 9%. Datastream 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 World Equity YoY % return US Bonds YoY return(%) average realized return (50% bonds & 50% equity) 20 April 2009 13 . last year. Bonds and Equity total returns since 1980 (%) 50% 40% 30% 20% 10% 0% -10% -20% -30% -40% -50% Source: SG Cross Asset Research. we can compare the above figures with the current pension position in terms of asset and liabilities and then calculated the expected surplus and deficit at year-end. The average realized return over the last ten years for a portfolio invested 50% in equity and 50% in bonds is about 7%. slightly above the average return for companies in our table on the previous page (6.Pension funds The table above is interesting for two reasons: Firstly. which is on average about 6. However. we can observe the expected long-term return on global invested assets. depending on the pension asset allocation.

313 1.039 1.228 716 693 15.934 4.143 4.297 5.976 1.722 4.235 3.585 11.057 1.777 5.479 25.Pension funds Change in discounting rate: companies at risk In the last ten years declining interest rates have increased the market-to-market value of benefit obligations. Pension Liabilities versus Market Cap (%) – 2008 figures in local currency LCm Mkt Cap Fair Value of plan Pension Liabilities assets * Pension Deficit (Surplus) Liabilities vs Mkt Cap (%) The companies in the table are strongly sensitive to any change in the discounting rate (30y Treasury + AA corporate bond spread).007 5.010 7.067 6. last year’s rise in corporate bond spreads offset the drop in fair value assets.810 7.480 17.291 42. SG Cross Asset Research.214 618 819 392 241 4.683 10.024 3.468 17.214 25.800 2.057 8.250 3. but a deficit in the Q4 08 as the same rate moved in opposite direction at year-end.327 776 1.286 11.163 2.011 4.200 1.101 12.724 225 2.009 4.403 1.890 6.069 31.905 3.199 3.070 10. Bloomberg (Market cap on April 14) Pension liabilities as a % of market capitalisation 900% 800% 700% 600% 500% 400% 300% 200% 100% 0% Deutsche Lufthansa Akzo Nobel Alcatel-Lucent BAE Systems Smiths Group Nexans Deutsche Post Invensys Thyssenkrupp BT Group Siemens EADS Peugeot Meggitt BMW GKN Daimler Bayer BASF British Airways Rolls-Royce Group Continental Philips Electronics Michelin Valeo Fiat Source: SG Equity Research. However.437 11.833 4.281 14.751 1.370 3.444 8.921 13.384 4.797 4.785 16.593 16.335 7.942 429 2.300 834 288 2.498 33.883 12.444) 625 867 5.637 6.194 5.272 25. Companies releases.442 (1.058 26.697 6.788 14.491 8.719 2.663 8.836 2.246 7.493 1. this was the case for Alcatel-Lucent which in Q3 08 reported a deficit surplus thanks to extremely favourable moves in the discount rate used. Companies releases.938 843 3. For instance.409 324 452 10.216 988 (700) 464 6.754 17. Bloomberg 14 20 April 2009 . SG Cross Asset Research.172 3.810 851% 656% 534% 366% 362% 175% 146% 145% 134% 120% 111% 101% 95% 93% 80% 79% 74% 72% 69% 65% 57% 57% 55% 51% 44% 40% *Present value of funded obligations + other pension liabilities Source: SG Equity Research.110 20. Therefore if easing credit conditions are confirmed the total amount of pension liabilities may increase by the end of the year British Airways Alcatel-Lucent BT Group GKN Invensys Deutsche Lufthansa BAE Systems Akzo Nobel Philips Electronics Smiths Group Deutsche Post EADS Rolls-Royce Group Continental Michelin Thyssenkrupp Valeo Peugeot Nexans Meggitt Daimler Siemens BMW Bayer BASF Fiat 1.044 24.659 11.118 28.843 5.044 7.899 2.500 2.

companies with the largest defined-benefit pension schemes are the most at risk when financial markets decline.899 10.754 3.788 716 14.480 7.327 1.044 8.663 26.246 3.777 693 11.007 5.833 464 625 867 6. SG Cross Asset Research.843 17.890 6.057 11.335 452 10.810 749% 645% 498% 341% 259% 139% 133% 119% 111% 111% 102% 72% 63% 56% 54% 47% 43% 43% 40% 38% 34% 31% 30% 20% 20% 19% *Present value of funded obligations + other pension liabilities Source: SG Equity Research.101 2.291 16.637 2.683 1.585 3. Companies releases.057 4.300 288 834 (700) 988 (1. Companies releases.905 3.444 7. Bloomberg 20 April 2009 15 .199 11. Bloomberg (Market cap on April 14) Plan Assets as a % of market capitalisation 800% 700% 600% 500% 400% 300% 200% 100% 0% Deutsche Lufthansa Akzo Nobel Alcatel-Lucent BAE Systems BMW Smiths Group Siemens Deutsche Post Invensys Nexans EADS GKN Meggitt Thyssenkrupp BT Group Peugeot Daimler Bayer BASF British Airways Continental Rolls-Royce Group Philips Electronics Michelin Valeo Fiat Source: SG Equity Research.039 28. As highlighted in the table below.479 8.228 24.Pension funds Financial market declines: companies at risk We show here the size of the plan assets relative to each company’s market capitalisation.044 4.143 8.785 7.437 2.491 324 8.067 12.442 241 1.214 618 1.384 776 12.200 6.110 5.403 1.286 7.800 5.272 25.024 11.724 225 1.011 819 4.070 4.797 4.593 16. Fair Value of plan assets versus Market Cap (%) – 2008 figures in local currency LCm Mkt Cap Fair Value of plan Pension Liabilities assets * Pension Deficit Assets vs Mkt Cap (Surplus) (%) British Airways Alcatel-Lucent BT Group Invensys GKN Philips Electronics Akzo Nobel Rolls-Royce Group BAE Systems Deutsche Lufthansa Smiths Group Continental Michelin Deutsche Post Peugeot Siemens EADS Meggitt BASF Daimler BMW Nexans Bayer Thyssenkrupp Valeo Fiat 1.444) 4.409 20.214 25.281 14.498 33.058 25.069 31.751 1.250 4.297 392 5.370 15.938 843 3.216 2.010 2.163 13.722 2.942 429 2.500 4.194 3.172 3.883 6.921 2.313 10.719 17.493 42.468 5.659 6.697 1.810 4.934 3.118 1.009 17.235 2.836 7.976 5. SG Cross Asset Research.

increasing the amount invested in bonds (%). added a £500m special injection and changed asset allocation. however. Some companies have also substantially reduced the pension risks. with large amounts of plan assets (as this is the most volatile part of the deficit) versus market cap. Despite the fact that both British Airways and Alcatel-Lucent have the highest exposure to defined pension plans. Bloomberg The above picture does not show which companies will have to tackle the high risk of cash injection to address their pension deficits. Naturally.378m provisions in last year’s balance sheet and it ended the year with a net cash position of €6. This is the case of EADS which has a mismatch between pension liabilities and fair value of assets. it is GKN that faces the biggest net pension deficit versus market capitalisation.Pension funds In the graph below.823m. Pension deficit (surplus) versus market capitalisation (%) 100% 70% 40% 10% Deutsche Lufthansa Akzo Nobel BMW Alcatel-Lucent BAE Systems Deutsche Post Thyssenkrupp Smiths Group BT Group Invensys Siemens Nexans EADS GKN Meggitt Peugeot Bayer Daimler British Airways Continental BASF Valeo Fiat Rolls-Royce Group Michelin Philips Electronics -20% Source: SG Equity Research. This is the case of Rolls-Royce. Our selected stocks BAE Systems Meggitt Deutsche Post Valeo Continental Michelin Daimler Peugeot Citroen BMW Akzo Nobel Alcatel-Lucent GKN Invensys ThyssenKrupp Bayer BT Group British Airways Deutsche Lufthansa Source: SG Equity Research Aerospace & Defence Air Freight & Logistics Auto Components Automobiles Chemicals Communication Equipment Industrial Conglomerates Metals & Mining Pharmaceuticals Telecoms Transportation . Therefore. However. we find similar results when we take into account the net pension liabilities versus the enterprise value. SG Cross Asset Research. which has closed UK defined benefit schemes to new members. the drop in the company’s market capitalisation is one the most important factors. Companies releases. we will only focus on companies that are already high leveraged. from now.Airlines 16 20 April 2009 . Below we provide a list of the stocks selected. we highlight the level of net pension liabilities as a % of each company’s market capitalisation. the company has already recognized €4.

0 63.8 24.0 8.6% 84.0 GKN British Airways Deutsche Lufthansa ThyssenKrupp Deutsche Post Valeo BT Group BAE Systems Meggitt Continental Bayer Invensys BMW Daimler Peugeot Citroen Michelin Akzo Nobel Alcatel-Lucent Industrial Conglomerates Transportation . mm) 2007 2008e 2009 Gearing Pension deficit / Market Cap (%) 2007 2008e 34.2 29.0 47. namely GKN and British Airways Gearing (%) 350 300 250 200 150 100 50 ALU 0% Michelin Peugeot Bayer Akzo Nobel 10% 20% 30% Deutsche Post BAE Systems 40% 50% 60% Meggitt Valeo ThyssenKrupp Deutsche Lufthansa GKN BT Group GKN British Airways Deutsche Lufthansa ThyssenKrupp Continental Deutsche Post Valeo BT Group BAE Systems Meggitt Continental Bayer British Airways Peugeot Michelin Akzo Nobel 70% 80% 90% 100% 110% ALU Mkt Cap / Pension Deficit (%) Source: SG Equity Research.5 48.301 53.071 7.0 43% 23% 54% 67% 52% 55% 6% 17% 14% 11% 17% 38% 29% 7% 17% 6% 14% -72% 108% 102% 64% 59% 54% 54% 36% 36% 23% 21% 21% 21% 20% 20% 18% 17% 13% 12% € 13.8 46.0 12.4 46.0 39.391 5.782 € 9.7 39.0 20.0 33.4% 79.0 22.0 11.0 31.0 8.876 440p 11. Equipment Hold Sell Buy Buy Hold Buy Hold Buy Hold Hold Hold Sell Buy Hold Buy Buy Hold Sell 70p 90p 774 1.6 12.912 745 324 1.602 1.9 38.044 € 12.9 19.502 5.75 *Pension Deficit/(Surplus) = (Principal pension deficit + Other post-employment benefit obligations)-(Fair Value of plan assets).Airlines Metals & Mining Air Freight & Logistics Auto Components Telecoms Aerospace & Defence Aerospace & Defence Auto Components Pharmaceuticals Industrial Conglomerates Automobiles Automobiles Automobiles Auto Components Chemicals Commun. mm) Pension deficit* (local currency.0 4.901 3.0 1.757 633 389 2.297 4.4 8.969 28. SG Cross Asset Research 20 April 2009 17 .011 618 2.065 2.0 8.0 0.020 153 337 4.0 30.0 54.0 62.0 2.216 241 625 5.0 17.1% 75.942 2.146 105p 120p € 15 € 38 120p € 30 € 20 € 42 € 27 € 1.9 49.Airlines Transportation .806) 834 1.0 3.0 7. (LC.0 14.0 28.106 4.0 28.5 34.2% 188. we have analysed those companies with high pension liabilities and a pension deficit versus market capitalisation.0 4.2 53. Companies releases.0 13.9% 28.2 6.214 6.8% 1.0 26.2 4.950 521 4.6% 33.906 331 437 2.4 40.6% 32.9% 345.4% 70.5 64.854 5.3 0.1 36.7 12.2 8.0 2.0 10.0 0.0 53.934 819 867 = 988 429 83.1 10.300 4.833 5.126 (2.1 0.0 62.2% 44.0 23.0 8.444 € 19.976 288 3.0 9 6.3 44. FactSet (Market cap on 14 April) Gearing and Pension Deficit/Mkt Cap (%) The companies most at risk are those with high deficits versus market capitalisation and at the same time high gearing.6 9.2 45.5 54.449 1.2% 36.389 1.837 € 24.0 4.1 15.1 12.75 8.0 65.386 16.0 40.3% nm nm nm 50.9 2. Pension deficit versus Market Cap (%) Asset Allocation (%) Bonds Equity Property Other Reco Target Market Cap.Pension funds Companies with large pension deficit vs market cap Initially.1% 32.0 50.0 2. Source: SG Equity Research.3 0.0 12.

0 17.0 29.0 45.749 € 19.Airlines Metals & Mining Automobiles Aerospace & Defence Auto Components Industrial Conglomerates Automobiles Pharmaceuticals Aerospace & Defence Telecoms Commun.1 8.5 28.215 46.950 153 389 -2.0 7.8% 32.740 13.757 331 437 2.0 13.0 2. mm) Pension deficit* (local currency.8 24.0 0. which was the most at risk comparing the deficit to market capitalisation.078 5.413 105p 22.659 120p € 30 € 38 120p € 1.602 4. Companies releases.9% 28.806 1.428 17. the picture is slightly different.0 8.1 12.3 44.0 4. Source: SG Equity Research.0 36.1% 84.472 70p 90p 2.0 40.2 8.0 50.9 38.020 633 521 4.0 34.6 23.0 0.4 46.3 0.122 5.2 € 20 € 42 € 15 1.6% 33.1 62.0 10.942 2.976 241 2.854 1.3% 75.377 € 24.0 9 12.5 34. Deutsche Post now appears among the risky stocks.4% 70.035 9. is now behind Deutsche Post and just ahead of British Airways 350 300 250 Gearing (%) 200 150 100 50 5% 10% 15% 20% 25% 30% 35% 40% 45% EV / Pension Deficit (%) Source: SG Equity Research.011 834 1.0 4.75 *Pension Deficit/(Surplus) = (Principal pension deficit + Other post-employment benefit obligations)-(Fair Value of plan assets).767 € 27.890 11.0 53.4% 79.2% 46% 16% 8% 27% 34% 11% 13% 24% 36% 27% 11% 7% 2% -56% 10% 8% 3% 3% 45% 39% 37% 32% 30% 29% 28% 23% 20% 19% 13% 12% 10% 9% 8% 8% 7% 5% € 13.833 5.0 63.1 20.6% 50.9 49. GKN.0 8.0 Deutsche Post GKN British Airways Deutsche Lufthansa ThyssenKrupp Daimler BAE Systems Valeo Invensys BMW Bayer Meggitt BT Group Alcatel-Lucent Akzo Nobel Peugeot Citroen Michelin Continental Air Freight & Logistics Ind.0 3.912 2.2 65. FactSet (Market cap on 14 April) Gearing and Pension Deficit/EV (%) Looking at the Pension Deficit versus EV.0 0.318 € 12.297 5.9% nm nm 44.0 11.7 39.850 53.Airlines Transportation .391 5.0 40.8 54.214 4.297 440p 15.300 429 = 988 819 867 625 36.0 17.4 15.0 32.7 12.4 19.0 2.216 618 288 3.0 8.2 53.3 2.0 62.0 9.285 5.126 745 324 337 6.0 0. Equipment Chemicals Automobiles Auto Components Auto Components Hold Hold Sell Buy Buy Hold Buy Buy Sell Buy Hold Hold Hold Sell Hold Buy Buy Hold € 9. SG Cross Asset Research BT Group GKN British Airways Deutsche Lufthansa ThyssenKrupp Deutsche Post Valeo BT Group BAE Systems Michelin Meggitt Valeo British Airways Meggitt GKN Deutsche Post Deutsche Lufthansa Continental Bayer Peugeot Michelin Akzo Nobel ALU Akzo Nobel ALU Bayer ThyssenKrupp BAE Systems 18 20 April 2009 .75 2.2% 345.2 12.0 54.0 8.1% 188.0 31.0 12.0 13.Pension funds Companies with large pension deficit vs Enterprise Value Pension deficit versus EV (%) Asset Allocation (%) Bonds Equity Property Other Reco Target 2009e EV (LC.2 8.6 22.428 2.934 4.0 30.6% 83.5 28. mm) 2007 2008e 2009 Gearing Pension deficit / EV (%) 2007 2008e 33.0 6.1 10.9 14.0 17.0 64.0 39.2% nm 1.0 2. Conglomerates Transportation .5 48.0 4.0 47.0 46.

Companies release 20 April 2009 19 .7% -7.113 8. Returns on plan asset by company Plan Assets Allocation (%) Bonds Equity Property Other Plan Assets returns Q4 2008 Q1 2009 Plans Assets Expected Dec-08 Plan Assets in Q109 (LCmm) (LCmm) Changes (LCmm) BT Group Akzo Nobel British Airways Daimler Deutsche Post BAE Systems Deutsche Lufthansa GKN ThyssenKrupp BMW Michelin Peugeot Citroen Continental Bayer Meggitt Alcatel-Lucent Valeo Invensys Average 29.9% 3.205 -665 -614 -475 -271 -235 -217 -147 -143 -107 -106 -64 -59 -43 -32 -25 -20 40 Source: SG Cross Asset Research.835 4.4% -8.0 62.1 12 7.0 4.480 14.8 14. Returns on funded plan assets (data as of 31 March) Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009 Bonds Equity Real Estate Hedge Funds Cash Source: SG Cross Asset Research 3% -13% -7% -2% 1% -4% -4% -3% 3% 1% 2% -10% -4% -10% 1% 17% -23% -7% -10% 1% -7% -11% -3% 0% 0% If we carry out the same exercise for the companies in our selection highlighted as being at risk of suffering pension deficit increases. the deficit should increase in the first quarter by about 7.0 8.762 -2.8% -6.2 10.6% 0.172 8683 452 25.070 4.0 39.3% -7.0 6.3% -6.4% -7.5 34.1 15.0 8.0% 1. in the ‘other’ asset allocation category.6 9.7 44.0 24.5 64. We have assumed that. the realised return of the funded plan assets in the first quarter of the year is negative.0 12. for our purposes.0 39.384 3.0 12.3% -8.964 12. half is invested in hedge funds.722 29.75 0.5% 31.2 45.4 46.0 38.704 1.3 50.2 65.8 53.044 205 4.0 23.9% -1.4% -5.0 63.4% -0. We have assumed that Real Estate exposure was invested tracking the Shiller Home price index (20-city composite). Assuming no change to liabilities.0 53.6% -4.9 40.75 36.0 49.815 13.0 0.0% -5. we have assumed that it remains in line with the target allocation in the table below. Factset.921 2.0 0.5% -8.4% 6.3% -2.0%.0 46.9 48.2% -9.7 9. Note that the return on the bond portfolio depends on government duration.4% -6.7% -7.1 20.094 2.8% 3.2 2.009 1.500 10.1% 7.7% 4.491 3.581 5.409 2.4% -8.0 3.635 5.0 31. We have assumed that the Long Duration Investment Grade bond portfolio was invested to closely match the liability (so-called Liability Driven Investing).0 53.345 2.7% -5.235 13.0 10.295 9.1% -5.0 54.069 225 4.9 4.0 47.4 8.4% -8.0 12.658 9. we have used a total return on Bonds with duration of more than 10 years.272 10.0% -9.724 5.8% -1.0 0.6% -7. tracked by the Tremont hedge fund index and half in cash (US).6% -0.Pension funds Sensitivity of pension deficit to market variables Main assumptions to estimate pension asset returns While asset allocation could change during the year.6 22.3 8.5 54.0 8. Based on these assumptions.0 4.1% -7.4 34.110 6.200 2.0 17.862 1.0 2.1 28.7% -2.0 28.5 33.0 2.9% -7.3 19.1 13.1% 2.0 30.0 -6.5% -7.2 12. we notice that those that still have high exposure to equity are the most at risk of seeing rising deficits. We have assumed that equity exposure was invested tracking half the MSCI US and half the MSCI Europe (total returns).0 2.9 8 0.640 420 25.0 62.0 40.

spreads have re-widened again. SG Cross Asset Research 20 20 April 2009 .5 7.5 5.6% -5. LDI).0% -6.0 4. However. and that assessment of risk and return should combine assets and liabilities.0 6.2% -55bp -55bp -169bp -93bp -10bp -9bp 45bp 9bp 15bp 5bp 17bp 12bp The table shows that in the fourth quarter of the past year the corporate bond yield (liabilities discount rate) decreased by 93bp. up from 17% in 2006. In an ideal world. as well as the use of risk-based capital principles for the purpose of assessing solvency and financial requirements. and.4% -8.8% -4. investment returns would fulfil three criteria: ensure that the assets do not lose value over time relative to liabilities.9% -2. the yield could be made up of three rates: yields on iBoxx AA corporate bonds in the UK and Europe. Corporate Bonds performance Bond performance (%) Q408 Q109 YTD Q408 Changes in spreads (bp) Q109 YTD iBoxx € iBoxx £ US A-AAA yield Average performance Source: SG Cross Asset Research 5.5 6. provide a buffer against unforeseen risks such as a rise in life expectancy. reduce the need for contributions.3% -4.8% -9. Liability-driven investment strategies are becoming increasingly popular. Liability-driven investment In calculating the sensitivity of liabilities to moves in the discount rate. It is surprisingly easy to overlook the point that pension funds exist to provide the necessary resources to fund payments to members. the liability ‘return’ becomes far from predictable and a high degree of volatility becomes a factor. However. With discount factors driven by market yields. The National Association of Pension Funds (NAPF) survey data indicate that 23% of schemes had implemented an LDI strategy in 2008. the pension liability and the bond index used as a benchmark are supposed to have similar sensitivities to interest rates: the performance of the bond portfolio should be a good proxy for the pension liability. an average yield on bonds rated between A and AAA in the US. We therefore look at the sensitivity of the pension liabilities to their discount rates. we assume that the long duration investment grade bond portfolio is invested to closely match the liability (Liability Driven Investing.9% 5.0 7. leading to a rise in pension liabilities of about 6%. we usually find that the discount rate used by actuaries is the AArated corporate bond yield. Therefore. This is the essence of Liability Driven Investment: the recognition that investment strategy should be constructed relative to the liabilities of a fund.1% 2.8% 9.0% -5.0 5. partially offsetting the previous deterioration in liabilities.Pension funds Liability calculation: impact of tightening spreads In company annual reports.5 Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 US Eurozone UK Source: Datastream. Funding allows investment returns to play a role in the provision of those resources. Credit spreads should tighten by year end 8. there is a clear global trend among financial regulators towards market-realistic valuations of liabilities. since the beginning of the year. Depending on the countries where the companies provide employers with contributions. and. the return on the liabilities should be predictable. We take into account three rates depending on the region.5 8. In a regulatory environment where the liabilities are discounted at a fixed rate.

938 16.2% 6.8% 6. Bloomberg To calculate the impact of interest rate changes on the pension liabilities.246 2.2% 6.8% 5.293 11.468 2.228 2.634 14.2% -70bp -60bp -60bp -30bp -20bp -10bp -10bp -10bp 0bp 0bp 0bp 10bp 20bp 40bp 40bp 70bp 80bp 110bp Aggressive assumptions. SG Cross Asset Research.2% 6.275 Source: SG Equity Research. liabilities may rise again on the back of falling discount rates.292 24.2% 6.2% 6. as reported in the annual report.755 4.9% 6. Companies releases The table above shows that while BT Group is the most negatively impacted company.2% 6.7% 5.223 1.286 6. LC) Company discount rate* (%) (1) Actual rate (%) (2) (2) – (1) ThyssenKrupp British Airways BT Group Meggitt BAE Systems Akzo Nobel Continental Michelin Alcatel-Lucent Invensys Valeo Bayer Deutsche Lufthansa BMW Peugeot Daimler Deutsche Post GKN 6.044 12.286 11.3% 5.2% 6.010 843 14659 7.843 6.5% 6. we compare the discount rate of the company.2% 6.147 2.2% 6.797 693 5.2% 6.2% 6. if widening spreads since the beginning of the year could reduce the Q1 09 deficit for some companies.228 15.1% 6. with the actual discount rate.5% 5. 20 April 2009 21 .2% 6.788 14.067 25.2% 6.2% 6.754 8.498 35.285 11.067 2.659 12.1% 6. Pension liabilities after changes in discount rate assumptions Local currency mm December 2008 Pension March 2009 Expected Pension Liabilities Liabilities Changes in pension liabilities BT Group British Airways BAE Systems ThyssenKrupp Akzo Nobel Michelin Continental Meggitt Invensys Valeo Peugeot GKN Deutsche Lufthansa BMW Bayer Deutsche Post Daimler Alcatel-Lucent 33.8% 6. Alcatel-Lucent benefits the most from the rise in the discount rate in the US. SG Cross Asset Research.1% 6. Actuarial rate vs actual rate for our selection Pension liabilities (mm. the latter being calculated as an equally weighted average of corporate yields in Europe.Pension funds As SG credit strategists’ forecasts point to tightening credit spreads in the second part of the year and in 2010e.2% 6.690 811 432 347 287 102 70 17 0 0 -81 -142 -194 -220 -366 -612 -752 -1.568 14. UK and the US.2% 6.718 7.843 7.800 693 17. risk of pension liabilities rising by the year-end Market assumptions Cautious assumptions *Average of different rates used in different countries and reported in the annual reports by the companies Source: SG Equity Research.754 8.2% 6.169 2.498 5.214 17.938 11.867 710 5.797 4.3% 6.044 25.788 3.0% 5.025 17. the situation may be different at year-end if SG’s scenario of tightening spreads were to materialise.3% 6. Company releases.246 15.490 17.2% 6.010 843 3.010 843 3.468 4.1% 6.214 33.800 16.4% 6. However.3% 6.560 8.701 7.

0% 12.7% (plan assets allocation: bonds 49.502 16.1% -2. then we estimate that the new net deficit position could have grown to £4bn at 31 March 2009e (2.490 11.113 3. We see British Airways and BT Group as the most at risk.640 4.635 8. If BA’s other smaller schemes were as reported in the accounts.044 17.223 3.184 4.094 205 1.7%).867 4.704 2.862 4.3x market cap).044 3.1% -32.7% -1. The next full actuarial valuation.9bn at 31 March 2008.560 3. before adjustments under the ‘corridor’ rule.146 774 4.169 843 2. BA’s last annual report put the net position of its pension schemes at 31 March 2008 as a deficit of £437m. but they related mainly to different discount rates.762 5. it should be a fairly simple exercise to recalculate the deficit (surplus) at the end of the first quarter.701 7.969 5.285 710 2. NAPS. at £245m (rather than a surplus of £1.4% -0.856 802 3.6% 5. which will determine how much BA should put into the schemes and over what time frame.449 1.3% 4.2% Source: SG Cross Asset Research.444 4.389 7.876 13.195 1.065 2.634 24.940 4.8% 0.651 290 754 1. Companies Annual Reports (Market cap on April 14) On the eighteen companies initially analysed.9% -3. APS. Assuming that its gross pension liabilities is discounted at the new actual rate. There is also room for some positive surprises: Alcatel-Lucent will switch from a deficit to surplus thanks to the rise in the discount rate.670 (821) 180% 99% 25% 43% 65% 28% 26% 21% 55% 110% 65% 18% 20% 18% 20% 18% 51% -21% 74. 22 20 April 2009 . that the value of plan assets fell by 7. British airways the most risky company in the SG coverage British Airways is the most risky company in terms of pension deficit.5bn (rather than a deficit of £357m under IAS19) and the deficit on its second scheme. or a deficit of £245m after ‘corridor’ adjustments. at £1.366 6.1% -1.7% 61. only half of them could disappoint the market in the first quarter of the year.1% 1. then we estimate that BA’s net position under the actuarial valuation was a deficit of £1.755 17. However.345 5.782 1.906 6.634 420 2. BA did not detail the differences between this actuarial valuation and the annual report.657 5.5% -0.658 29.Pension funds Expected pension deficit at end Q1 09 When the expected value of the plan assets and the actual value of the pension liabilities are calculated. Expected deficit (surplus) at end Q1 09 Local Currency mm Market Cap Q1 09 expected assets Q1 09 expected liabilities Q1 09 expected deficit/surplus Q109 expected deficit/surplus vs mkt cap (%) Rise/Drop versus Dec-08 British Airways BT Group Akzo Nobel BAE Systems ThyssenKrupp Meggitt Continental Michelin Valeo GKN Deutsche Lufthansa Peugeot BMW Daimler Bayer Invensys Deutsche Post Alcatel-Lucent 1.653 248 5.837 8.295 9.901 11.301 28.6% 0.010 11.9% and other 10.0% 4.236m under IAS19).718 7.106 26.1% 5.815 12.883 5. equity 39. is due as at 31 March 2009 and is likely to be published by September.835 1.6% 4.293 5.071 1.964 25.147 8.025 35. in our view.292 14. in September 2008 the pension trustees published an actuarial valuation putting the deficit on its main scheme.384 9.568 14.386 11.074 638 839 2.4%.

This is in part because older generations of workers were less apt to change employment than younger generations. Long term loyalty can only be gained through a dedicated approach to ongoing personnel development. In the UK. have already reached or will soon reach retirement age. rising from 33% in 2002. Additional financial incentives for organisations to keep older workers engaged. the Canadian Centre for Occupational Health and Safety reports that older workers exhibit lower turnover. Skilled workers from the “Baby Boom” generation. the number of people aged 50 and over will have reached 46% of the total UK population. the combination of declining birth rates and greater longevity means that. In sectors heavily afflicted with an aging and rapidly retiring workforces the knowledge deficit is already being felt. to take advantage of the aging workforce. particularly because the generation following the baby boomers. Germany. 20 April 2009 23 . These soon-to-be retirees hold the deep knowledge of processes and technologies that are vital to the successful operation of businesses and industries. is significantly less populous than its predecessor. although it is longer when it does happen. This situation poses several problems for employers and national social security systems.Pension funds Pension Deficits/Ageing Workforce From baby boom to ageing workforce The problem of a rapidly ageing workforce nearing retirement is a predicament currently faced by employers around the world. born between 1946 and 1964. is also given by studies which suggest older people are better workers. According to the US Bureau of Labour Statistics 19 million Baby Boomers. retaining aging employees reduces staff turnover rates and provides an immediate financial benefit. though that is certainly a concern. and the current rates of retirement. Figures suggest that the average working age in the US is now 41 up from 35 in 1980. These trends are also evident in other developed countries such as France. by 2030. born between 1965 and 1983 and often referred to as the “Generation X”. Benefits of older employees Despite the deficits in manpower and knowledge cause by an aging workforce. However. will be ready for retirement by 2011. Knowledge gap The deficit brought on by the retirement of the populous Baby Boom generation is not just one of manpower. it seems there are also benefits for businesses staffed by “graying” employees. The most crucial gap left when million of aging skilled workers retire is that of knowledge. and have more positive work values. more dedication to the workplace. Considering the representative populations of the baby boom generation and Generation X. which will effectively be lost to both businesses and future generations. it is estimated that there will be a deficit of 7 million skilled workers by 2010 (Source: industryweek. Absenteeism is less frequent. For example. According to the American Association of Retired Persons. Spain and Japan. First of all. 76 million and 41 million respectively. of a national total of 76 million. Industry experts worry that when the Baby Boomers retire they will take a vast amount of precious and undocumented knowledge with them. Changing jobs less frequently gave employees the time and experience to accumulate a company-specific or even task-specific body of knowledge that cannot be achieved if an employee is rapidly changing positions. organisations need to treat their existing employees (both young and old) as more than merely “assets”.com). one of every five employees will be at least 55 by 2015.

defined contribution plans — by contrast and by definition with Defined benefit plan — are always "fully funded. for companies. Many companies are losing a large percentage of their skilled workforce. essentially all at once. The employee deficit. the Board of the Pension Protection Fund (the PPF) was created under the Pensions Act 2004. everything is then lost in the event of bankruptcy. qualified employees to fill existing positions companies are forced to compete with each other to attract the highest calibre employees. Yet. This programme gradually acclimatises mature workers to retirement by steadily reducing their work hours and pay rates. The Board of the PPF is a Statutory Corporation responsible for managing the Fund and for making payments to members. All eligible schemes are required to pay annual levies to the PPF to contribute towards administration and the compensation Fund itself. of up to 7 million in the US according to some studies. while encouraging them to mentor younger employees. and keep pension insurance premiums at the lowest level necessary to carry out its operations. and they are clamouring to recruit new skilled workers to replace those retiring. Both in UK and in the US. since there are not enough new. but concurrently gives them their pensions. in the US public sector. The principle is quite simple: any member who is over their normal retirement age or who retired early due to ill health will receive 100% of the pension they are currently receiving. The PPF started on 6 April 2005 in response to public concern that when employers sponsoring defined benefit pension schemes became insolvent. some companies are pouring resources into recruitment and training programmes for young employees. an independent agency of the United States government that was created by the Employee Retirement Income Security Act of 1974 (ERISA) to encourage the continuation and maintenance of voluntary private defined benefit pension plans. However. they are not protected by law. This is one approach to improving the looming knowledge deficit. provide timely and uninterrupted payment of pension benefits. is making the job market for skilled professionals very competitive. and despite the changes introduced in 2006 regarding trustee fiduciary duty. legislators have decided to tackle the pension bankruptcy threat. In UK. For example. there is an equivalent body since 1974 with the Pension Benefit Guaranty Corporation (or PBGC). not job seekers necessarily. This is partly due to the compensation cap and 90% restriction on benefits but also because the indexation provided by the PPF may not be as generous as that otherwise provided by the scheme. scheme members could lose some or their entire pension if the scheme was underfunded. as is understandable. Employee development To tackle the problem of an ageing workforce and the associated encroaching knowledge deficit. Protecting the pension funds: avoiding the Enron failure The picture is gloomy for some pension funds but there is some room for serenity." Thus. However.Pension funds Retaining retiring-age workers as part-time or contract employees can also benefit businesses and organizations by allowing more experienced workers to pass on their knowledge to the new employees who are essentially their replacements. and when a company like Enron strongly encourages workers to massively invest their 401k plan in shares of their own employer. In the US. the amount of compensation is often less than a member would have been entitled to under the rules of their original pension scheme. especially after some famous cases like Enron’s. 24 20 April 2009 . The Chicago Transit Authority implemented a Phase-In Retirement programme for retiring employees. Other members will receive the 90% level of compensation capped at a certain level.

although the remuneration for production workers in aerospace is significantly higher than for jobs in other manufacturing industries. many of whom see it as an "old-fashioned industry". perceptions of non-competitive salaries. mechanical and computer engineering disciplines this year is expected to be double what it was 10 years ago. length and complexity of the hiring process. Public sector The ageing of the global workforce is hitting government agencies especially hard. To combat the demographic trends companies in the aerospace industry are aggressively pursuing strategies to attract the next generation of skilled workers and retain older employees to act as mentors to new employees. But. in 1998. Some of the main causes for this are the relatively poor public image of the federal government as an employer. For example. the demand for aerospace. as well as preparing and supporting the next generation of aerospace workers. At least 20 percent were between the ages of 55 to 64.8% with total sales expected to amount to $214 billion. nearly 60 percent of the workforce was 45 or older. A 2008 study estimated that around 25% of the 637. The problem is essentially one of supply and demand. companies are offering internships and traineeships to students. raising fears that America could be facing a serious skills shortage in the factories that churn out commercial and military aircraft.000 aerospace workers by 2018. the aerospace industry lacks the recruitment appeal that it once had in the years following the Cold War. if not most.000 aerospace workers in the US would be eligible for retirement that year. In 2007. and budget constraints and uncertainties. This problem is exasperated by the poor record in math and science instruction in public schools. The growth forecast for 2009 is an enviable 4. were already eligible for retirement.203 employees — were 65 or older. inviting teachers to aerospace plants to gain insight into the industry to pass along to students and practicing aggressive recruitment in colleges and universities.Pension funds Sectors with ageing workforces Aerospace sector The aerospace sector is being hit especially hard by the wave of retirement of skilled workers from the baby boom generation. To address this issue. since the average age of public sector employees exceeds that of their private sector counterparts. Both the commercial and military segments of the industry are enjoying robust growth. One industry initiative in Wichita. Kansas. the industry's largest age group was 35 to 44. According to the Aerospace Industries Association (AIA). even in light of the global economic downturn. electrical. increasingly fewer people are seeking careers in government. And. NASA and the state of Florida have funded the development of an entirely web-based virtual learning and collaboration community. is critical to ensure the success of future military and commercial space operations. NASA has recognized that capturing the knowledge of the experienced workforce. urges the creation of a world-class aviation training centre to help meet the need for an additional 12. visiting public schools to increase students’ interest in math and science. Despite the attractive salaries offered the aerospace sector doesn’t register strongly on the radars of most young job seekers. analysts and industry representatives say that colleges and universities are turning out far too few graduates with engineering and aeronautical credentials to fill upcoming vacancies. An additional 2 percent — or 12. At the same time. Moreover. and many. home to five major aircraft plants in addition to hundreds of aerospace industry suppliers and vendors. 20 April 2009 25 .

The Korean government took a step away from the traditional method of advancement to executive positions.Pension funds According to a study completed by Accenture’s Public Service Research Division. exit interviews to evaluate perceptions of work environments. and some agencies are working on crafting new policies to soften the blow. For example. the UK and Germany are also considering doing. and targeted recruiting for certain positions. if governments around the world fail to make concentrated and long-term efforts to develop and retain their existing workforce as well as attract new talent. then they will face an increasingly insufficient pool of skilled employees over the next thirty years. the effects of ageing in the workforce are of significant concern. and opened up about 20% of its top civil service posts to competition from both the public and private sector. some governments are implementing policies to keep experienced workers longer. seniority. 26 20 April 2009 . Attracting new employees Some governments have already tried this approach and experienced positive results. Changes to national or public sector retirement policies are often disliked by workers and the public. workforce shortages and decreased productivity of the aging workforce. Moreover. companies may feel increasing competition from countries such as China and India whose demographic profiles do not mirror that of wealthy countries and have a surplus in available labour in addition to the fact that they are quickly advancing in technology and innovation in the sector. 37 states in the US have developed new recruitment approaches such as offering flex-time scheduling. Retaining existing talent To fight the knowledge gap produced when retiring employees outnumber new employees. Another example is in Austria. energy and manual dexterity of employees. or have already done so. Part of this is about making salaries more attractive but it is also about creating an engaging and rewarding job experience. Many companies in the automotive sector are seeing the average age of their workforce increase to between 55 and 64. raising concerns about decreased productivity in manufacturing plans where tasks often depend on the speed. governments need to make employment in the public sector more appealing to potential workers. where the government has worked to align the compensation for public sector jobs with the private sector to increase interest in public sector employment and avoid losing the best candidates to the traditionally higher-paying private sector. Other ways to attract potential employees to public sector jobs include promoting jobs to regional immigrants and pioneering programmes that make it easier for stay-at-home parents to work. Most of the public debate is focusing on the impact of changing demographics on social security. Automotive sector For automotive sector companies operating in developing countries. such as allowing workers to draw on their pensions whilst still employed. France. These types of measures have been implemented to some extent in Sweden and Japan while Italy. One approach to this is changing retirement policies by either encouraging people to continue working beyond normal retirement age or to offer disincentives to early retirement. To avoid this scenario.

Some reasons for this include the perceived insecurity of the oil and gas job market. the experimental production line achieved the same productivity as the younger line after three months of consistent improvement and also resulted in a 50% drop in absenteeism and a defect rate of zero. The expected outcome was that the experimental line would be less productive due to the increase in average age of workers and associated decrease in speed. the average age of employees in Exploration and Production (E&P) was 50 years in 2005. there is a growing skills gap that could impede the industry’s ability to operate caused by fewer students pursuing programs related to E&P. Companies are encouraging employees to store vital information as to how they resolve problems and make crucial decisions via the use of handheld computers and other media. Students are choosing programmes they perceive as more exciting and preparing them for the “jobs of the future” such as those in the IT sector. Oil and gas sector Like many other sectors. showing that an aging workforce need not be a concern if small measures are taken to attend to the needs of aging workers. among the oldest of any industry. energy and manual dexterity. According to the World Petroleum Council. with 40-60% of aging employees set to retire by 2010. To the contrary. During the study they conducted an experiment to mimic the demographic shift that is projected for 2017 at which time the average age of the facility’s workforce will increase to 47 from the current average age of 39. electronic. To tackle the problem of an ageing resource nearing retirement and the resulting personnel and knowledge gap. workbenches and flooring in the facility. Companies One study conducted by professors from INSEAD and an employee of German automaker BMW focused on the problem of the aging workforce at a particular BMW manufacturing plant in Germany. the oil and gas sector is faced with an ageing workforce. companies are practicing more aggressive recruitment and outreach to schools and developing new. The shift to electronic data logging will archive knowledge and allow employees to communicate with each other as well as with management on a larger 20 April 2009 27 . And while energy demand is set to increase in the coming years. methods of archiving special industry information and problem solving knowledge. The improvements in productions made by the experimental line came as a result of small improvements such as better seats.Pension funds Auto and ageing workforce: Valeo 1% 1% 14% 25% Auto and ageing workforce: PSA 2% 19% 24% 23% 24% 31% 36% <20 20-29 30-39 40-49 50-59 >60 <20 20-29 30-39 40-49 50+ Source: SG Equity Research. and thus maintain desired levels of productivity. In the experiment a production line was assembled with an age distribution amongst line workers similar to that projected for 2017. tough working conditions such as dangerous environmental and political environments and attention to the negative environmental impacts of the industry.

The shift is also expected to reduce costs associated with training new employees. both in the office and on the field. Datastream.Pension funds scale. Worldscope 85 900 118 272 145 100 60 675 124 700 441 502 49 779 127 241 50 400 46 500 119 913 54 867 223 863 35 517 4 187 156 500 174 262 42 600 76 410 106 200 45 140 111 900 272 382 26 002 113 529 61 051 88 000 107 539 105 261 536 350 37 735 7 360 207 800 199 374 62 807 86 994 114 791 55 896 114 636 372 977 64 300 123 942 64 915 72 445 106 511 86 878 389 899 37 733 5 026 193 518 188 492 + + + + + + + + 28 20 April 2009 . Companies with pension deficits may experience staff growth! Name 1999 2009 Average 1999-2009 Growth Akzo Nobel Alcatel-Lucent Bayer British Airways BT Group Daimler Invensys Michelin Valeo BAE Systems BMW Deutsche Lufthansa Deutsche Post GKN Meggitt Peugeot ThyssenKrupp Source: SG Equity Research.

Pension funds Company Profiles 30 Akzo Nobel NV 31 Alcatel-Lucent 32 BAE Systems 33 Bayer AG 34 British Airways 35 BT Group 36 Daimler 37 Deutsche Lufthansa 38 Deutsche Post AG 39 GKN 40 Invensys 41 Meggitt 42 Michelin 43 Peugeot Citroen PSA 44 ThyssenKrupp 45 Valeo 20 April 2009 29 .

through a €750m 6-year 7.6 14.3 32. In total.5bn.8 57.85 11. The plan asset allocation is heavily weighted towards bonds. Next events & catalysts Source: SG Equity Research Q1 09e results: PPG and Sherwin Williams 16/04. with cash of €1.€750m is not due until Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e RIC AKZO.9 4.0 Type of investment payments of £172m for the ICI Pension Fund (ICI top-ups are expected to continue at current levels for a few years) and £25m for the UK AkzoNobel (CPS) Pension scheme. an MA 100 undrawn revolving credit facility of €1.6 Revenues (€bn) EBIT margin (%) Rep. funded and unfunded pension plans amounted to almost €11.9 3.9 2. net debt was only €2.0 €27. at end-2008.49 1.5 0 2008 2009 2009 Our TP of €27 implies just over 10x our 2009e EPS.8 5.23 7.9 5. we do not see Akzo’s pension deficit as a major issue. In March the group refinanced €1bn of debt maturing in May 2009. Impact Value Cost reduction programme High dividend yield 1 year Price 65 At end-2008.9 12.00 70.0 -40.clark@sgcib.7 SG acted as joint bookrunner in the Akzo Nobel's senior bond issue.0 3m 12m 12.80 252.8 0.6 492 2.2 625 3.a. versus 23% in equities.6% 9.0 0.5bn p. Eurofirst 300 1m 20.3 2.43 2.9 3.socgen.130 7. we note Akzo’s stronger business today. (€m) Free float (%) Performance (%) Ordinary shares Rel.sgresearch.2 230 3. its strong balance sheet (28% gearing). In this regard. With a cash generative business model and the related financial strength that goes with this.2 26. The next major refinancing of c.2 435 2.5 14.5 -4.46 7.25% bond and a £250m 7-year 8% bond.8 -3. AKZO NOBEL NV on www.9 13.).90 84.8 2.0 32.3 14.AS. in 2004 the pro forma net deficit.1-22. (€m) EPS (adj.5bn (to 2013) and a commercial paper programme of US$1bn and €1.1 0.2 0. its ICI synergy and rationalisation programmes (looking at benefits in excess of €0. Bloom AKZA NA 52-week range EV 09 (€m) Market cap. primarily reflecting under funding at 15.9 5.80 95.42 9.12.80 9. giving a 5% plus yield.5bn.8 0.3 0.57 1.897 100. and a maintained dividend.9 0.84 11.2 2.7 9.95 8. with Akzo actually seeing an annual average P/E of c.595m.90 1.5 5. Target price & rating 50 35 20 2008 (m) 7.0 0.9 0.5 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: -0. 30 20 April 2009 .2 5.3 2.9 0. its leading global market positions (and brands). 10x P/E is a level that historically has acted as a floor for similar stocks on trough earnings.5x in the 1990s recession.6 4.5 5 2.1 10.7 33.3 0. Akzo 23/04.Pension funds Chemicals (Netherlands) Akzo Nobel NV Pension deficit We do not see pension deficit as a major issue Pension position At end-2008 Akzo Nobel’s pension deficit was €988m down from Hold (12m) Price 17/04/09 12m target €1. net inc.510m in 2007 on a pro forma basis including ICI. there was also €441m of other post retirement benefits (€286m). 72% of assets were in long-term interest earning investments.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Peter Clark (44) 20 7762 5084 peter. Akzo Nobel and the former ICI have been aggressively topping up the pension schemes. the largest by far being the ICI Pension Fund and the AkzoNobel (CPS) Pension scheme in the UK.9 0.7 11. was nearer €4bn and Akzo Nobel expects to contribute €304m again in 2009e with additional €34.1 5.76 8.084m (28% gearing).6 2.

139 77.20 Underweight Preferred stock Qualcomm Least preferred stock Alcatel-Lucent The future trend in US corporate bond yields vs government debt will be key.9bn compared to $35.98 2.6 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 07-10e: nm nm -45. Impact €1. We expect Source: SG Equity Research sales of €3.2 0.socgen.37 37.perkins@sgcib.83 Sector Weighting €1. Based on our calculations.5 0.61 5.10.41 Surendran Panicker (Sp.3 nm 16.4 -52.3 nm -13. However.372 -0.3 0.7 0.5bn surplus in March 2009.3bn surplus as of September 2008.000 nm 0.7 -0.0 0. However.1 0.4 0. it could have a negative impact on the pension MA 100 surplus again.000 nm 0.8 20 April 2009 31 . Alcatel-Lucent on www.0 19.9 0.sgresearch.Pension funds Communications Equipment (France) Alcatel-Lucent Pension deficit Future trend in US corporate bond yields will be key Pension position 12m target Sell (12m) Price 17/04/09 Alcatel-Lucent has the vast majority of its pension plan assets and liabilities related to US pensions.112 0.87 1. sales) (44) 20 7762 5525 surendran. net inc.050 nm 1.7 1.6bn deficit. A deficit in the pensions as of December 2009 would require some cash funding no later than in September 2011.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Vincent Rech (33) 1 42 13 85 16 vincent.2 7.5 0.7 2. an op margin of 5% and 10% WACC.90-0.4 32. Eurofirst 300 1m 46. we estimate that AlcatelLucent’s pensions will post a $1.20 based on a DCF valuation.5 4.2 0.2 3m 12m 21.0 -867 0.panicker@sgcib. we estimate that pension sensitivity to external interest rates adds further risk to our valuation.4 4.8 Revenues (€bn) EBIT margin (%) Rep. down 8% yoy. As of December 2008 total assets were $34. should 1 year Price 6 this situation reverse later this year.0 1.6 -443 0. The main reasons for the volatility of this surplus are the recent swings in US corporate bond yields: this directly impacts around 50% of the asset value (through the estimated corporate bond allocation) and 100% of the liability calculation (though the discount rate). (€m) Free float (%) Performance (%) Ordinary shares Rel. This compares to a $4. op margin of -3% and EPS of -€0. which is favourable to Alcatel-Lucent.6 28.79 0.0 Share data Financial data 12/07 12/08e 12/09e 12/10e Ratios 12/07 12/08e 12/09e 12/10e RIC ALUA.0 nm -21.2 0.318 -0. The spread in March was at a historical high. We assume normalised growth of 0%.7 -703 0.2 0.528 4.2 0.27 9.4 14. 4 2 Target price & rating Our target price is €1. Next events & catalysts Alcatel-Lucent will report Q1 09 earnings on 5 May.0 13.91 4. Since August 2007 this spread has been widening and extremely volatile. (€m) EPS (adj.4 0.2 0.rech@sgcib.PA.118 Andy Perkins (44) 20 7762 5413 andy. We believe that current 0 2008 (m) 105 70 35 0 2008 2009 2009 liquidity is adequate.5bn.1 16.5bn liabilities resulting in a $0. Bloom ALU FP 52-week range EV 08 (€m) Market cap.0 -247 0.6 0.000 nm 1.22 35.7 34.

54 9.Pension funds Aerospace & Defence (United Kingdom) BAE Systems Pension deficit Strong balance sheet maintained despite £400m-£500m pension top-up Pension position 12m target Buy (12m) Price 17/04/09 BAE ended 2008 with an IAS pension deficit.3 16.3% 9. net inc. We would expect the group to reiterate the ‘good outlook’ for the group and the strong visibility provided by the order 32 20 April 2009 .3 1. The substantial increase in the deficit was due to a combination of factors.2 487. it will make an incremental contribution of £200m in respect of the UK pension scheme and $250m (£175m) to the US pension schemes.45 41.13 37.2 1.8 20. an increase in real discount rates and the inclusion of an allowance for a minimum rate of future improvements in the mortality assumption. Indeed. The fair value of group plan assets at end-2008 was £13. £403m contribution) to the defined benefit plan in 2008.0 1. (£bn) EPS (adj.6 0.01 9.campbell@sgcib. At our target price.5 1.socgen. We expect a broadly cash neutral balance sheet after the pension fund contribution.99 9.2 1.0 18.1 Revenues (£bn) EBIT margin (%) relatively favourable outcome for the group of the 2010 US defence budget submission.3 4.7 1.sgresearch. 347.7 nm P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: +7.6 1.52 43.5 42. particularly against the civil-biased companies Next events & catalysts Source: SG Equity Research BAE should publish an interim management statement with the AGM on 6 May 2009.5%).5 15.7 4. excluding the group’s share of amounts allocated to equity accounted investments (£891m).7 Rel. including worse-than-expected investment returns.678 12.4 6. BAE expects to make regular contributions at a similar level to those made in 2008 but.7 1.) (p) Dividend/share (p) Payout (%) Interest cover (x) Net debt/equity (%) Zafar Khan (44) 20 7762 5317 zafar.4 1. BAE would trade at a 10% premium to the 2009 P/E average for the European Aerospace & Defence sector which we believe is justified by the group’s robust medium-term prospects.2 17.L.570m).6 1.3 0.325m (2007.khan@sgcib.0 13.9 4.5 39.75 7.0 1.66 6. It should also note the BAE Systems on www.8 nm 22.0-302.6 -24.7 1.5 0.3 15. after dividends but before the 440 pension top-up payments.5 39.03 9.3 8.0 7.070m and some 60% of the defined benefit pension plan was invested in equities (expected return assumption of 8. Bloom BA/ LN 52-week range EV 09 (£m) Market cap.0 7.220 100.1 14. of £3. BAE contributed £399m (2007.2 0. Financial data 12/08 12/09e 12/10e 12/11e Share data Ratios 12/08 12/09e 12/10e 12/11e RIC BAES. deficit of £1. (£m) Free float (%) Performance (%) Ordinary shares 1m -1.1 Colin Campbell (44) 20 7762 5609 colin.3p Sector Weighting 440.58 5.0p Neutral Preferred stock BAE Systems Least preferred stock EADS 1 year Price 510 MA 100 Impact The group has a strong balance sheet with 2008 year-end net cash of £39m.3 39.1 1.6 10.0 8.7 1.2 nm 21.9 17.1 -9. We expect the group to generate some £400m net cash. This year. Target price & rating 2008 2009 370 300 2008 (m) 45 30 15 0 2009 We reiterate our ‘Buy’ recommendation with a target price of 440p.4 7. which will make for continuing volatility in the valuation of these assets. the group could benefit from a lump sum payment if it is able to sign a follow on equipment order from Saudi Arabia on the Salam programme. in addition. Eurofirst 300 -13.6 1.88 8.2 1.3 5.3 17.1 22.1 1.61 45.0 3m 12m -8.

6 1.4 2.9 3. Impact €38.6 0.2 0.86 potentially add >5% to our FY09e core EPS forecast.3 1.2 34.5-32. Eurofirst 300 1m 57.80 39.9 10.2 1.28 11. (€m) Free float (%) Performance (%) Ordinary shares Rel. but could BAYER AG on www. which should include an update on demand for its MaterialSciences products.2 4. (€bn) EPS (adj.5 1.89 1.98 6.3 6.3 -25.9 -11.486 97.60 46. we note that the company made a €300m cash contribution to its pension fund in 2008 and is expecting to make a similar contribution in 2009.7 46. However.4 1.5 3. shares.1 8.Pension funds Pharmaceuticals (Germany) Bayer AG Pension deficit Pension liability adds to the company’s net debt but not a big risk Pension position 12m target Hold (12m) Price 17/04/09 Changes in relevant valuation parameters such as interest rates.9 2.3 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: +32. we do not believe it 1 year Price 75 represents a concern for investors. real estate and other investments.1 4. On 3 June.1 5.58 14.78 4.DE.5 Revenues (€bn) EBIT margin (%) Rep.98 12.7% 19.50 1. and/or it may necessitate additional contributions by the 32.7 1.miemietz@sgcib.8 1. Bloom BAY GR 52-week range EV 09 (€m) Market cap.7 2. Declining or even negative returns on these investments may negatively impact the future fair value of plan assets.6 22.9 2. set on 4 March.0 3m 12m 17. Bayer will hold its Meet Management Seminar in Leverkusen (Germany).8 0.2 Sector Weighting €38. A large proportion of Bayer’s pension and other post-employment benefit obligations is covered by plan assets including fixed-income securities.2bn before pension liabilities) following the 2006 acquisition of Schering.92 10. This again may diminish equity.9 86.931 31.2 14.20 2. which generated net cash flow of €2. mortality and rates of increases in compensation may raise the present value of our pension obligations.3 3.9 16.83 1.40 50.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Marietta Miemietz (44) 20 7762 5074 marietta.40 128.7 -12. MA 100 notably from its healthcare business.3 15.61 1.9 12. Financial data 12/08 12/09e 12/10e 12/11e Share data Ratios 12/08 12/09e 12/10e 12/11e RIC BAYG. Next events & catalysts Source: SG Equity Research We expect the FDA’s decision on the anticoagulant Xarelto for acute use (VTE prevention in orthopaedic surgery) in Q2 09e.8 44. net inc.7 1.0 Overweight Preferred stock Novartis Least preferred stock Novo Nordisk While the pension liability adds to the company’s net debt (2008: €14. but believe that approval may be delayed until at least 2010e.2 4.sgresearch.6 32.05 15.3 1.30 10.98 1. Target price & rating 60 45 30 2008 (m) 24 16 8 0 2008 2009 2009 We maintain our sum-of-the-parts based price target of €38.3 32.6 0. with 2009e EBITDA possibly falling below EUR300m (vs >€1bn in 2008) according to the company (SG 2009e underlying BMS EBITDA: €265m).3bn in 2008.8 1.2 10.7 1. This may lead to increased pension costs or diminish stockholders’ equity due to actuarial losses being recognized directly in equity. A demand rebound in H2 09 looks unlikely to us.1 9. We also note that the BayerMaterialSciences (BMS) division is highly cyclical.5 20 April 2009 33 . Bayer generates strong and sustainable cash flows.socgen.45 12.8 13.3 1.7 1.

280 190 Impact 100 2008 (m) 60 40 20 0 2008 2009 The possible magnitude of BA’s deficit position at March 2009 raises the 2009 prospect that BA will need to put more cash into the schemes. at £245m (rather than a surplus of £1.) (p) Dividend/share (p) Interest cover (x) Net debt/equity (%) Jonathan Wober (44) 20 7762 5270 jonathan.7 -153 -13. then we estimate that BA’s net position under the actuarial valuation was a deficit of £1.7 0. which will determine how much BA should put into the schemes and over what time frame.0p Neutral Preferred stock Lufthansa Least preferred stock British Airways 1 year Price 370 assets in the schemes remained stable.2 9.2 Matthew O'Keeffe (44) 20 7762 5385 matthew.9 5.6 1.0 na 84. BA did not detail the differences between this actuarial valuation and the annual report.78 3. that the value of equities in the pension assets fell by 31% (in line with the fall in the FTS100) and that the value of other 174.4 nm 8.8 -0. Target price & rating Source: SG Equity Research Our 90p target price is derived by applying BA’s historic trough P/BV of 0.8 0.Airlines (United Kingdom) British Airways Pension deficit Could be twice market cap Pension position 12m target Sell (12m) Price 17/04/09 BA’s last annual report put the net position of its pension schemes at 31 March 2008 as a deficit of £437m.4 Preliminary FY09 results due 22 May.7 49.236m under IAS19).8 10.13 6.0 0. potentially compromising new fleet capex. at £1. the pension trustees published an actuarial valuation putting the deficit on its main scheme.1 1.0 3m 12m 4.5 0.7bn at 31 March 2009e (2x market cap).2 P/E (x) Price/cash flow (x) Dividend yield (%) ROIC (%) Price/book value (x) EV/IC (x) EV/EBITDAR (x) ROIC/WACC (x) CAGR 08-11e: -50.0 682 58. If BA’s other smaller schemes were as reported in the accounts.8 0.88 8. (£m) EPS (adj. NAPS.6 -20.07 7.2 0.7 -0.5-109. and/or take difficult decisions about lowering pension benefits potentially sparking union opposition. Eurofirst 300 1m 25.86 8.socgen.0 -1.1 1.wober@sgcib. (£m) Free float (%) Performance (%) Ordinary shares Rel.0 -1.437 2.0 4.021 100.44 10. or a deficit of £245m after ‘corridor’ adjustments.4 2.7 -277 -17.okeeffe@sgcib.0 0.3 0. but they related mainly to different discount rates.0p Sector Weighting 90. APS.sgresearch. Newsflow on the Iberia merger and pension valuation will also be closely watched. then we estimate that this net deficit position MA 100 could have grown to £3. It is also possible that BA will be allowed to reduce the deficit over a longer time frame. The next full actuarial valuation.2 27.2 nm 4.9 79.0 4.7 0. is due as at 31 March 2009 and is likely to be published by September.8 0.1 -1.Pension funds Transportation .87 5. With 44% downside potential we reiterate our Sell.9bn at 31 March 2008.5bn (rather than a deficit of £357m under IAS19) and the deficit on its second scheme.3 2.1 0.9 5.L.8 -1. However.0 na 70. net inc.1 0. in September 2008.5 Revenues (£bn) EBITDAR margin (%) EBIT margin (%) Rep.6 85 8.3 282. Bloom BAY LN 52-week range EV 09 (£m) Market cap.4x to our FY10e forecasts.2 23.0 3.1% 3. Assuming that its gross pension liabilities remained unchanged at 31 March 34 20 April 2009 .7 10.2 0.8 2.9 9.7 2. before adjustments under the ‘corridor’ rule. Next events & catalysts British Airways on www.75 18. Financial data 3/08 3/09e 3/10e 3/11e Share data Ratios 3/08 3/09e 3/10e 3/11e RIC BAY.8 9.9 10. This issue has added complexity to BA’s merger talks with Iberia by making valuation a more difficult subject.

e.7bn (net of 12m target Hold (12m) Price 17/04/09 91.Sales) (44) 20 7762 5755 saeed. Target price & rating We retain a Hold rating on BT. we estimate BT may need to raise its life expectancy assumptions by 2 to 3 years.5 5.6 1. Thus.) (p) Dividend/share (p) Payout (%) Interest cover (x) Net debt/equity (%) Stéphane Beyazian (33) 1 42 13 45 04 stephane.0 20.9 42.592 7.6 -25.75% (expressed in real terms) to discount its pension liabilities.8 8. As of 31 December. BT recorded a Type of investment Pension risk 1 year Price 310 MA 100 230 150 70 2008 (m) 270 180 90 0 2008 2009 2009 Source: SG Equity Research £2.1 0.3 15.4 1.9 1.4 23.8 71. raising pension liabilities by an estimated £2.1 1. (£bn) EPS (adj. This rate compares to an average 2. BT posted a pension deficit of £1. lowering discount rates and rising life expectancy.2bn.9bn shortfall driven by an accelerated deterioration in the value of its ex-equity assets. Easing long-term inflationary pressure could offset pressure from weakening equity markets on the pension assets in the short term.1 6.62 16. 3/09e 3/10e 3/11e Share data Ratios 3/08 3/09e 3/10e 3/11e RIC BT.3 Revenues (£bn) EBIT margin (%) Rep.9 1. Rising credit spreads for financial institutions boosted AA-rated bond yields and in turn reduced the BT pension deficit (as AA-rated bond yields were used to discount BT future pension liabilities). we estimated BT to have used a rate of 3.55 15. with a SoP-based price target of 105p.6 5. net inc.08 8.9 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: -0.6bn of pension liabilities.3 20 April 2009 35 .7 1.8 6. the £24.L.4 0.131 100.socgen.2bn.4 1.0p tax).4 4.9 5.3 143.9bn estimated value of the core business pales in comparison to BT’s £37.6 Ottavio Adorisio (44) 20 7762 5761 ottavio.5 21.. Lowering discount rates.8 1. Eurofirst 300 1m 235.6p Sector Weighting 105.7 174.1 1. i.3 1.6% used by actuaries in their last triennial review. but two powerful drivers could increase liabilities permanently and require additional cash funding.beyazian@sgcib. The actuaries’ final decision on discount rates could be significant since any 25bp increase in the discount rate reduces the BT pension deficit by £1.16 12.1 7. anything that increases the latter can have significant repercussions for the former.0 3m 12m 13. Impact Overweight Preferred stock France Telecom Least preferred stock Vodafone The upcoming triennial valuation may lead to a tangible increase in the BT pension deficit.2 1.1% (expressed in real terms) and life expectancy assumptions in line with Saeed Baradar (Sp. during Q3. Bloom BT/A LN 52-week range EV 09 (£m) Market cap.7 204.1 -26.0 15.3 21.3bn based on a discount rate of 3.5-71.9bn drop in the value of its pension assets with £0.0 1.1 1.baradar@sgcib.5% 5.4 -0. Value of pension assets risks derating.8 11.8 5.70 14.11 9.3 Thierry Cota (33) 1 42 13 84 45 thierry.3 Next events & catalysts Financial data 3/08 14 May – Q4 results and triennial pension review.83 12.86 6.8bn-4.8 81.As of 31 December 2008.Pension funds Diversified Telecommunication Services (United Kingdom) BT Group Pension deficit Pension risk weights on the equity story Pension position .4 5.cota@sgcib.4 21.1 1.4 1.8 6.0 169.4 42.9 7.3 -32.6 1.6 17. We include in the SoP an estimate for BT’s pension deficit of £4.8 10.69 18. However.50 12.4 6. BT Group on www. Finally.adorisio@sgcib. Rising life expectancy Benchmarking against recent triennial actuarial reviews by other FTSE100 companies.sgresearch. We therefore see greater risk of further downside should the trustee decide to adopt a more cautious stance on the less liquid portion of BT’s pension assets (such as property and alternative assets).09 8.74 18. (£m) Free float (%) Performance (%) Ordinary shares Rel.

compared with obligations almost stable at €15bn (€37bn in 2006).1bn.6 17.0 Overweight Preferred stock Vokswagen pref Least preferred stock GM As the bulk of the liabilities and deficits are located in Germany.87 2.6 0.20 43.7 95. net inc. Impact €26.7 Eric-Alain Michelis (33) 1 42 13 50 95 eric.2 na 7. Target price & rating 60 35 10 2008 (m) 60 40 20 0 2008 2009 2009 We maintain our Hold rating. Eurofirst 300 1m 24.514 26.7 Sector Weighting €24. (€bn) EPS (adj. and are not 1 year Price 85 fully covered by specific assets.45 0.978 88. the provision for pension benefits rose slightly to €4. the payments to pensions funds should not exceed €0.6 0.4 9.2bn in 2009e as indicated in the group’s latest financial report. The recent change in share ownership structure after the €1.8 Revenues (€bn) EBIT margin (%) Rep.8 3.0bn for the rest of the world (mainly the US).2 na 52.1bn due to unrecognized actuarial losses of €1.3 0.DE.4 19.7 5. On the balance sheet. €1.0 0.7 0. the group reported a deficit of €4. All in all.michelis@sgcib. Indeed.86 2.barrier@sgcib.8 nm nm P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: +12.9 -14.95n capital increase reserved for the Abu Dhabi Aabar investment fund could also reduce scope for a break-up (cars and trucks) and limit M&A conjecture.38 0.15 2.90 4. the disposal of Chrysler in 2007 considerably reduced the related risk.9 9.8 0.51 1.30 2. The bulk is related to Germany. run at a manageable €1bn.23 10. as the plan assets value decreased by 27% to €10.33 1.6 0.3 0.3 19. including a €2bn negative impact from ‘miscellaneous’ items.60 5.2 9.sgresearch. Daimler is not obliged to refund the pension funds to MA 100 reduce the deficit and does not intend to make special contributions in the coming years.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Philippe Barrier (33) 1 42 13 84 42 philippe. In 2008. which are not covered by plan assets.4 -46. Wed 29 April in 2008). with investors likely to be highly sensitive to the depth of losses.2 0.Pension funds Automobiles (Germany) Daimler Hold (12m) Price 17/04/09 Pension deficit No cash related risk on pension funds Pension position 12m target Although many investors are still keeping a close eye on pensions and benefit issues at Daimler. Next events & catalysts Source: SG Equity Research Q1 results due in April (no date yet.4 0.9 nm nm 85.0bn deficit vs c.9 8.3 2.24 8.60 40. with tougher than expected conditions in Europe and no quick rebound likely in the US.9-17. with a €4.4 3m 12m 11.3 0.6% 10. pensions and benefits should have no impact on our estimate of net cash at €6.7 0. Daimler has simply committed to contributing $1bn (€750m) to rescue funds should the US company go bankrupt.5bn by Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e RIC DAIGn.3 1.9 nm nm 94.18 3.8 2. the healthcare benefits.67 3. Our €24 TP is obtained from a SoP approach.41 2. o/w €1bn related to Chrysler.8 10.6 0.8 1.7bn.7 nm nm 36 20 April 2009 .60 45. Bloom DAI GR 52-week range EV 09 (€m) Market cap.6 4.5 0.9bn on the pension schemes. Daimler on www. (€m) Free float (%) Performance (%) Ordinary shares Rel. The stock looks moderately valued but we see high short-term risk related to the truck business. On top of this.9 2.73 1. up €3bn.socgen.50 42.

Longer-term potential is substantial: our SOP points to €19.) (€) Dividend/share (€) Interest cover (x) Net debt/equity (%) Jonathan Wober (44) 20 7762 5270 jonathan.6 0. Equities accounted for 38% of the combined assets of its schemes in Germany and abroad.917 4.8% 6.70 25.1 3.9 18.5 7.6 0.3-7.0 Neutral Preferred stock Lufthansa Least preferred stock British Airways The key point to stress is that Lufthansa’s annual transfers are voluntary and so Lufthansa has considerable flexibility regarding the cash flow consequences of its 1 year Price 19 pension position.1 0. 26.91 9. Deutsche Lufthansa on www.833m before adjustments allowed under the ‘corridor’ rule.wober@sgcib.1 Matthew O'Keeffe (44) 20 7762 5385 matthew. supported by a state-backed insurance scheme (Pensionssicherungsfond).8 5. It remains on course to achieve its aim of funding its pension obligations over a 10-15 year horizon (from 2004) in our view. in the event of bankruptcy of the sponsoring company.3 4. we reiterate our Buy rating.6 19.2 24.2 39.sgresearch. in 2004 Lufthansa decided to create a pension trust to build up assets to fund future pension payments.4 4.87 8.72 4.0 0.DE. Eurofirst 300 1m 19.40 6.2 9.4 -44.99 10.Airlines (Germany) Deutsche Lufthansa Pension deficit On course to reduce provision to zero Pension 12m target Buy (12m) Price 17/04/09 position Lufthansa reported a pension provision of € Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e RIC LHAG. The aim is to reduce the provision to zero over a 10-15 year horizon through annual transfers of €565m into the trust.6 0.78 Sector Weighting €13.0 4.Pension funds Transportation . (€m) Free float (%) Performance (%) Ordinary shares Rel.5x P/BV on which it traded 12m after the last trough would imply € SG acted as joint bookrunner in the Lufthansa's senior bond issue (6. With 41% upside potential. Impact €9. MA 100 Lufthansa only transferred €283m in 2008.74 2.5 5.6 24.9 2.9 2.56 0.0 3m 12m -8.70 3. 20 April 2009 37 .5 11 5.6 -11. It has indicated that it may not transfer the usual €565m in 2009.4 4.87 11.8 1. and the 1.2 0.3 17.8x to our FY2009e forecasts.2 629 1.7 0.1 -9.1 4.7 8.1 39.9 Revenues (€bn) EBITDAR margin (%) EBIT margin (%) Rep.1 1.okeeffe@sgcib.8 1.503 100.5 2. Pension schemes in Germany are typically unfunded and.5 0 2008 2009 2009 P/BV multiple of 0.5 0.37 0.80 5.6bn in 2007 and has transferred €3.40 3.45 0.3 0.86 8. Next events & catalysts Source: SG Equity Research Lufthansa shares go ex-dividend after the AGM on 24 April. (€m) EPS (adj.5bn since 2004.0 599 1.2 2. net inc. derived by applying LHA’s historic trough 7 2008 (m) 16.3 256 0.8 0.7 28.9 0.75% 24/03/2014 EUR). but transferred €1.socgen.8 7.400m as of 31 December 2008.2 6. and Q1 earnings are due on 30 April. Bloom LHA GR 52-week range EV 09 (€m) Market cap.49 0.7 P/E (x) Price/cash flow (x) Dividend yield (%) ROIC (%) Price/book value (x) EV/IC (x) EV/EBITDAR (x) ROIC/WACC (x) CAGR 08-11e: -1.9 26. although the underlying figure was €2.71 4. Target price & rating 15 11 Our TP remains €13.3 226 0.

4 0.05 0.23 6. Deutsche Post AG on www.2 Jonathan Wober (44) 20 7762 5270 jonathan.1-6.5 2.3 0.5 6 2008 (m) 30 20 10 0 2008 2009 2009 TNT on the basis of earnings multiples for next year.1 0. We have not included the paper component in our forecasts. This suggests that the shares are fairly valued.1bn in early January with a further €1.9 4.Pension funds Air Freight & Logistics (Germany) Deutsche Post AG Pension deficit Pension liabilities Pension position 12m target Hold (12m) Price 15/04/09 Deutsche Post is the largest employer in Germany (with 456.0 -1.1bn.6 53.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Matthew O'Keeffe (44) 20 7762 5385 matthew.1 12.4 -1.60 nm na 89.0 3m 12m -2.5 0.955 11.60 1. until the outlook is clearer we see the risk of further cuts to EPS.9bn to the disposal proceeds thereby bringing the grand total to €6.9 -24. on the assumption that these shares can be sold at market value.19 54.7 6. In connection with the sale of Postbank to Deutsche Bank.5 Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e RIC DPWGn.2bn. (€m) Free float (%) Performance (%) Ordinary shares Rel.4 52.4 6.27 17.2 1. Bloom DPW GR 52-week range EV 09 (€m) Market cap.5 1.47 -1.5 MA 100 19 12.6 1.8% 6.40 0.9 -53.0 16. Target price & rating In relative terms.65 3.22 0.8 na nm P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: -2.716 employees as of the last year-end) so it is understandable that questions about its pension liabilities arise from time to time. this would add an additional €1.okeeffe@sgcib.5 1.65 13.4 22.5 1. net inc.34 nm 0.5 0. (€bn) EPS (adj.3 36.69 1.80 4. DP is to host a Capital Markets Day at the Source: SG Equity Research same time as releasing its interim report for Q1.9 9. our sum-of-parts approach points to an unchanged target price of €9.2 6.2 6.5 Revenues (€bn) EBIT margin (%) Rep.2 11. the group plans to dispose of the 50m Deutsche Bank shares (received as part consideration) over the next couple of months. In absolute terms. DP trades at a 7% premium to its closest peer Change in management Debt reduction High dividend yield 1 year Price SG acted as Co-Lead Manager of Deutsche Postbank rights issue 38 20 April 2009 .5 0.2 8.53 0.30 Sector Weighting Preferred stock €9.0 3.socgen.3 0.60 42.6 -0.sgresearch.237 70.3 55. However.DE. On top of this. the group received €3. Next events & catalysts On 6 May 2009.60 335. for the purposes of our own forecasts we have always treated the pension liabilities as essentially additional debt so the liabilities are already captured in our numbers. but. The pension deficit was around €5bn as of the last year-end which is equivalent to around 59% in relation to its market capitalisation.5 0.wober@sgcib.27 1.60 57. However.85 0.00 Dubai Ports Least preferred stock Kuehne & Nagel Type of investment year large enough to offset most of its pension liabilities.70 1.2 0. The company has also promised at this stage to give some guidance for the full year: it is to be hoped things will be clearer then. Impact Deutsche Post is also in the happy position that it will receive a windfall this €9.6 na 6.5 1.1bn now received to give a sub-total of €4.1 13. Eurofirst 300 1m 22.4 0.

4 5. Quantitative easing in the UK may further widening the gap between UK pension assets and liabilities.2 0.Pension funds Industrial Conglomerates (United Kingdom) GKN Pension deficit Pension liabilities and high debt bring risk Pension position 12m target Hold (12m) Price 17/04/09 Pension liabilities ballooned to £834m in FY08.8 0.5 4.6 -63.) (p) Dividend/share (p) Payout (%) Interest cover (x) Net debt/equity (%) Roderick Bridge (44) 20 7762 5086 roderick.6 Gerard Moore (33)1 42 13 99 76 gerard.2 33. a WACC of 10.8-56.7 0.9 Gael de-Bray (33) 1 42 13 84 14 gael.3 76.7 0.0 0.6% and growth of 1%.4x towards the end of the year. with a 1 year Price 335 further $36m to be paid in instalments beyond 2010.1 223 31.bridge@sgcib. We believe that the UK pension fund is around 42% weighted to 12.6 5.0p Underweight Preferred stock Siemens Least preferred stock Emerson We believe debt is a significant issue for GKN.7x in FY09e. But this has been partially offset by a MA 100 £40m payment from EADS for R&D sunk into the A400m.7 0.91 5.6 12. Management is running the business for cash.0 84.38 4.41 7.L. GKN has agreed to inject £2m funding in FY09e and £20m in 2010e into the Filton scheme to protect existing employees. Financial data 12/08 12/09e 12/10e 12/11e Share data Ratios 12/08 12/09e 12/10e 12/11e RIC GKN.6 39.9x in FY09e compared to its bank covenant of 3.7 4. (£m) Free float (%) Performance (%) Ordinary shares Rel. achieve cash conversion of 80%. £95m was paid on completion for the Filton acquisition in January 2009.5 1. Next events & catalysts Source: SG Equity Research An interim management statement should accompany the AGM on 7 May 2009. GKN shares are likely to remain volatile and highly sensitive to expectations for global car production. We have a Hold rating with a 12-month target price of 70p.8 Revenues (£bn) EBIT margin (%) Rep.0 nm 2.0 3m 12m 18.6 11.5 17.3 0.8 0.0 -41.8 4. charged to the P&L.9 0.0 320.7 -79 4.0p Sector Weighting 70. Bloom GKN LN 52-week range EV 09 (£m) Market cap.35 5.9 -5. FY08 year-end net debt stood at £708m. Around half of this reflected the impact of currency movements on unfunded pension liabilities in Europe and North America and the other half reflected the dual impact of both falling discount rates and lower equity prices on the UK fund.6 2 21. Besides. (£m) EPS ( 20 April 2009 39 . The company has indicated that the notional interest cost of pensions.7 0. where we are now seeing some early signs that the GKN on www. is likely to leap from £3m in 2008 to £45-50m in 2009. an increase of £503m yoy.1 3. Our forecasts assume that GKN’s EBITDA/net interest ratio falls to 4.2 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) 4.7 nm 5.9 0. This is based on our EV/EBIT model and assumes that the group can generate a 6.socgen.6 4.sgresearch. and could even reach a run rate of 0.92 2.5 49. pension deficits can prove to be an ephemeral problem caused by movements in financial markets.3 131 18. 0 4. Target price & rating 240 145 50 2008 (m) 45 30 15 0 2008 2009 2009 The equity market cap representing 31% of EV should mean that the shares will remain volatile.0 56.50 12.8 0.9 0.186 755 100.5% margin through the cycle.moore@sgcib. But.8 2.7 0.2 1. Eurofirst 300 1m destocking process may become less acute.9 6.0 6.7 4. capital expenditure is to be around 0. net inc. Impact 107.8 0.4 39.44 194.4 14.6 0.9 0.25 7.

1 3.7 0.1 2. using a WACC of 11.1 0.3 9.0 334 35. while the company has recognisable assets of £4.socgen.9 0.864m.2 0.55 9. The latest data available from the annual report FY March 2008 showed that only 13% of the fund’s assets were invested in equities.0p Underweight Preferred stock Siemens Least preferred stock Emerson Invensys’ estimated pension deficit (£475m) represents 36% of the company’s market capitalisation.53 0. Impact 177. reducing the overall volatility.9 0.4 -36. We are looking for EBITA before restructuring charges of £234m vs guidance of £240m. Invensys on www. Target price & rating 270 195 120 2008 (m) 45 30 15 0 2008 2009 2009 We reiterate our Sell recommendation and target price of 120p.2 Gael de-Bray (33) 1 42 13 84 14 gael. Eurofirst 300 -10.507 1. The latest assessment dated 31 March 2008 pointed to a deficit of £285m.3 Rel.moore@sgcib.6% 5. cash conversion rate of 85%.9 50.0 nm nm 2. (£m) EPS (adj.0 3m 12m 11.Pension funds Electrical Equipment (United Kingdom) Invensys Sell (12m) Price 17/04/09 Pension deficit Restated pension deficit worth more than a third of the market cap Pension position 12m target As at 30 September 2008.4%.L.576m. Next events & catalysts FY results on 14 May. Source: SG Equity Research Our valuation relies on a simplified DCF. (£m) Free float (%) Performance (%) Ordinary shares 1m 2.0 nm 2. with an EV/EBIT derived terminal value.2 0.2 115 14.1 343. this scheme is subject to a triennial actuarial review with scheme trustees.4 14.8 0. we estimate that Invensys has a total pension deficit of £475m (£285m from UK scheme + £190m form other obligations using the IAS definition).8 55.0 0.1 101 12.6 2. However.11 15.3 3.2 Revenues (£bn) EBIT margin (%) Rep.2 3. net inc. As such. while the total IAS obligation represents 365% of the company’s 1 year Price 345 market capitalisation. Using the sensitivity analysis from the FY March 2008 annual report we see that by decreasing the discount rate applied to the UK pension scheme for example by 1% would lead to a £540m increase in the obligation (67p per share).53 6.2 0. This is the valuation that determines future cash flows for the company and we use this deficit in our valuation model.3 12.2 2.2 Share data Financial data 3/08 3/09e 3/10e 3/11e Ratios 3/08 3/09e 3/10e 3/11e RIC ISYS.0 11.4 0.3 2.63 8.sgresearch.431 100.1 40 20 April 2009 . Bloom ISYS LN 52-week range EV 09 (£m) Market cap. The largest obligation for the company is its UK scheme.8-122. Invensys faced a pension deficit of £288m under IAS.2 0. Invensys’ pension assets are relatively well funded.1 14.78 5.0 2. It is also reasonable to assume that such a decline in discount rates would coincide with a rise in the value of fixed rate assets.8bn and a deficit of £98m.8p Sector Weighting 120. Any changes to this deficit could obviously have a significant MA 100 impact on the group’s valuation.9 nm nm 2.5 1.38 7.58 9.0 0. which has obligations worth £3.2 0.0 1.3 7.0 3.9 1.2 Roderick Bridge (44) 20 7762 5086 roderick. tax rate of 30% and long term growth rate of 2%.3 106 13. The value of the pension obligation is £4.) (p) Dividend/share (p) Payout (%) Interest cover (x) Net debt/equity (%) Gerard Moore (33)1 42 13 99 76 gerard.5 3.4 nm nm P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: -29.0 2.

com 20 April 2009 41 .16 25.0 5.socgen.1 9. (£m) Free float (%) Performance (%) Ordinary shares Rel. Next events & catalysts Meggitt on www.0 8.5 Revenues (£bn) EBIT margin (%) Rep.2 0.0 3m 12m 8. using WACC of 9%.3 5.0 5.3 5.0 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: +2.42 level there will be a benefit of £120m to revenues and £40m to profit. the shares would trade on only 6.5 40.75% and the overseas scheme a 9.0 2.5% expected return on the equities.81 8.7 0.6 8.113 100.20 24. but ratios remain within bank covenants. We forecast the group should have positive cash flow in 2009e of £50m. Therefore.6 8. At our target price.8 1. The next results are the interims due on 4 August. which may include some comments on current trading. and 1% perpetuity growth rate.5 0.3m in 2007 to £241. Financial data 12/08 12/09e 12/10e 12/11e Share data Ratios 12/08 12/09e 12/10e 12/11e RIC MGGT.2m in 2008. This is supported by our DCF model output value of 119p. The main shift in the present value of the scheme liabilities (now £693. Eurofirst 300 1m 26.7 130 22.16 23.7%. as forex moves added £312m to debt.6 81.3 7. 260 185 110 2008 (m) 13.9 1.7 304.0 9.048m (up from £815m).72 7.7 1.7 0.9 Zafar Khan (44) 20 7762 5317 zafar.7 1.2m of the deficit is related to unfunded overseas healthcare schemes acquired with the K&F Industries acquisition.3-113.) (p) Dividend/share (p) Payout (%) Interest cover (x) Net debt/equity (%) Colin Campbell (44) 20 7762 5609 colin.19 23.sgresearch. with the UK scheme looking for a 7.L.9m.4 69.khan@sgcib.1 0.9% 8.6 62.5 9 4.91 8.8 1.0 0. the yield of 5. Our forecasts assume EPS will be below the 2008 level in both years.9 11.Pension funds Aerospace & Defence (United Kingdom) Meggitt Hold (12m) Price 17/04/09 Pension deficit Debt and pension liabilities increased in 2008 Pension position 12m target Meggitt’s net pension liabilities moved from £153.1m) was exchange rate adjustments which added £95.1 0.8 5.5m.2 -1.1 0.6 -38.2 1.6 0. we believe debt will not be a major impediment to maintaining the dividend.3 7. Net debt is £1.1 5. the group made a deficit reduction payment of £22.8 7.7 0.7 47.1 139 18.5 1.0p Neutral Preferred stock BAE Systems Least preferred stock EADS Type of investment Overvalued For 2009e & 2010e. £69. In 2008. net inc.8m to liabilities. Impact 167. this may increase after the next formal valuation of the Meggitt scheme which will take place this year with the outcome likely in March 2010. Management is keen to stress that the balance sheet remained strong and that there is absolutely no need for a rights issue.3x P/E for 2010.5 51. assuming the £/$ rate remains around the current 1.5 79 20. 52% of the scheme assets are invested in equities.6 75.2 123 19.166 The group will hold its AGM on 23 April.83 8.6 5.5 0 2008 2009 2009 Source: SG Equity Research Target price & rating We maintain our TP and Hold rating.6% offers some support.0 7.1 46.4 0. (£m) EPS (adj.8 1.7 7. we assume that civil aerospace revenues will fall by 1 year Price 335 around 5% in each year with the mix being impacted by a larger drop in the high-margin MA 100 aftermarket activities.campbell@sgcib.3p Sector Weighting 120. Bloom MGGT LN 52-week range EV 09 (£m) Market cap. The deficit is large relative to scheme assets of £451. However.4 5. terminal margin of 23.2 8.8 8.

9bn in 2010e.5 7.0 5.9 770 6.PA.1bn.85 5. Target price & rating 70 45 20 2008 (m) 6 4 2 0 2008 2009 2009 Buy rating confirmed.3 4.8 16.17 2. including all pensions and employee benefit-related items. as €452m of actuarial losses are not recognised.76 14. The total provision in the balance sheet.3 80 (+6%e). the deficit of the defined benefits pension schemes for the Michelin group stood at €867m. against €324m in 2007. the liabilities went down from €5.8 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: +26.7 73. the company’s quick reaction to adjusting operating expenses.4 445 4.00 63.03 2.40 32.9 3m 12m 6.8 67.5 2. Impact €38.9 0.0 Overweight Preferred stock Michelin Least preferred stock Continental The only effective risk concerns the cash that could be used to refund the pension schemes to meet the local regulations if there is no rebound in the stock market in 2009. capex and production adjustments justify our assumption that margins will improve sharply from 2010.4 5.0 0.0 2. which affect the P&L.5 6. essentially medical care benefits paid to the US employees and 16. Financial data 12/08 12/09e 12/10e 12/11e Share data Ratios 12/08 12/09e 12/10e 12/11e RIC MICP.00 179. These payments are not factored into our net financial debt estimate of €3.6 1.1 360 2.1bn to €4.9 -0.80 34. then by a further €100m in 2011. the cash payments might increase by 1 year Price 95 about €200m in 2010.3 3.6 1.56 7.73 9.2 Eric-Alain Michelis (33) 1 42 13 50 95 eric.2 1.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Philippe Barrier (33) 1 42 13 84 42 philippe.barrier@sgcib.4bn.5 -5.95 1.1 15. Our €42 target price is based on 2009e EV/sales moving back to the historic average of 0. Despite our recent earnings downgrade.6 1.7 1. This provision takes into account a €1.0 0. (€m) EPS (adj.41 5. (€m) Free float (%) Performance (%) Ordinary shares Rel. Next events & catalysts Source: SG Equity Research Q1 sales on 28 April. hence lower risk.9 18.8 2.4 79.8 1. While volumes are likely to drop by around 20%.0 0.9 67.3 0. net inc.8% 12. was slightly down at €2. This is based on maintained MA 100 funding requirements in the US.5 19.723 SG is acting as joint bookrunner in the MICHELIN's senior bond issue.1 5.82.2bn.3 4. Bloom ML FP 52-week range EV 09 (€m) Market cap. 42 20 April 2009 .1 12. Moreover.socgen.sgresearch. Eurofirst 300 1m 34. The medical care benefits. particularly for 2009e. we believe there will be a gradual market upturn.1 Sector Weighting €42. Thanks to a higher discount rate.116 5.6 15.10 1.96 1.6 83.7 3.5 Revenues (€bn) EBIT margin (%) Rep.6 1. As all US employees hired in the recent years benefit from defined contribution schemes. the liabilities relating to previous pension schemes should progressively decline. due to a 33% reduction in the value of plan assets (about half of which is in equities) from €4.3 1.2 9.6bn deficit related to non-covered liabilities.michelis@sgcib.1 0.7bn to €3.2-23.0 0.9 -40. we believe the market will appreciate the very positive price/mix effect Michelin on www.76 14. According to the company’s calculation.0 0.00 26.Pension funds Auto Components (France) Michelin Buy (12m) Price 17/04/09 Pension deficit Limited cash risk on pensions deficit Pension position 12m target As at 31 December 2008.0 0. are not a concern and the company has also implemented limitations on expenses.

due to the deterioration of the financial markets.Pension funds Automobiles (France) Peugeot Citroen PSA Pension deficit Cash outflows to refund pension deficits is the only concern Pension position 12m target Buy (12m) Price 17/04/09 PSA Peugeot Citroen’s defined-benefit plans concern mainly France and the UK.5 73.00 nm na 50. PSA will release its Q1 unit sales and turnover before Source: SG Equity Research market hours.0 Overweight Preferred stock Volkswagen GM Least preferred stock 1 year Price 70 employees no matter how the funds perform.0 7.7 -0. Target price and rating Target price and rating unchanged. that all the bad news is now fully discounted.4 47.536 56.0 0.95 -1. PSA offers an excellent opportunity to fully benefit from a recovery which we believe could come sooner than the market expects.3 0.7 nm 54.04 1. net inc.michelis@sgcib. Thanks to a higher discount rate.5 0.PA.26 1.2 41.4 50.5 0.5 8.26 0. 34% in 2007) and -9.socgen. €222m) in France and €229m (vs.4 0.0 0.18 6.50 2. According to the company’s calculation.4 0.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Eric-Alain Michelis (33) 1 42 13 50 95 eric.8 36.8 3m 12m 42.9 45.2 40. Next event & catalysts On 22 April.4 0.4 6.34 0.36 0. Impact As defined-benefit plans are used by PSA. the liabilities went down from €3.74 -2.1 21. We anticipate fairly weak numbers but we do not expect much of a reaction from the shares. (€bn) EPS ( SG is acting as global coordinator. it has no exposure both to the US car market and to trucks market. due to unrecognised actuarial gains of €122m.9 1.5 125.50 35.3 -129.12 170.94 0. If financial market turmoil continues in MA 100 2009.0 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 07-10e: -6. Meanwhile.4 -0. the actual return on external funds was -10% for French plans (23% of equities vs.7 Philippe Barrier (33) 1 42 13 84 42 philippe.00 nm 0.00 4.768m to €3. Eurofirst 300 1m 26.7 -58.3 Sector Weighting €20.1 -0.22 nm 0. the fair value of external funds decreased by 20% to €2.8 Revenues (€bn) EBIT margin (%) Rep. Peugeot has a fairly 50 30 10 2008 (m) 9 6 3 0 2008 2009 2009 straightforward investment case. €238m in 2007 and €302m in 2006). 55%).3 4.228m. The last year.0 nm -15.9 0.8% 3. On the balance sheet.3 0.barrier@sgcib.89 5.2 0.2 0. We forecast group sales to decline by roughly 26% to around € 58.5% for UK plans (53% of equities vs. the biggest concern by far will be cash outflows which could be brought to refund the pension deficits. the deficit increased slightly to €819m from €745m in 2007. the provision for pensions reduced to €699m.1 0. At the end of December 2008.409m. €300m) in the UK and represents roughly 19% of its market cap.7 7. pension benefits payable in 2009 are estimated at €230m (vs. lead manager and bookrunner of the planned rights issue of Faurecia 20 April 2009 43 .7-11. We expect management will give more precise guidance regarding H1 09 earnings.1 10.9 -33.28bn. Peugeot Citroen PSA on www.26 1.492 4.5 14.3 Share data Financial data 12/07 12/08e 12/09e 12/10e Ratios 12/07 12/08e 12/09e 12/10e RIC PEUP. We believe.sgresearch.3 0. (€m) Free float (%) Performance (%) Ordinary shares Rel.3 0.68 2. Bloom UG FP 52-week range EV 08 (€m) Market cap. the group must provide benefits to €19. of which €321m (vs.8 0.60 0.

2 0.8 0.65 38.5 1. optimising support functions and accelerating decision making.2 2.4 2.7% 4. Next events & catalysts To adapt to further deteriorating economic conditions.938m.8 0.7 14. Therefore. The discount rate for the (outside accrued pension as liability of 30 was reduced from to 6. Following significant changes. Stainless and Services) and new Technologies (Technologies. restructuring.2 54.3 10.44% Germany) September 2008 €18. Therefore.4 0.9 10.25 4.5 44 20 April 2009 .1 35.7 2. Source: SG Equity Research ThyssenKrupp on www. the defined benefit obligation was €6. In general.8 0.william@sgcib.94% (outside Germany) as of 31 December 2008.20 4.51 0. We see TK’s reorganisation as a way to increase the group’s efficiency by reducing management layers.30 4.24 0.79 1. (€m) Free float (%) Performance (%) Ordinary shares Rel.61 1.466 8. the fair value of plan assets was €1.6 -53.0 Overweight Preferred stock ArcelorMittal Least preferred stock Antofagasta (Germany)/5. Elevator).7 3m 12m 7.8 5. Bloom TKA GR 52-week range EV 09 (€m) Market cap.74 7.6 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: +1.7 7. In H2. Impact The future trend in corporate bond yields will be very important for the total amount of the pension liabilities.4 1.63 2.7 1. the accrued pension liability increased from €5.6 0.2 3.9 0.449 51.1 0.70 0.7 46.43 6.40 78.20 2. Q2 08/09 results on 13 May.2 50.6 14. the company could make additional contributions 10 2008 (m) 15 10 5 0 2008 2009 2009 during the next years.8 33. net inc.1 3.0 0.2 6.8 15. Target price & rating We keep a Buy rating and €19 target price.6 Revenues (€bn) EBIT margin (%) Rep.8 -5.0 16.227m.227m (as of 30 September 2008) to €5.775m (as of 31 December 2008).6-12.DE.Pension funds Metals & Mining (Germany) ThyssenKrupp Pension deficit Lower discount rate increases pension liabilities Pension position 12m target Buy (12m) Price 17/04/09 As of September 2008 the accrued pension liability was €5.1 -25.00 Share data Financial data 9/08 9/09e 9/10e 9/11e Ratios 9/08 9/09e 9/10e 9/11e RIC TKAG.socgen.00% (Germany)/6.8 0. This will yield additional cost savings of up to €500m when the new group structure is implemented as of the beginning of FY09/10. Eurofirst 300 1m 25. the group’s funding policy is to contribute 1 year Price 55 amounts to the plan sufficient to meet the minimum statutory funding requirements MA 100 relevant in the country in which the plan is located.6 6. an updated valuation was performed as of 31 December 2008. in particular regarding interest rates compared to 30 September 2008.22 5. JV’s).5 3.75% 6.1 53.7 0. We think that this could also increase flexibility for M&A moves (disposals.31 3.7 0.724m resulting in a deficit of about €5.6 0.sgresearch.84 1.7 0. TK also announced the reorganization of its operating segments into two divisions: Materials (Steel.30 28.5 0.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Alain William (33) 1 58 98 12 61 alain.2 Sector Weighting €19. (€bn) EPS (adj.1 18.214m.0 46.5 0.4 0.0 25. TK should 40 benefit the most from a sharp drop in input costs while a recovery in apparent demand 25 should also enter into play.40 16.

Owing to current financial market turmoil.54 0.8 3m 12m 64. obligations decreased from €933m in 2007 to €843m thanks to higher average discount rate.39 226. Financial data 12/08 12/09e 12/10e 12/11e Share data Ratios 12/08 12/09e 12/10e 12/11e RIC VLOF.2 give us more precise guidance for 2009 when reporting Q1 figures.1 nm 2. but it should also be the worst quarter of the year.9 105 1.9 0.5 27.PA.0 0.5 69. with the average age of the group’s workforce at around 8.socgen.Pension funds Auto Components (France) Valeo Pension deficit High exposure to the equity market Pension position 12m target Buy (12m) Price 17/04/09 At 31 December 2008.1 -37.35 11. as indicated in the most recent group financial report.3 6. 72% in 2007) and particularly where the group is the most exposed in terms of pension liabilities (Europe and North America). Valeo is still booking new contracts that should provide additional sales on the top of the cyclical recovery.7 8. Meanwhile. €300m in 2007).0 0.48 0.3 0.0 10. The bulk is related to Europe (mainly Western Europe) with a deficit of €344m (vs.2 -90 -0. Next event & catalysts On 24 April.9 7. Last year the actual return on asset plans was a negative €75m.9 0.5 0.50 0.5 0.4 0.8 0. Target price and rating Target price and rating unchanged. 2009 should be a very tough 26 17 8 2008 (m) 2. up €11m.sgresearch.0 4.3 195 2.3 0.1 Philippe Barrier (33) 1 42 13 84 42 philippe. No doubt Q1 will see a severe loss.31 0. the only concern will be cash 1 year Price 35 outflows which could be used to refund the pension deficits. down €15m and this represents roughly 50% of its market cap. Valeo will report Q1 09 earnings.1 0.9 20 April 2009 45 . equity securities are typically the best class of asset for long-term plan benefit obligations (best returns on LT compared with bonds). the provision for pensions and other employee benefits rose slightly to €611m from €608m.4 Revenues (€bn) EBIT margin (%) Rep.0 61. €435m in 2007) and North America with a deficit of €220m (vs. When we look closely at the MA 100 breakdown of plan assets.4 P/E (x) FCF yield (/EV) (%) Dividend yield (%) Price/book value (x) EV/revenues (x) EV/EBIT (x) EV/IC (x) ROIC/WACC (x) CAGR 08-11e: nm nm 8.31 7. (€m) EPS (adj.25 1. Valeo is very exposed to shares.816 1. which represent 62% of the total plan (vs.0 0.00 nm 0. Valeo posted a deficit of €618m on the pension plans.2 Sector Weighting €12.9 0.barrier@sgcib.0 10. (€m) Free float (%) Performance (%) Ordinary shares Rel. Eurofirst 300 1m 45. The payment to pension funds should be around €28m in 2009e.80 19.2 0.0 Overweight Preferred stock Michelin Least preferred stock Continental If the collapse in stock markets continues in 2009.9 0. net inc.3 7.19 0. We expect management to Valeo on www. the value of the plan assets decreased to €225m (vs.2 7.3 0.13 2. €155m in 2007). Bloom FR FP 52-week range EV 09 (€m) Market cap.5 0.0 27.34 4.5-8. However.3 7.75 0 2008 2009 2009 Source: SG Equity Research year for the Group but it should benefit from its innovative products and from its global presence to come out of the crisis stronger than its main competitors.81 0.) (€) Dividend/share (€) Payout (%) Interest cover (x) Net debt/equity (%) Eric-Alain Michelis (33) 1 42 13 50 95 eric.296 61.9 54.29 nm 0. mainly due to actuarial gains of €56m and a negative impact from changes in the scope of consolidation (€12m).3 84.78 2.michelis@sgcib. On the balance sheet.6 -206 -2.82 -0.00 nm na 60.6 3.5 -0. compared with a gain of €23m in 2007. Impact €15.

In an unfunded defined benefit pension. Despite the fact that the participant in a defined contribution plan typically has control over investment decisions.Pension funds Appendices – Definitions Defined contribution plan A defined contribution plan will provide a payout at retirement that is dependent upon the amount of money contributed and the performance of the investment vehicles utilised. contributions from the employer. Money contributed can either be from employee salary deferral or from employer contributions. rather than depending on investment returns. as more and more employers see pension contributions as a large expense avoidable by disbanding the defined benefit plan and instead offering a defined contribution plan. the member's account is used to provide retirement benefits. the plan sponsor may not have the financial resources to continue funding the plan. no assets are set aside and the benefits are directly paid to the retired employees. with benefits paid directly from current workers' contributions and taxes. and are now the dominant form of plan in the private sector in many countries. For example. investment risk and investment rewards are typically assumed by the sponsor/employer and not by the individual. Defined benefit plan A defined benefit plan guarantees a certain payout at retirement. Defined contribution plans have become widespread all over the world in recent years. often through the purchase of an annuity which then provides a regular income. The portability of defined contribution pensions is legally no different from the portability of defined benefit plans. In a funded plan. for example in the stock market. and the returns on the investment (which may be positive or negative) are credited to the individual's account. The pension deficit (or surplus) should be treated as debt (or financial assets) on an after-tax basis and added back to enterprise value and capital employed. because of the cost of administration and ease of determining the plan sponsor's liability for defined contribution plans. and sometimes also from plan members. If a plan is not well funded. In a defined contribution plan. To do so. On retirement. defined contribution plans have become generally portable. investment risk and investment rewards are assumed by each individual/employee/retiree and not by the sponsor/employer. the contributions to be paid are regularly reviewed in a valuation of the plan's assets and liabilities. However. Pension arrangements provided by the state in most countries in the world are unfunded. A traditional defined benefit plan is a plan in which the benefit on retirement is determined by a set formula. Typically. The future returns on the investments and the future benefits to be paid are not known in advance. contributions are paid into an individual account for each member. so there is no guarantee that a given level of contributions will be enough to meet the benefits. the plan sponsor retains a significant degree of fiduciary responsibility over investment of plan assets. This means that in a defined benefit pension. are invested in a fund towards meeting the benefits. The contributions are invested. the number of defined benefit plans in the US has been steadily declining. including the selection of investment options and administrative providers. in practice. carried out by an actuary to ensure that the pension fund will meet future payment obligations. Defined benefit plans may be either funded or unfunded. we use the 46 20 April 2009 . In a defined contribution plan.

IAS 19 applies to (among other kinds of employee benefits): wages and salaries compensated absences (paid vacation and sick leave) profit sharing plans bonuses medical and life insurance benefits during employment housing benefits free or subsidised goods or services given to employees pension benefits post-employment medical and life insurance benefits long-service or sabbatical leave 'jubilee' benefits deferred compensation programmes termination benefits.000 300 (700) (20.Pension funds difference between the companies’ benefit obligations and the fair value of the plan assets (as detailed in the notes to the balance sheet). unless otherwise stated) Philips Amounts recognised in the balance sheet Prepaid pension costs Provisions for pensions Other post-retirement benefits Total obligations recognised in the balance sheet Amounts presented in appendices Benefit Obligation (1) Fair Value of plan assets (2) Underfunded pension liabilities =(1)+(2) Other post-retirement benefits Total liability treated as debt on a pre-tax basis Unrecognised gains/losses in the balance sheet (+) / (-) Source: SG Equity Research (2. 20 April 2009 47 . It also explains how the pension asset or liability may be affected by a statutory or contractual minimum funding requirement.000 (1.000) 300 (700) 0 Objective of IAS 19 The objective of IAS 19 (Revised in 1998) is to prescribe the accounting and disclosure for employee benefits (that is. all forms of consideration given by an enterprise in exchange for service rendered by employees). This interpretation does not have any impact on the group’s financial statements.000) 19. The principle underlying all of the detailed requirements of the Standard is that the cost of providing employee benefits should be recognized in the period in which the benefit is earned by the employee. Adjusting debt for pension liabilities – an example (€m. Minimum funding requirements: IAS 19 It provides the guidance on assessing the limit on the amount of the surplus that can be recognized as an asset. rather than when it is paid or payable.000) 1.

In the long term. actuarial gains and losses may offset one another and. a portion of that net gain or loss is required to be recognised immediately as income or expense. actuarial gains and losses arise that comprise experience adjustments (the effects of differences between the previous actuarial assumptions and what has actually occurred) and the effects of changes in actuarial assumptions. The portion recognised is the excess divided by the expected average remaining working lives of the participating employees. On an ongoing basis. The rate used to discount estimated cash flows should be determined by reference to market yields at the balance sheet date on high quality corporate bonds. These include both formal plans and those informal practices that create a constructive obligation to the enterprise's employees.although the enterprise may choose to do so. changes in benefits under the plan will result in increases or decreases in the enterprise's obligation. 48 20 April 2009 . Under a defined contribution plan. A defined benefit plan is a post-employment benefit plan other than a defined contribution plan. Over the life of the plan. the enterprise is not required to recognise all such gains and losses immediately. Projected unit credit method valuations The present value of the defined benefit obligation should be determined using the Projected Unit Credit Method Valuations which should be carried out with sufficient regularity such that the amounts recognised in the financial statements do not differ materially from those that would be determined at the balance sheet date. The standard specifies that if the accumulated unrecognised actuarial gains and losses exceed 10% of the greater of the defined benefit obligation or the fair value of plan assets. Actuarial gains and losses that do not breach the 10% limits described above (the 'corridor') need not be recognised . The assumptions used for the purposes of such valuations should be unbiased and mutually compatible. as a result. the enterprise pays fixed contributions into a fund but has no legal or constructive obligation to make further payments if the fund does not have sufficient assets to pay all of the employees' entitlements to post-employment benefits.Pension funds Types of post-employment benefit plans The accounting treatment for a post-employment benefit plan will be determined according to whether the plan is a defined contribution or a defined benefit plan.

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A unique and innovative approach Global coverage from Europe Does it make sense to cover EADS without covering Boeing? GDF Suez without Gazprom? Or SAP without Oracle? No Does it make sense for Renault and Nissan to be covered by different analysts in different countries? Or H&M without Esprit? No BARR ranking for some of our recent global recommendations * Didier Laurens SolarWorld and Sunpower # 4 BARR Tesco and Safeway H&M and Anne Critchlow Esprit GDF Suez and Gazprom ABB and Emerson Holcim and Cemex EADS and Boeing # 1 BARR Tom Gadsby # 5 BARR Thierry Bros # 1 BARR Emmanuelle Axa and AIG Cales SAP and Oracle Renault and Honda # 1 BARR Gerard Moore # 1 BARR Richard Nguyen # 1 BARR Muriel Fellous # 4 BARR Philippe Barrier # 3 BARR Zafar Khan # 2 BARR # BARR = Bloomberg reco. Ranking at 30/03/09 .

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