Delta galvanises value instinct
Posted on May 20, 2009 by Richard Beddard
Filed Under Companies |
In practice:
A company with tangible problems and a commitment to fixing them
I’m grateful to Delta (DLTA ), a British engineer that operates mostly in Australia, for helping me get a step closer to deciding when it’s a good time to invest in a company with a gargantuan pension fund.
The answer may well be when it’s managed to offload enough of it’s pension obligation that the value of the fund no longer dwarfs the value of the company, especially if the company appears to be doing well, and it has over a hundred million pounds in cash stashed in various bank accounts.
Aga (AGA), the cooker company, is not quite in this position, and you may have read me agonising about it before, many times . Although it’s in surplus, its pension fund is worth about ten times more than the market capitalisation of the company, enough to put me off for now.
The problem with large defined benefit pension funds is that wild swings in their value can put huge liabilities on company balance sheets, which they might have to plug with future profits. Companies in this position must prioritise pensions over, say, expansion, hoarding cash lest they need it to shore up the fund and eschewing debt, which would add to their liabilities.
There’s no getting away from the pension issue as proud companies with long histories, like Aga and Delta, are quite likely to have big pension funds and lots of retirees drawing on them. They’re also the kind of ‘boring’ company that attract value investors.
It’s not a problem I imagine the grandfather of value investing, Benjamin Graham , faced. In his day, pensions funds were much smaller. More recently, thanks to the mother of all bull markets, pension funds, had more money than they knew what to do with.
Times change!
Delta and its pension fund trustees have paid Pension Corporation , which, incidentally, owns a big stake in Aga, to take on the pensions of former employees who had retired by December 2007. Now PIC has provided them with annuities, Delta is only responsible for the pensions of existing employees and retirees who have deferred their pensions or retired since then.
It means that Delta’s pension obligation has fallen from £631m, more than three times the company’s market capitalisation, to £197, little more than the value of the company. It’s still enough, the company thinks, to make it unattractive to investors, so the company will continue its quest to reduce the size and ‘de-risk’ its pension.
Obviously, there are two sides to this transaction and PIC must think it can profit by taking on a chunk of Delta’s pension fund. Maybe Delta could have continued to finance the whole fund, and save itself some money in the end. But I think the company’s right. Investors are sceptical of companies with large and volatile liabilities (look at banks) and by reducing the size of its pension fund it’s making it much easier to evaluate the investment opportunity.
Since the pension deficit is only £2.5m and with the shares costing no more than the value of Delta’s net working capital, the value of its current assets minus all liabilities, I think the shares are cheap.
Particularly since the company is financially strong, after a year in which it sold more road safety barriers and power and street light poles, and galvanised more metal than before, a year in which profit margins rose, as commodity prices fell and demand remained strong thanks to a resilient Australian economy.
Even the Australian economy should contract this year though, according to the Economist, (although much less than America, Asia and Europe, which together account for a third of turnover) and Delta’s chief executive is cautious about his company’s prospects in 2009 in comparison to an ‘exceptional’ 2008.
Graham would have preferred a margin of safety, that the shares cost substantially less than net working capital, to declare the company a bargain, but I think its legitimate to pay more because Delta’s financial strength means its fate is in its own hands. It’s busy pruning businesses, like Manganese Metal Company, a South African company it part-owns, and Investment Tooling International, its last remaining British business, and investing the money in engineered steel, galvanising services, and reducing its pension obligations.
I like a company with tangible problems and a commitment to fixing them. The problems, pension obligations and over-diversification, may be putting other investors off, but the solutions are already working.
Delta’s ten year price earnings ratio is 11. Again, by this measure of value it’s not desperately cheap (somewhat arbitrarily I think a company must limbo under a PE of 10 or less to be an obvious bargain) but it’s probably close enough bearing in mind its F_Score, a measure of financial strength, which is eight out of nine.
Its recent annual report, and earlier reports are on its website .
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