Cancer is deadly for many different reasons. For one, it often lies undetected, while causing bodily harm for a lengthy amount of time. Ford (NYSE:F) has a similar problem, one that doesn't fully show up on the balance sheet or financials and often goes unknown among investors: an underfunded pension.
It's important that investors are aware of this issue, and since the underfunded pension can be a little complicated, I'll explain it step by step, tell you how it could be turned into a positive, and what Ford's plan to tackle the problem is.
Grasping the size
To give you a sense of how large the underfunded pension issue is, since it doesn't fully show up as a number on the financial sheets, I'll compare it to automotive debt, as both are obligations due from the company.
Ford's roughly $86 billion in total debt is misleading, because that includes the financial division, where it takes on huge loans at low interest rates and dishes the money out to consumers for financing. The profit in this sector nearly offsets Ford's losses in Europe. So if you take out the financial division, which adds approximately $72 billion of debt to the books, you find that Ford's real automotive debt sits at about $14 billion. Remember that number.
In contrast, it's estimated that Ford's pension is underfunded by about $18.7 billion. That's more than its automotive debt, and it's only about $6 billion shy of the massive $23.4 billion private loan it took out (and eventually paid back) before the recession hit. Ford put up its legendary Blue Oval as collateral on that loan. It's a big number.
Now, don't panic, Let's look at why this pension number is so large, how it will change going forward, and what Ford is doing about it.
What inflates the number
Low interest rates are supposed to be a good thing. They certainly allowed Ford to borrow money cheaply and use it to offer discounts to help sell cars or other company interests. But these rock-bottom rates also inflate the underfunded pension number, because they cause Ford to lower its discount rate, which essentially defines how large pension requirements need to be. Ford had to lower its rate from 4.6% to 3.84%, appearing to wipe out any progress it made on paying into the pension funds over the past year.
But hang in there, There is good news, too!
From debt to surplus
Let's say that in eight years, the housing market has steadily improved, the automotive market has been healthy, the economy is more stable than ever, and politicians are working together in harmony. Well, OK, scratch the part about the politicians. Anyway, imagine, too, that interest rates have risen for the past few years and the discount rates have followed. This hypothetical situation would significantly change the look of Ford's underfunded pension. It would narrow the gap, and it's possible that if Ford had been diligent in paying into the fund, the company could actually be looking at a pension surplus! This is a real possibility, and can you imagine how the stock price would react if it happened?
Back here in the real world, interest rates are likely to be low for at least two years, so what is Ford doing now to fix this issue? In 2012 it paid $3.4 billion into the fund. It's been executing a plan to offer buyouts to salaried workers, which knocked off about $1.2 billion in obligations. And it's committed to putting $5 billion into the fund this year, with plans to have a fully funded pension by mid-decade.
If Ford handles this underfunded pension just as it dealt with its pre-recession loan -- which, again, is now paid off -- this goal is certainly achievable. If discount rates rise, even a surplus is possible. Either way, the issue should be much easier to deal with in the future. I'm bullish on the automotive industry and its companies, and I'm especially bullish on Ford.
Fool contributor Daniel Miller owns shares of Ford. The Motley Fool recommends and owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.