Sunday, July 29, 2012

NARS - misleading accounts re pension deficit

An interesting situation occurred last week, which I think deserves further consideration. As you know, the format here during the week is that I spend a manic hour each day between 7-8am reading as many results RNSs as I can, and then publishing a report on them here.


The key USP is that I don't just say xyz plc has delivered profits up 20%, divi up, etc. What I try to do is put it into context, and comment on whether the shares look good value or not (NB this is never financial advice, but is purely me expressing my opinion on shares). So if the share that delivers a 20% rise in profits is priced on a PER of 30, then I will point that out, and state that it's probably fully-priced, or even over-priced.


Very few other commentators do this - all too often I read reports which give the headline numbers, but don't even attempt to put that into context, making their reports meaningless.


So far so good. However, the danger of my format is that because I'm rushing to crunch the numbers in 5-10 mins per company, then I only have time to look at the headline figures, the key Outlook Statement, have a quick glance at the Net Cash/Debt (which is obviously a major factor in deciding whether or not the PER is reasonable), and then a very quick review of the P&L and Balance Sheet. I don't usually have time to look at the cashflow, or notes to the accounts, nor do anything other than a quick skim of the narrative.


So this means I will miss things from time to time. Hence the key message is always do your own research - which ideally should include downloading & reading the last Annual Report - reading the whole thing. Time-consuming yes, but it will throw up any "funnies" such as pension fund problems, different categories of share capital which you occasionally find (although very rare), issues such as litigation, etc.


Also, the other key message is that if you spot anything that you think I've overlooked, then please let me know a.s.a.p. either by email, or best of all by using the comments feature below the Blog here. I'll always check, and promptly correct anything that doesn't look right.


I commented favourably on results from Nationwide Accident Repair Services plc (NARS) last week, on the basis that they had just issued a brief in-line trading statement, which said as follows;


"Following our recent announcement on 1 June 2012, Nationwide is pleased to confirm that trading during the six months to 30 June 2012 was in line with management expectations and the cash position of the Group remains strong. "


So I checked out the figures, and the shares appeared to be on a current year forecast PER of just 6.3, and to have a stinking dividend yield of almost 9%, which looks sustainable.

I quickly checked the Balance Sheet next, and was pleased to see an apparently strong Balance Sheet, with the most recent one looking like this (here is the link to the most recent accounts);


NATIONWIDE ACCIDENT REPAIR SERVICES PLC
CONSOLIDATED STATEMENT OF FINANCIAL POSITION
At 31 December 2011
                                                                                                                                                               


2011
2010

Notes
£'000
£'000
Assets



Non‑current assets



Goodwill

6,266
7,768
Property, plant and equipment

11,353
12,066
Pension assets

11,391
9,589


29,010
29,423
Current assets



Inventories

2,459
3,148
Trade and other receivables

28,113
27,322
Current tax receivable

692
-
Cash and cash equivalents

7,995
7,459


39,259
37,929
Total assets

68,269
67,352




Liabilities



Non‑current liabilities



Long-term provisions

2,621
40
Deferred tax liabilities

2,525
2,621


5,146
2,661
Current Liabilities



Short-term provisions

1,353
31
Trade and other payables

35,740
33,800
Current tax liabilities

-
164


37,093
33,995
Total liabilities

42,239
36,656
Net assets

26,030
30,696




Equity



Equity attributable to the shareholders of the parent



Share capital
6
5,400
5,400
Capital redemption reserve

1,209
1,209
Share premium account

11,104
11,104
Revaluation reserve

8
8
Retained earnings

8,309
12,975
Total equity

26,030
30,696



In the context of a £26m mkt cap, that looks OK to me. £26m net assets too, and even after writing off Goodwill (which I always do, as it's just a book entry to record the surplus over net assets paid for acquisitions) we still have Net Tangible Assets of £26m.
Plus there is a net cash position, and the balance sheet looks to me sensibly structured, with a £2m net current assets position, and only £5m of long-term liaibilities.

It's a mature business which generates consistent EBIT of around £6-7m p.a., so far this all looks fine.

So  I went ahead & flagged up these shares as looking interesting & good value on this Blog.

Imagine my horror then when my friend Mark B kindly commented on this Blog that NARS actually has a an unfunded pension fund deficit of £26.1m which is only disclosed in Note 5 to the accounts, but not shown on the Balance Sheet at all!
In fact, worse than this, they have used what I can only describe as accounting trickery to disclose a completely false position of a pension fund asset of £11.4m on the Balance Sheet.

I see that the Balance Sheet above fails to put a "note 5" flag next to the pension fund asset. Funny that, since they do flag up notes 2,3, 4, and 6 on the face of the P&L and Balance Sheet. One might be forgiven for imagining that they are trying to bury the bad news in the notes. In fact, unless you had read note 5 to the accounts, you would be totally unaware that this company actually has an unfunded pension deficit (i.e. a liability) equal to its entire market cap, and that the £11.4m pension fund "asset" on its balance sheet is non-existent!

How on earth can this be done? And why is it legal?


There is an excellent discussion on this matter on TMF here, well worth reading in full (bear in mind that the deficit has since increased to £26m)

Note 5 to the accounts explains (sort of) how they managed to spirit away a £26m liability, and falsely show it as an asset (sorry this is very long, but I've included it in its entirity, as it's important - I have highlighted in yellow the key figures);


5.         PENSION AND OTHER EMPLOYEE ASSETS/OBLIGATIONS

The Company operates a funded pension scheme in the UK. The Fund has both defined benefit and defined contribution sections. Since 1 January 2002 the Fund has been closed to new members. Active members of the Fund ceased to accrue further benefits in the defined benefit section on 31 July 2006. Under the current Schedule of Contributions, contributions to the Fund for the year beginning 1 January 2012 will be £2.6m. This disclosure is in respect of the defined benefit section of the Fund only.

The Company has opted to amortise all actuarial gains and losses above the corridor (10% of the greater of assets and liabilities) over a term of 15 years (2010: 17 years).

A full actuarial valuation of the scheme was carried out as at 31 December 2011 by a qualified independent actuary. The major assumptions used by the actuary were (in nominal terms) as follows:

IAS 19
2011
2010
2009
2008
%
%
%
%
The major assumptions used by the actuary were (in nominal terms):




Discount rate
4.8
5.6
6.0
6.5
Rate of increase to pensions in payment
3.0
3.0
3.0
 3.0
RPI rate of inflation
2.80
3.30
3.5
2.7
CPI rate of inflation
2.10
2.60
n/a
n/a

Assumed life expectancies on retirement at age 65 are:


31 Dec 2011
31 Dec 2010



Current Pensioners
Current Pensioners
Retiring today:
Males

21.2
21.1

Females

23.8
23.7


31 Dec 2011
31 Dec 2010



Future Pensioners
Future Pensioners
Retiring today:
Males

20.9
20.8

Females

23.5
23.4
Retiring in 20 years time:
Males

22.8
22.7

Females

25.4
25.3

The assumptions used in determining the overall expected return of the scheme have been set with reference to yields available on government bonds and appropriate risk margins. The pre and post retirement mortality assumptions use the A92 and PA92 tables respectively. The 1992 series of mortality tables were published by the Continuous Mortality Investigation Bureau and are based on mortality data from life assurance companies over the years 1991 to 1994 inclusive. The "A92" tables are based on the mortality experience of life assurance policyholders. The "PA92" tables are based on the mortality experience of pension annuity policyholders.
  
The assets in the scheme and the expected rate of return were:

2011
2010
2009
2008

Long term rate of return expected

Value £'000
Long term rate of return expected

Value £'000
Long term rate of return expected

Value £'000
Long term rate of return expected

Value £'000
Equities
8.7%
37,563
8.5%
39,723
9.2%
33,940
9.6%
26,575
Bonds
3.9%
13,093
4.9%
13,220
5.2%
12,776
5.2%
9,668
Property
8.7%
4,704
8.5%
4,570
9.2%
4,212
9.6%
4,378
Other
2.9%
1,796
3.9%
1,793
4.2%
2,012
4.2%
3,047
Total market value of assets

57,156

59,306

52,940

43,668
Present value of defined obligations (funded plans)

(83,251)

(73,366)

(73,195)

(60,131)
Present value of unfunded obligations

(26,095)

(14,060)

(20,255)

(16,463)
Unrecognised actuarial losses

37,486

23,649

28,904

24,082
Net asset in balance sheet

11,391

9,589

8,649

7,619
Actual return on assets in period

(1,967)

5,781

8,752

(11,783)

Reconciliation of opening and closing balances of the present value of the defined benefit obligations


2011
2010
2009
2008

£'000
£'000
£'000
£'000
Benefit obligation at beginning of year
73,366
73,195
60,131
65,040
Interest cost
4,031
4,331
3,842
3,911
Contributions by scheme members
-
-
-
-
Actuarial (gain)/loss
8,637
(2,145)
11,284
(6,983)
Benefits paid
(2,783)
(2,015)
(2,062)
(1,837)
Balance at end of year
83,251
73,366
73,195
60,131

Reconciliation of opening and closing balances of the fair value of plan assets


2011
2010
2009
2008

£'000
£'000
£'000
£'000
Fair value of scheme assets at beginning of year
59,306
52,940
43,668
54,733
Expected return on scheme assets
4,320
3,940
3,352
4,236
Actuarial gain/(loss)
(6,287)
1,841
5,400
(16,019)
Contributions by employers
2,600
2,600
2,582
2,555
Contributions by scheme members
-
-
-
-
Benefits paid
(2,783)
(2,015)
(2,062)
(1,837)
Asset at end of year
57,156
59,306
52,940
43,668

  
The amounts recognised in the statement of comprehensive income are: 

2011
2010

£'000
£'000
Current service cost
-
-
Interest on obligation
4,031
4,331
Expected return on assets
(4,320)
(3,940)
Curtailments and settlements
-
-
Actuarial loss recognised in year
1,087
1,270

798
1,661
Charged to:


Administration expenses
1,087
1,270
Finance costs
(289)
391

798
1,661

History of scheme assets, obligations and experience adjustments


2011
2010
2009
2008
2007

£'000
£'000
£'000
£'000
£'000
Present value of defined benefit obligations
(83,251)
(73,366)
(73,195)
(60,131)
(65,040)
Fair value of scheme assets
57,156
59,306
52,940
43,668
54,733
Deficit in scheme
(26,095)
(14,060)
(20,255)
(16,463)
(10,307)






Experience adjustments arising on scheme liabilities
8,637
(2,145)
11,284
(6,983)
(8,042)
Experience item as a % of scheme liabilities
10%
(3%)
15%
(12%)
(12%)
Experience adjustments arising on scheme assets
(6,287)
1,841
5,400
(16,019)
(207)
Experience item as a % of scheme assets
(11%)
3%
10%
(37%)
0%



Apologies if the formatting plays up from here, something has gone funny - blasted technology! But the bottom line is this. There is no way in the world that NARS balance sheet can possibly be described as giving a True & Fair view - which is the over-riding requirement of all audited accounts. Instead, in my view, a £26m liability has been hidden off Balance Sheet, and a fictitious £11.4m asset has been created and disclosed on the balance sheet.

This may have been done in accordance with accounting standards, but it presents such  an obviously untrue & unfair picture of the company's assets and liabilities that I regard these accounts as false. Hence I will be writing to the company's auditors, Grant Thornton UK LLP, for their comments as to why they signed off a set of accounts which clearly do NOT present a true & fair view at all, but which conceal a massive liability.

And it is a liability, since the cashflow shows that the company is making £2.6m p.a. overpayments into the pension fund to correct this deficit.

Apparently this accounting treatment will be rightly outlawed from accounting periods beginning after 1 Jan 2013, but in my view it presents such a misleading view of the balance sheet that it should be withdrawn now, and the accounts restated.


Including a note to the accounts which discloses a £26m pension deficit, whilst not disclosing it at all on the balance sheet, is not acceptable to me. The balance sheet cannot possibly be considered to give a true & fair view, therefore the accounts are misleading in my view. Otherwise any other liability could just be hidden off balance sheet, and disclosed in a note only. That would be ridiculous, so why is it acceptable for a pension deficit. It isn't, and this seems to me an example of where accounting standards have gone badly wrong, and where the true & fair over-ride should have been invoked to disclose this massive liability on the balance sheet itself.

Thanks again to Mark for pointing out this issue, I am most grateful.

So golden rule - always do your own research!

2 comments:

  1. Hi Paul,

    You mention emailing above, but I can't find the address. Do you have a public email address? I will use the comments box whenever possible.

    Regards,
    Anthony
    V4Value

    ReplyDelete
  2. This comment has been removed by the author.

    ReplyDelete