October 13, 2016 / 6:25 PM / 3 years ago

U.S. companies' reduced pension costs could lead to earnings surprises

NEW YORK (Reuters) - A little-noticed change in corporate pension funding rules could help more U.S. companies beat their earnings estimates this quarter at the expense of higher costs down the road.

In September 2015, the U.S. Securities Exchange Commission adopted new rules that allow companies to opt for a so-called spot rate approach, which essentially allows them to get a short-term decline in service and interest costs in exchange for recognizing more of their defined benefit pension payments over time.

The drop in pension costs among the 210 companies that have adopted the new approach has boosted pre-tax earnings by an average of 2.6 percent this year, said David Zion, an analyst at Credit Suisse.

At 10 companies, including United Technologies Corp (UTX.N), PepsiCo Inc PEP.N, General Mills Inc (GIS.N) and 3M Co (MMM.N), pension savings have accounted for more than 50 percent of their earnings growth over the last year, Zion said.

Overall, S&P 500 companies are expected to show that earnings slipped 0.7 percent in the third quarter, according to Thomson Reuters estimates.

While pension-related gains are “not too shabby in the current environment,” investors should be wary because these “low-quality” earnings do not reflect any gains in the underlying fundamentals of a business, Zion said.

“It’s when times get tough that companies tend to push the envelope,” Zion said.

Few analysts and fund managers focus on pension costs as part of their analysis of a company, and most companies do not discuss their pension-funding plans on quarterly earnings calls.

PepsiCo, for instance, reported earnings per share 6.4 percent higher than analyst estimates in its most recent results, according to StarMine data. General Mills, meanwhile, reported earnings per share 3.6 percent higher than consensus estimates.

“We really don’t take that into consideration at all” said one portfolio manager who did not wish to be identified by name who has a significant position in Ashland Global Holdings Inc (ASH.N), a company that Credit Suisse expects will get a roughly 15 percent in earnings this year after adopting the spot-rate plan.

Not every company that has adopted the spot-rate approach has been successful in keeping its costs at bay.

Shares of Alcoa Inc (AA.N), which saw a 40 percent boost to its pre-tax income over the last year after adopting the new funding approach, fell nearly 15 percent after the company missed estimates and said it had reached an agreement with U.S. pension insurer Pension Benefit Guaranty Corp. The company will improve its funding status by making $150 million in additional payments over the next 2-1/2 years.

Reporting by David Randall; editing by Grant McCool

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