U.K. Retailers, The Bond Market's Not Finished With You: Gadfly
John Lewis department stores, Next, Primark owner Associated British Foods. A slew of household retail names have already said this month that their pension obligations have worsened, thanks to the fall-out from Brexit.
It's going to get worse. Much worse. With the referendum vote fueling demand for investment havens, and the Bank of England wading back into the bond market to stoke growth, debt yields are dropping, and that's raising the burden of company pension obligations.
Some of Britain's biggest retailers will reveal the extent in the coming few months.
First up is Tesco, which will report interim results next week. Some analysts and pensions experts reckon its shortfall could have widened to about 4 billion pounds ($5.2 billion) to 5 billion pounds. That's about 30 percent of its market capitalization.
The company is already paying 270 million pounds a year into its pension fund, but if conditions don't correct themselves soon, it could face making higher contributions. Though chief executive Dave Lewis is working to improve sales and cut borrowings, Tesco still had debt and debt equivalents of 12.9 billion pounds at the end of February, so putting yet more money into the pension fund would be unwelcome.
Luckily, Tesco doesn't have a triennial valuation coming up until next year. The outcome of this will be used to decide how much it will have to put in to close its pension gap.
But there's no need to wait to get more detail on how lower bond yields might drag down discount rates, thereby raising the amount a company has to set aside now to cover future obligations. Many retailers have already spelled out their sensitivities in their annual reports.
Tesco says a 0.1 percentage point change in its discount rate alters its pension obligations by 312 million pounds. So, a 1 percentage point drop would imply that the deficit would widen by about 3 billion pounds -- though analysts at Barclays note that gains in the value of assets held in the plan, along with deferred tax, might reduce the impact to about 2 billion pounds.
Tesco's not the only grocer in this position. Sainsbury, which had a pension deficit of 389 million pounds as of March, revealed in its annual report that a 0.5 percentage point fall in the discount rate would inflate its pension obligations by 859 million pounds. So a 1 percentage point drop in the rate implies about 1.7 billion pounds more liabilities.
As with Tesco, that could be offset by higher asset values, but there's still a prospect that the company will have to shoulder a bigger burden. Analysts at Bernstein estimate the end result could double Sainsbury's deficit to about 800 million pounds.
The efforts Marks & Spencer has been making to stay on top of its pension commitments may soften the blow from the current environment. Its latest annual report showed a surplus of 824.1 million pounds in March. It reckons that a 0.25 percentage point decrease in the discount rate would cut the surplus by 90 million pounds. So even a 1 percentage point decline should still leave it with more assets than liabilities. And, it's hedged against interest-rate movements.
It's a similar picture with Morrison. The Northern grocer said earlier this month that its discount rate had fallen from 3.7 percent -- pretty typical among the big retailers -- to 2.4 percent. But since it also had an interest-rate hedge, its pension surplus actually rose.
The Bank of England has recognized that the pressure on yields that follows from its easing policy can leave companies in straitened positions, having to forgo investment or spending on staff in order to meet higher pension obligations. Policy makers should pay heed to the price war that supermarkets are still fighting, and the growing trend for high-street shoppers to draw in their purse strings.
While some shops may so far be weathering the storm, even the best-prepared should brace for a struggle. Movements in bond yields have been so extreme that few are likely escape a mauling.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
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