Interest rates, gilt yields and corporate bond yields have fallen materially in the UK and with these a factor in determining the rate used to discount corporate pension liabilities, the low rates result in a significant increase in pension deficits.
This was recently highlighted by main market listed Carclo, a global supplier of technical plastics products based in Osset, West Yorkshire. Carclo announced in August that their increased IAS 19 pension deficit would have the effect of extinguishing their available distributable reserves, which meant the company would not be able to pay its final dividend.
While trading might be fine, a good proportion of cash being generated by many main market companies is now being redirected to top up growing pension deficits, as opposed to reinvestment in the business to support growth or return to shareholders via dividends and share buybacks.
The latest Pension Risk Survey by consultancy Mercer showed pension deficits among FTSE 350 companies rose by £70bn to £936bn, leaving a record collective accounting deficit of £189bn. Mercer’s data covers around 50 per cent of FTSE 350 companies.
While there are mature businesses on AIM which have pension deficits, it’s much more of a rarity for an AIM business to have a pension deficit. AIM is largely made up of more youthful enterprises who aren’t weighed down by the baggage of history.
Flooring manufacturer James Halstead and soft drinks Group Nichols are two well-established AIM companies that are popular with inheritance tax planning investors. While both have pension deficits they are also cash rich and can easily support their pension funding requirement without impacting their dividend, which has, in the case of James Halstead, been consistently raised for more than 40 years.
While the low oil price has been a significant challenge for Sheffield-based specialist engineer Pressure Technologies, thankfully the AIM quoted business hasn’t had to contend with the additional cash demands of a pension deficit. This has meant that positive operating cash flow has been retained in the business to support growth and debt reduction as opposed to an historic pension issue.
AIM listed EMIS Group is a major provider of healthcare software in the UK. It was founded by Dr Peter Sowerby and Dr David Stables, both GPs in North Yorkshire, and Tony Jones. The group was admitted to AIM in 2010 at a share price of 300p and market capitalisation of £175m which has now soared to 873p and £500m respectively.
The group’s defined contribution pension scheme was wound up during 2009 and there is no leftover defined benefit scheme. The business is highly cash generative and with no legacy issues to contend with cash can be recycled into new product development and acquisitions.
AIM quoted Fulcrum Utility Services is a Sheffield-based energy solutions company. A framework contract with British Gas underpins the business.
However, it is the expanding pipeline operation that looks really interesting. Cash generated from installations is being used to build its estate of owned pipeline assets, which would be constrained if cash had been needed to prop up a pension deficit, which thankfully isn’t the case.
Investors can be confident that AIM is no longer the ‘Wild West’ market of old, where speculative resource stocks and unknown international companies proliferated.
It is now home to many well-managed, profitable, dividend yielding, predominantly UK-based, businesses, the majority of which are thankfully also free of pension issues.