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Saturday, September 26

Response to Barel Karsan's Post : Twin Obligations

Many frugal misers invest in the stock market. Just like I would never overpay for a new outfit, I prefer value in investing as well. One blog that I follow is Saj Karsan's value investing blog. One of his entries this week discussed the underfunded pension obligations of Twin Disc (TWIN), a Wisconsin company that sells marine and heavy duty off-highway power transmission equipment. The stock dropped 14% Friday following publication of this story. The thesis of his article is that Twin Disc has a pension plan that is underfunded by $60MM. Since the company is only valued at $160MM, the pension obligation should be a concern to investors.

I agree that this $60MM pension obligation should be a concern, but let's make sure we understands how this obligation increased from $34MM last year. Like many pension funds, Twin Disc invests its assets in the open market.

  • In 2009, TWIN began the fiscal year (which ended June 30th) with $111MM in plan assets. The company lost $24MM due to the perils of the market. The company paid out just under $9MM in benefits. On June 30, 2009, the pension plan had assets of $77MM.
  • In 2008, TWIN began the fiscal year with $117MM in plan assets. Those assets experienced a negligible gain, but the company paid about $9MM in benefits.

Okay, so for the last two years, the company's plan assets have declined from $117MM to $77MM. The bulk of this decline can be attributed to declining markets and not by mismanagement. If it were due to mismanagement, I would be running in the opposite direction as fast as I could. But, if you go back one more year, to 2007, TWIN began the fiscal year with $104MM in plan assets. The plan earned $14MM on those assets, but only paid out $9.7MM in benefits. Additionally, the company contributed $8.8MM to the plan. So while the company began the fiscal year with $104MM, it ended it with $117MM.

The company has frozen benefit accruals effective August 1, 2009. It estimates benefit payments will average $10MM per year through 2019. It also reports a historical return of 8.5% on its investments. The company needs $118MM in assets earning 8.5% annually to fund pension obligations out of earnings.
  • With markets rebounding, isn't it possible that pension assets could grow by more than 8.5% this year?
  • The company earned $11MM in fiscal 2009, and paid out $3MM in dividends. Assuming business only improves from here, could profits be diverted to the pension plan?
My point is that the pension plan is underfunded, but this should be an item of concern and not one to despair over. With a market cap at $128MM, the P/E ratio based on 2009 earnings is 11. The value investor has to decide whether this is a good price. I'd like to see the stock at $10/share or less, which would give this a trailing P/E in the single digits.

1 comment:

  1. Hi Frugal,

    Good post. I agree the underfunding is nothing to despair over; I bring it up only as a key item investors must include as part of their valuation. I also agree that as the markets have recovered, the plan's assets have likely gained to some extent. However, relying on the market to increase or even stay at its current level is risky, as things may not go as expected, so DB pension plans always carry some risk.