Europe

Special report

20 April 2009

SRI
an0g
le

Pension funds
What’s the risk that companies use cash to shore up their pension funds?

Markets
underestimate the
extra funding needs
for companies’
pension obligations.

This should put

further pressure on
indebted companies
and particularly on
those largely
invested in equities.

We expect a
negative impact on
British Airways and
BT Group.

Analysts
Claudia Panseri
(33) 1 58 98 53 35
claudia.panseri@sgcbi.com

Sarbjit Nahal
(33) 1 58 98 12 55
sarbjit.nahal@sgcib.com

and SG’s analysts

PLEASE SEE IMPORTANT

Tristan Paviot

DISCLOSURES AT THE END

OF THE DOCUMENT
 Pension funds

2 20 April 2009
 Pension funds

Pe nsio n funds

20 April 2009

Contents
3 What’s the risk that companies use cash to shore up their pension funds?
4 The implications of the financial crisis for pensions
7 Different pension scheme concepts explained
9 Discounting future liabilities
10 Pension discount rate components
11 Plan assets – companies with high exposure to equities
14 Change in discounting rate: companies at risk
15 Financial market declines: companies at risk
17 Companies with large pension deficit vs market cap
18 Companies with large pension deficit vs Enterprise Value
19 Sensitivity of pension deficit to market variables
23 Pension Deficits/Ageing Workforce
23 From baby boom to ageing workforce
25 Sectors with ageing workforces
29 Company Profiles
30 Akzo Nobel Nv
31 Alcatel-Lucent
32 BAE Systems
33 Bayer Ag
34 British Airways
35 BT Group
36 Daimler
37 Deutsche Lufthansa
38 Deutsche Post AG
39 GKN
40 Invensys
41 Meggitt
42 Michelin
43 Peugeot Citroen PSA
44 ThyssenKrupp
45 Valeo
46 Appendices – Definitions

20 April 2009 1
 Pension funds

What’s the risk that companies use cash to shore

up their pension funds?
Q In line with our previous debt-linked reports “Capital raising: who is at risk?” published
on 22 December 2008 and “2009: year of shareholder dilution?” published on 5 February,
this report focuses on another factor that we believe should be treated as a debt (or financial
assets): the pension deficit. SG analysts have already published some notes on the subject
(British Airways, BT group, Alcatel-Lucent), however, we now apply our approach to the entire
SG coverage universe.

Q In this note we discuss a number of issues relating to pensions deficits (or surpluses)
considering the current difficult environment for asset performance and the likely fall in the
discount rate for pension liabilities. With the publication of annual reports, many companies
have communicated on their pension deficit figures. Although the value of pension assets has
generally fallen substantially, in many cases the value of pension liabilities has fallen too, due
to higher discount rates last year (widening spreads) and a lower inflation rate.

Q However, the macro picture is worrying, particularly in the US and in the UK where the
number of companies reporting rising pension deficits is increasing and where pension fund
assets exceed 100% of national income.

Estimated deficit for UK pension schemes (£bn)

150

100

50

0
Mar-03 Sep-03 Mar-04 Sep-04 Mar-05 Sep-05 Mar-06 Sep-06 Mar-07 Sep-07 Mar-08 Sep-08 Mar-09
-50

-100

-150

-200

-250

-300

Source: PPF, The Pensions Regulator

Q Some companies have warned that pensions will have an adverse effect on 2009 earnings
or require additional contributions. The companies most exposed are those largely invested in
equities and with large pension schemes. Unless the equity markets rebound significantly
during 2009, pension funds will remain significantly under funded, which will result in high
contribution requirements in 2010e and 2011e, in our view. All of the companies with larger
schemes are at risk of increased contributions being needed.

Main risks for defined benefit plans

Liabilities-related risks Assets-related risks
Fall in corporate bond spreads (fall in discount rate) Negative performance of financial markets
Increase in life expectancy Rise in volatility of assets
Hikes in salaries and health care costs
Higher inflation rate
Source: SG Cross Asset Research

2 20 April 2009
 Pension funds

Q Assuming that government action will restore confidence, corporate bonds spreads should
fall leading to a decline in the discount rates for pension liabilities, and thus wider deficits.
Companies with large gross liabilities clearly face greater risks than their peers, and we would
expect the share prices of the former to be more volatile. As suggested by IAS 19, pension
liabilities are discounted using high quality corporate bond yields, of appropriate currency and
duration.

Q Stock conclusions In SG’s coverage universe, few companies are likely to disappoint the
market in the first quarter of the year, on our estimates. British Airways and BT Group are the
most at risk. Negative surprises may come from BAE Systems, ThyssenKrupp and Akzo
Nobel. There should also be some pleasant surprises: Alcatel-Lucent will switch from a deficit
to surplus thanks to the rise in the discount rate.

Risk of using cash to shore up pension deficits (3 High risk; 1 Low risk)
Pension liabilities risk Asset plans risk Pension deficit risk Global Risk (sum of the previous columns)

British Airways 3 3 3 9
BT Group 3 3 3 9
BAE Systems 3 3 2 8
ThyssenKrupp 3 2 2 7
Akzo Nobel 2 3 2 7
Continental 2 2 1 5
Michelin 2 2 1 5
Deutsche Lufthansa 1 3 1 5
GKN 1 2 1 4
Meggitt 1 2 1 4
Peugeot 1 2 1 4
Daimler 1 2 1 4
Deutsche Post 1 2 1 4
Invensys 1 1 1 3
Valeo 1 1 1 3
Alcatel-Lucent 1 1 1 3
Bayer 1 1 1 3
BMW 1 1 1 3
Source: SG Cross Asset Research

20 April 2009 3
 Pension funds

The implications of the financial crisis for pensions

Over the last few months, investors have started to worry about pensions. We decided to
publish this note to highlight the controversial position of the private pension system and the
rising possibility that policymakers may take advantage of current turmoil to shrink private
components of the pension system. Some governments may also point to the temporary
weakness of private pensions to justify delaying necessary reforms of the public pension
system. Such opportunistic messages should be countered with a long-term outlook, based
on independent financial projections for both the public and private systems. In this report, we
will focus on both asset depreciation due to the financial crises and increases in asset
liabilities due to the age pyramid thanks to the contribution of our SRI Equity Research team.

Investment losses on all OECD private pension plans (including individual retirement accounts
and pension insurance contracts) are estimated at $5trillion, with $3.3trillion in the United
States alone. These losses are smaller than the decline in equity values. Pension funds have
benefited from having diversified investment portfolios, often with a large proportion invested
in bonds which carry yields that are lower but more stable than those of equities. The situation
is different in other countries. For example, in the defined contribution systems of Australia
and the United States, the purchase of annuities at retirement is not mandatory. But, the
default investment option for older workers may often have as much as 50 to 60% of assets
invested in equities. Even if these people maintain their savings in equities in the expectation
of a recovery, retirement income will be lower, at least temporarily.

Global pension environment faces higher asset volatility

Detailed figures for global pension assets were published by the OECD in December 2008.
The total value of pension assets managed globally rose by 10% to $30.4 trillion at end-2007,
but then fell by some 18% to $25 trillion at end-2008. The global market is dominated by the
US, which accounts for 64% of assets, followed by the UK with 11% of assets, Canada 5%,
and the Netherlands, Australia and Japan, each with 3%.

Global pensions assets ($ trillion)

35

30

25

20

15

10

0
2001 2002 2003 2004 2005 2006 2007 2008 est.

Source: OECD, IMF, IFSL estimates

Last year, the higher volatility of returns on equities versus bonds largely penalised those
funds with a bias towards equities. As a consequence, investors are now worried that the
sharp decline in equity values may cause some pension surpluses from 2008 to move into
deficit this year or send those in negative territory deeper into deficit.

4 20 April 2009
 Pension funds

Although a decrease in estimated liabilities as a result of rising corporate bond yields (AA
corporate bonds are set as the benchmark in IAS19 accounting regulations for discounting the
net present value of future liabilities) has partially offsetted the decline in assets, fears are
linked to the belief that companies may use cash to shore up their pension funds in the event
of spread tightening during 2009 and at the same time further negative performance of
equities. Therefore, the major risk this year may occur if spreads narrow ahead of any
significant recovery in equity markets, in that case, the financial position of pension funds
would deteriorate and further capital injections may be required.

In the last update of the IFSL (International Financial Services London) report, we obtained
some figures showing that many developed countries have extensive funding pension
arrangements. At end-2007, pension fund assets exceeded 100% of national income in
Denmark, the US, the Netherlands, the UK, Australia, Canada and Switzerland. Assets
between 50% and 100% of GDP have been accumulated in Finland, Chile, Sweden and
Ireland. While autonomous pension funds remain the primary focus of investment in the US,
the UK, Canada and the Netherlands, they remain scarce in other large western European
countries: Germany, France and Italy. Pension insurance policies and personal pensions are
also an important source of provisions: accounting for the majority of pension assets in
Denmark and Sweden, and for around 19%in the UK. Assets in retirement products other than
pension funds and pension insurance make up 42% f assets in Canada and 35% in the US.

Pension assets as % of national income

180

160

140

120

100

80

60

40

20

0
Germany

Denmark
Norway

Mexico

Sweden

UK

US
France

Hong Kong

Canada
Korea

Japan
New Zealand
Italy

Israel
Portugal

Netherlands
Russian Fed

Spain

Poland

South Africa

Ireland

Switzerland
Brazil

Chile

Finland

Australia

Source: IFSL estimates based on OECD and World Bank data

The number of UK under-funded schemes is increasing

Calculations made by the Pension Protection Fund show how changes in market conditions
since last year have caused considerable variations in aggregate funding positions of pension
schemes. The aggregate funding position varied significantly, with the largest deficit at
£109.2bn in February 2003 and the greatest surplus at £148.9bn in June 2007. The credit
crunch has resulted in falling equity markets and sent interest rates lower, so that the deficit
by end-October 2008 had widened to £80.9 billion.

The aggregate funding position is estimated to have worsened over the month to a deficit of
£242.0bn at end-March 2009, from a deficit of £204.7bn at end-February 2009.

20 April 2009 5
 Pension funds

Pension deficit in UK schemes (£bn) Estimated number of schemes in deficit

150 7,000
100 6,500
50 6,000
0 5,500
03 04 05 06 07 08 09
-50 5,000
-100 4,500
-150 4,000
-200 3,500
-250 3,000
-300 03 04 05 06 07 08 09

Source: PPF, The Pensions Regulator Source: PPF, The Pensions Regulator

Companies have to cover the shortfall in asset values

To keep up with their pension funding requirements after disappointing investment returns,
many companies may be forced to increase their contributions to pension funds which were
already quite high as a result of recovery plans implemented after the 2000 stock market
declines.

Policymakers seek to protect pension fund participants by setting funding levels sufficiently
high. Employers may then have to make up the shortfall caused by lower asset values.
Canada recently decided to give pension funds and their sponsoring employers more time to
allow funding levels to return to their targets levels in order to avoid putting further strain on
employers when the general economic situation is deteriorating. Pension funds in Ireland and
the Netherlands have been given more time to prepare their recovery plans also.

A lowering in the funding level targets is less likely as this would weaken benefit security over
the long term. On the other hand, there could be much debate on the suitability of statutory
investment performance requirements on pension funds and the valuation standards for
assets and liabilities. In Switzerland, for example, the government is considering a reduction in
the minimum return that pension funds must guarantee, from 2.75% in 2008 to 2% in 2009.
Questions are also being raised about the suitability of mark-to-market valuations for pension
funds (an accounting practice that values assets and liabilities at current market prices rather
than their book value, which is the original cost minus depreciation).

6 20 April 2009
 Pension funds

Different pension scheme concepts explained

Some companies provide post-employment benefits for their active employees and for
retirees, either directly or by contributing to independently administered funds (private pension
plans). The way these benefits are provided varies according to the legal, fiscal and economic
conditions of each country in which the company operates, the benefits generally being based
on the employees’ remuneration and years of service. Post-employment benefits are provided
under defined contribution and/or defined benefit plans.

„ Defined contribution plans, the company pays contributions to publicly or privately

administered pension insurance plans on a mandatory, contractual or voluntary basis. Once
the contributions have been paid, the company has no further payment obligations.

„ Defined benefit plans may be unfunded, or they may be wholly or partly funded by

contributions by an entity, and sometimes by its employees, into an entity, or fund, that is
legally separate from the employer and from which the employee benefits are paid. Benefits
are generally payable under these plans after the completion of employment. The plans are
classified by the company on the basis of the type of benefit provided as follows: Reserve for
employee severance indemnity, Pension plans, Health care plans and Other.
− Funded pension plans accumulate dedicated assets to cover the plan’s liabilities. Under
these plans a contribution is generally made to a separate fund (trust) which independently
administers the plan assets. The company’s funding policy is to contribute amounts to the plan
equal to the amounts required to satisfy the minimum funding requirements prescribed by the
laws and regulations of each individual country. Prudently the company makes discretionary
contributions in addition to the funding requirements.
− Unfunded pension funds plans are financed directly from contributions from the plan
sponsor or provider and/or the plan participant, no assets are set aside. Pension
arrangements provided by the state in most countries in the world are unfunded, with benefits
paid directly from current workers' contributions and taxes. Unfunded pension plans are said
to be paid on a current disbursement method (also known as the Pay-As-You-Go method).
Unfunded plans may still have associated reserves to cover immediate expenses or smooth
contributions within given time periods. Most OECD countries do not allow unfunded private
pension plans. If the unfunded pension fund plans present a surplus compared to the
requirements of law, the companies concerned may not be required to contribute to the plan
in respect of the minimum performance requirement as long as the fund is in surplus.

Minimum funding requirements

On 5 July 2007 IFRIC issued the interpretation IFRIC 14 – IAS 19 – The Limit on a Defined
Benefit Asset, Minimum Funding Requirements and their Interaction effective retrospectively
from 1 January 2008. The interpretation provides general guidance on how to assess the limit
in IAS 19 - Employee Benefits on the amount of the surplus that can be recognised as an
asset. It also explains how the pension asset or liability may be affected when there is a
statutory or contractual minimum funding requirement in the Consolidated Financial
Statement. All the details are usually reported in the Company Annual Report in the Notes to
Consolidated Financial Statements. The Consolidated Balance Sheets include the following
significant components related to pension plans:

20 April 2009 7

€4,361m is the amount
recognised in the
Consolidated Balance Sheet
under the line ‘pension
plans and similar
commitments’
The surplus (deficit) of the
defined benefit obligations (DBO)
relative to the plan assets as of
the balance sheet date. The DBO
is calculated based on the
projected unit credit method and
reflects the net present value as
of the balance sheet date of the
accumulated pension
entitlements of active employees,
former employees with vested
rights and of retirees and their
surviving dependents with
consideration of future
compensation and pension
increases.
8 20 April 2009
Pension funds
Accounting for defined benefit plans – the case of Siemens
€m September
2008
Principal pension benefit plans (1) 2,580*
Principal other post-employment benefits plans (2) 639
Other (3) 1,142
Liabilities for pension plans (1)+(2)+(3) 4,361
Prepaid costs for post-employment benefits 99
Actuarial (losses)/gains (4) (1,591)
Income Tax effect (5) (16)
Net amount recognised in the Consolidated Statements of Income (1,607)
Source: SG Equity Research
*Principal pension benefit plans (1)
€m September
Fair value of plan assets (1) 20,194
Total defined benefit obligations (funded + unfunded) (2) 22, 654
Surplus/(Deficit) = (1) + (2) (2,460)
Unrecognized past service cost (70)
Net amount recognized (2,530)
Pension Asset 50
Pension Liability (2,580)
Source: SG Equity Research
The provision for pensions and other employee benefits (including long-term benefits) is equal
to the present value of the company’s future benefit obligation less, where appropriate, the fair
value of plan assets in funds allocated to finance such benefits. The calculation of this provision
is based on valuations performed by independent actuaries using the projected unit credit
method and final salaries. These valuations incorporate both financial assumptions (discount
rate, expected rate of return on plan assets, and increases in salaries and medical costs) and
demographic assumptions, including rates of employee turnover, retirement age and life
expectancy. The effects of differences between previous actuarial assumptions and what has
actually occurred (experience adjustments) and the effect of changes in actuarial assumptions
(assumption adjustments) give rise to actuarial gains and losses. Actuarial gains and losses
arising on long-term benefits payable during employment are recognized in full in the income
statement for the financial year in which they were incurred. However, actuarial gains and
losses on post-employment benefits are taken directly to equity in the year in which they arise.
Deficit treatment
European law provides protection to the beneficiaries of company sponsored defined benefit
schemes. In 2003 the Pensions Directive EU (2003) was enacted. This sets out requirements
on the calculation of pension liabilities, and the funding of those liabilities.
The European Directive requires appropriate assets to cover provisions for pension schemes
meaning that large deficits will translate into cash payments. In the UK, for example, the
Pensions Act 2005 effectively gives Trustees the power to impose higher contributions. In the
event that the sponsor company does not make payments, or trustees and the sponsor
cannot agree on a contribution schedule, there is recourse to the pensions regulator which
can direct the company to make payments to eliminate the deficit.
 Pension funds

Discounting future liabilities

Recent difficulties have drawn attention to the risk management practices of institutional
investors in general and defined benefit pension plans in particular. Adverse market conditions
over the past two years have negative impacted many corporate defined benefit pension
plans. Negative equity market returns have eroded plan assets at the same time as declining
interest rates have increased the market-to-market value of benefit obligations and
contributions. In extreme cases, this has left corporate pension plans with funding gaps as
large as or larger than the market capitalisation of the plan sponsor. As IAS 19 requires that
future pension payments are discounted back to the present day using discount rates based
on the yields available on ‘high-quality’ corporate bonds (and corporate bond yields went
higher in 2008), negative returns on assets have been offset by lower present values of
liabilities.

iBoxx AA bond yield (%) MSCI European index (rebased to 100)

7.5 114

7 104

6.5 94

6 84

5.5 74

5 64

4.5 54

4 44
Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09 Mar-07 Jul-07 Nov-07 Mar-08 Jul-08 Nov-08 Mar-09

Source: SG Cross Asset Research, Datastream

The risk arising from pension obligations does not produce immediate cash costs. However, a
pension obligation is a form of long debt financing. There are two forms of defined-benefit
obligations: funded and unfunded. Companies with unfunded obligations, mainly in Germany
and Italy, have not set assets aside to fund the future pension payments. This unfunded nature
of the pension obligation explains why German companies have high pension deficits as a
percentage of market capitalisation. For companies that have funded defined-benefit plans,
the burden of the pension obligation is mitigated by having pension assets to pay out the
pension payments.

The funded status of a defined-benefit pension plan represents the value of the plan's assets
less the projected benefit obligations. While the first part is simple to value, the second is
more complicated, given that it relates to payments to be made in the future, requiring
actuaries to estimate the value by analysing the retiree population, salary increases, bond
yields among other things, to discount the future benefit streams back to a present value. This
last part makes it difficult to see the real value of a pension fund at a given moment. Of great
importance are the assumptions used for the fair value of invested assets and the present
value of the future obligations. For example, a company can decrease its future obligations by
increasing its discount rate or lowering the salary increase assumptions.

Funds are required to disclose how they are invested (% in equities, bonds etc), which allows
us to estimate the impact of asset volatility. When the funds become underfunded, the
company needs cash.

Some investors are not concerned as they mention that the liabilities durations is long.
However, we believe that the problem is real and that regulators are investing a lot of time to

20 April 2009 9
 Pension funds

find a better ALM system. For example, in the UK, the pension fund is seen as a creditor like
others and has to ask for increased cash contributions in the event of widening deficits. All of
the companies with larger schemes are at risk of having to increase contributions. However,
some schemes benefit from special status, which provides additional protection.

Pension discount rate components

To calculate their pension liabilities many plan sponsors use the AA-rated yield curve which is
calculated by adding the spreads of AA-rated corporate bonds at several maturity points to
the Treasury curve. This pension discount rate index can be broken down into its two main
components: the 30-year Treasury yield and a credit spread. The two main components have
moved in different directions, almost offsetting each other.

While 30-year Treasury yields could still fall Liabilities discount rate’s components
from now until year-end despite their current 400 AA-corporate bond spread 8
350 30y Treasury yield (rhs)
low levels, AA credit spreads are very high 7
300
and could fall as the economy starts 250
6

recovering. Falling credit spreads for a given 200 5

level of Treasury yields will cause pension 150

4
100
liabilities to increase. As a result, required 50
3

pension contributions could be very high in 0 2

99 00 01 02 03 04 05 06 07 08 09
both 2010e and 2011e based on IAS
(International Accounting Standard) rules for Source: SG Cross Asset Research, Datastream

the timing of contributions. This could cause

credit rating agencies to downgrade companies with material underfunded pension plans.
Many companies in this situation have BBB ratings and could be downgraded to junk status.
The impact of interest rate changes can be hedged with bonds and/or derivatives but there is
also a lack of liquidity that could potentially make hedging more difficult.

10 20 April 2009
 Pension funds

Plan assets – companies with high exposure to equities

Taking a look at the allocation between asset classes helps, initially, in assessing the risk
exposure of companies with high levels of investment in stock markets and then the impact that
declines in equity values may have on the pension deficit/surplus. This is particularly true since
the beginning of the year as stability of corporate bond spreads is no longer acting as a support
to offset the falling value of (equity) assets.

„ Equity allocations dropped in the UK from 67% in 2003 on average to 56% in 2007,
following a fall in the share of domestic equities in pension portfolios, while the equity
allocation remained stable in the US, Australia and the Netherlands but increased from 44% to
51% in Japan over the same four-year period.
„ Bond allocations fell sharply in Japan from 45% to 32%, primarily as a result of reductions in
domestic bond holdings, while the US also saw a decrease in bonds from 34% to 30%. In
contrast, investment in bonds doubled in the UK over 2003-2007, from 15% to 30%, while
schemes in the Netherlands also increased holdings from 40% to 43%, although investment
by Australian schemes remained stable at 21%.
„ Figures showing the allocation of assets to cash, real estate and other investments varied
between the five countries, with Australia holding around 25% in other investments, including
10% in both cash and real estate, while Japan has 12% in assets such as hedge funds,
private equity and derivatives, compared to a 7% allocation to both cash and real estate in the
UK.
Below, we highlight those companies largerly invested in equities (more than 50% of the
global allocation) and therefore more exposed to declines in the value of the assets. As we
mention above, those companies largerly exposed to equities and with significant pension
scheme could suffer. Of course, the global size of the pension liabilities versus market cap or
versus the entreprise value remains key.

This is why, despite Sandvik’s extensive exposure to equities we are not concerned about its
pension deficit as it represents no more than 5% of market capitalisation. On the other hand,
GKN has lower exposure to equities than Sandvik but the risk borne by the company is higher
as pension liabilities represent about 170% of the market capitalisation. SG Capital Goods
analysts calculate that another 10% decline in the value of plan assets would reduce the
equity value of GKN by 29%.

Net pension liabilities as a % of mkt cap Fair value of plan assets as a % of mkt cap

60% 200% 417%

173% 339%
180%
50% 46% 158%
160%

40% 140%
32% 120%
30% 100%
78%
20% 80%
20% 14%15% 60% 50%54%
10%12% 29%29%
38%
8% 8% 40% 20%20%
10% 4% 5% 5% 12%18%
2% 2% 2% 3% 3% 20% 0% 3% 3% 7% 9% 9%
0% 0%
Alstom
SKF

GKN
Tognum

Areva

Nexans
Siemens
Tomkins
Emerson

Tomkins

Alstom

Legrand

Emerson

Sandvik

Philips
Invensys
SKF
Areva
Siemens

Invensys

Nexans
Tognum

GKN

Vallourec
Rockwell
Legrand
Sandvik

Schneider

Rockwell
Atlas Copco
Assa Abloy

Vallourec

Atlas Copco
Schneider

Assa Abloy

ABB
ABB

-10% -6%
Philips

Source: SG Equity Research (Capital Goods Team) Source: SG Equity Research (Capital Goods Team)

20 April 2009 11
 Pension funds

Pension asset allocation – companies with equity exposure above 50%

Year end date Bonds (%) Equities (%) Property (%) Other (%) Expected LT Return Rate
On Pension Assets (%)
Pirelli 31/12/2008 15.7 80.2 4.1 na 7.8
Gazprom 31/12/2007 na 79.0 21.0 na na
Delhaize 31/12/2008 18.0 78.0 4.0 na 6.0
Lindt & Sprüngli 31/12/2008 9.0 78.0 4.0 9.0 4.9
Norbert Dentressangle 31/12/2007 19.8 77.8 2.4 na 5.9
Aegis Group plc 31/12/2008 4.0 75.0 21.0 na na
Centrica 31/12/2008 22.9 74.6 1.0 1.5 6.4
Ryanair 31/03/2008 14.2 73.7 7.5 4.5 6.2
Safran 31/12/2007 22.9 72.5 2.2 2.4 5.8
BP 31/12/2008 22.9 70.7 2.1 4.3 5.6
Vodafone 31/03/2008 17.7 68.5 13.5 0.3 4.6
Home Retail Group 01/03/2008 31.0 68.0 1.0 na 6.1
Groupe Eurotunnel 31/12/2007 28.0 68.0 4.0 na na
Aegon 31/12/2008 27.5 68.0 4.6 na 7.4
Signet Jewelers Limited 02/02/2008 29.0 65.0 1.0 5.0 7.2
Software AG 31/12/2008 11.5 64.4 24.1 na 5.5
BG Group 31/12/2008 15.0 63.0 22.0 na 6.1
Emerson 30/09/2008 30.0 63.0 7.0 na 7.7
Valeo 31/12/2008 30.2 62.2 7.6 na 5.7
Rio Tinto 31/12/2007 29.4 60.2 3.2 7.2 6.2
Anheuser-Busch InBev 31/12/2008 33.0 60.0 3.0 4.0 4.2
Liberty International 31/12/2008 30.0 60.0 4.0 6.0 7.0
DSG International 03/05/2008 30.8 59.4 4.7 5.1 6.1
AXA 31/12/2008 27.0 59.0 7.0 7.0 6.0
Delachaux 31/12/2007 31.0 59.0 10.0 na 7.2
Bic 31/12/2008 36.0 58.0 6.0 na 8.5
Fiat 31/12/2007 39.0 58.0 2.0 1.0 7.6
British Land Co 31/03/2008 40.0 57.5 2.5 na 5.7
Diageo 30/06/2008 23.0 57.0 10.0 10.0 6.7
Reckitt Benckiser 31/12/2008 33.9 56.0 10.1 na 6.8
Belgacom 31/12/2008 41.0 56.0 3.0 na 6.0
Tomkins 03/01/2009 39.6 55.7 4.7 na 6.0
Publicis Groupe 31/12/2008 41.0 54.8 1.0 3.2 7.1
Cobham 31/12/2008 37.4 54.6 1.4 6.6 6.8
Whitbread 28/02/2008 28.4 54.5 7.2 9.9 6.0
IMI 31/12/2008 34.4 54.4 7.9 3.3 5.4
A.P. Moller-Maersk B 31/12/2007 40.0 54.0 4.0 2.0 7.4
SAP 31/12/2008 36.0 54.0 9.0 1.0 5.5
STMicroelectronics 31/12/2008 27.0 54.0 10.0 9.0 6.3
Tesco 23/02/2008 22.0 53.9 15.5 8.6 7.1
Wm Morrison 01/02/2009 39.6 53.6 1.4 5.4 5.8
Meggitt 31/12/2008 40.0 53.0 2.1 4.9 7.0
Lloyds Banking Group 31/12/2008 33.9 53.0 2.8 10.3 5.4
Debenhams 30/08/2008 38.9 52.8 4.5 3.8 7.0
CRH 31/12/2008 33.1 52.1 4.9 9.9 5.7
Atos Origin 31/12/2007 30.0 52.0 18.0 na 6.5
Unilever NV 31/12/2008 27.7 51.6 11.7 9.0 6.3
Christian Dior 31/12/2007 44.0 51.0 na 5.0 5.5
KBC 31/12/2007 39.0 51.0 2.0 8.0 5.2
Legal & General 31/12/2007 43.1 50.8 0.4 5.7 6.1
Land Securities 31/03/2008 48.9 50.7 0.4 na 18.1
Source: FactSet and Company releases (Annual reports published in March 2009)

12 20 April 2009
 Pension funds

The table above is interesting for two reasons:

„ Firstly, we can observe the expected long-term return on global invested assets, which is on
average about 6.6% for the companies in our selection.
„ Secondly, we can compare the above figures with the current pension position in terms of
asset and liabilities and then calculated the expected surplus and deficit at year-end,
depending on the pension asset allocation.

The average realized return over the last ten years for a portfolio invested 50% in equity and
50% in bonds is about 7%, slightly above the average return for companies in our table on the
previous page (6.%). Over the last 20 years the realized average is about 9%. However, last
year, portfolios 50% invested in equity and 50% in bonds generated realized returns of about
-13%. This is the average loss caused by the drop in equities and it’s the percentage we
should apply in estimating the pension surplus/deficit for companies half invested in equity
and half in government bonds. Of course, the loss in asset value is higher when the
percentage invested in equities is above 50% and is around 30% for companies with more
than 80% of investments in equities.

Bonds and Equity total returns since 1980 (%)

50%

40%

30%

20%

10%

0%
1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008
-10%

-20%
World Equity YoY % return
-30%
US Bonds YoY return(%)
-40% average realized return (50% bonds & 50% equity)

-50%

Source: SG Cross Asset Research, Datastream

20 April 2009 13
 Pension funds

Change in discounting rate: companies at risk

In the last ten years declining interest rates have increased the market-to-market value of
benefit obligations. However, last year’s rise in corporate bond spreads offset the drop in fair
value assets. For instance, this was the case for Alcatel-Lucent which in Q3 08 reported a
deficit surplus thanks to extremely favourable moves in the discount rate used, but a deficit in
the Q4 08 as the same rate moved in opposite direction at year-end.
Pension Liabilities versus Market Cap (%) – 2008 figures in local currency
LCm Mkt Cap Fair Value of plan Pension Liabilities Pension Deficit Liabilities vs Mkt
assets * (Surplus) Cap (%)
The companies in the table are British Airways 1,905 14,272 16,214 1,942 851%
strongly sensitive to any change Alcatel-Lucent 3,890 25,069 25,498 429 656%
in the discounting rate (30y BT Group 6,327 31,500 33,800 2,300 534%
Treasury + AA corporate bond
GKN 776 2,009 2,843 834 366%
spread). Therefore if easing credit
conditions are confirmed the total Invensys 1,384 4,722 5,010 288 362%
amount of pension liabilities may Deutsche Lufthansa 4,437 4,921 7,754 2,833 175%
increase by the end of the year BAE Systems 11,810 13,070 17,286 4,216 146%
Akzo Nobel 7,883 10,480 11,468 988 145%
Philips Electronics 12,836 17,899 17,199 (700) 134%
Smiths Group 2,585 2,637 3,101 464 120%
Deutsche Post 11,044 6,235 12,246 6,011 111%
EADS 7,697 3,335 7,777 4,442 101%
Rolls-Royce Group 6,024 7,163 5,719 (1,444) 95%
Continental 3,007 2,172 2,797 625 93%
Michelin 5,057 3,200 4,067 867 80%
Thyssenkrupp 8,751 1,724 6,938 5,214 79%
Valeo 1,143 225 843 618 74%
Peugeot 4,493 2,409 3,228 819 72%
Nexans 1,039 324 716 392 69%
Meggitt 1,058 452 693 241 65%
Daimler 26,291 10,110 15,044 4,934 57%
Siemens 42,785 20,194 24,444 4,250 57%
BMW 16,118 5,491 8,788 3,297 55%
Bayer 28,479 8,683 14,659 5,976 51%
BASF 25,663 10,313 11,370 1,057 44%
Fiat 8,281 1,593 3,403 1,810 40%
*Present value of funded obligations + other pension liabilities
Source: SG Equity Research, SG Cross Asset Research, Companies releases, Bloomberg (Market cap on April 14)

Pension liabilities as a % of market capitalisation

900%
800%
700%
600%
500%
400%
300%
200%
100%
0%
Deutsche Lufthansa

Akzo Nobel

BMW
Alcatel-Lucent

BAE Systems

Smiths Group

Nexans

Siemens
EADS
GKN

Deutsche Post
Invensys
BT Group

Thyssenkrupp

Peugeot

Meggitt

Bayer
Daimler

BASF

Fiat
Valeo
British Airways

Continental
Rolls-Royce Group

Michelin
Philips Electronics

Source: SG Equity Research, SG Cross Asset Research, Companies releases, Bloomberg

14 20 April 2009
 Pension funds

Financial market declines: companies at risk

We show here the size of the plan assets relative to each company’s market capitalisation. As
highlighted in the table below, companies with the largest defined-benefit pension schemes
are the most at risk when financial markets decline.

Fair Value of plan assets versus Market Cap (%) – 2008 figures in local currency
LCm Mkt Cap Fair Value of plan Pension Liabilities Pension Deficit Assets vs Mkt Cap
assets * (Surplus) (%)
British Airways 1,905 14,272 16,214 1,942 749%
Alcatel-Lucent 3,890 25,069 25,498 429 645%
BT Group 6,327 31,500 33,800 2,300 498%
Invensys 1,384 4,722 5,010 288 341%
GKN 776 2,009 2,843 834 259%
Philips Electronics 12,836 17,899 17,199 (700) 139%
Akzo Nobel 7,883 10,480 11,468 988 133%
Rolls-Royce Group 6,024 7,163 5,719 (1,444) 119%
BAE Systems 11,810 13,070 17,286 4,216 111%
Deutsche Lufthansa 4,437 4,921 7,754 2,833 111%
Smiths Group 2,585 2,637 3,101 464 102%
Continental 3,007 2,172 2,797 625 72%
Michelin 5,057 3,200 4,067 867 63%
Deutsche Post 11,044 6,235 12,246 6,011 56%
Peugeot 4,493 2,409 3,228 819 54%
Siemens 42,785 20,194 24,444 4,250 47%
EADS 7,697 3,335 7,777 4,442 43%
Meggitt 1,058 452 693 241 43%
BASF 25,663 10,313 11,370 1,057 40%
Daimler 26,291 10,110 15,044 4,934 38%
BMW 16,118 5,491 8,788 3,297 34%
Nexans 1,039 324 716 392 31%
Bayer 28,479 8,683 14,659 5,976 30%
Thyssenkrupp 8,751 1,724 6,938 5,214 20%
Valeo 1,143 225 843 618 20%
Fiat 8,281 1,593 3,403 1,810 19%
*Present value of funded obligations + other pension liabilities
Source: SG Equity Research, SG Cross Asset Research, Companies releases, Bloomberg (Market cap on April 14)

Plan Assets as a % of market capitalisation

800%

700%

600%

500%

400%

300%

200%

100%

0%
Deutsche Lufthansa
Akzo Nobel

BMW
Alcatel-Lucent

BAE Systems

Smiths Group

Siemens

Nexans
EADS
GKN

Deutsche Post
Invensys
BT Group

Peugeot

Meggitt

Thyssenkrupp
BASF

Daimler

Bayer

Fiat
Valeo
Continental
British Airways

Rolls-Royce Group

Michelin
Philips Electronics

Source: SG Equity Research, SG Cross Asset Research, Companies releases, Bloomberg

20 April 2009 15
 Pension funds

In the graph below, we highlight the level of net pension liabilities as a % of each company’s
market capitalisation. Despite the fact that both British Airways and Alcatel-Lucent have the
highest exposure to defined pension plans, it is GKN that faces the biggest net pension deficit
versus market capitalisation. Naturally, the drop in the company’s market capitalisation is one
the most important factors, however, we find similar results when we take into account the net
pension liabilities versus the enterprise value.

Pension deficit (surplus) versus market capitalisation (%)

100%

70%

40%

10%
Deutsche Lufthansa

Akzo Nobel
BMW

Alcatel-Lucent
BAE Systems
Nexans

Siemens
Smiths Group
EADS
GKN

Thyssenkrupp

Deutsche Post

Meggitt

Invensys
BT Group

Peugeot
Bayer

Daimler

BASF
Fiat
Valeo
British Airways

Continental

Michelin

Rolls-Royce Group
Philips Electronics
-20%

Source: SG Equity Research, SG Cross Asset Research, Companies releases, Bloomberg

The above picture does not show which companies will have to tackle the high risk of cash
injection to address their pension deficits. This is the case of EADS which has a mismatch
between pension liabilities and fair value of assets. However, the company has already
recognized €4,378m provisions in last year’s balance sheet and it ended the year with a net cash
position of €6,823m. Some companies have also substantially reduced the pension risks. This is
the case of Rolls-Royce, which has closed UK defined benefit schemes to new members, added
a £500m special injection and changed asset allocation, increasing the amount invested in
bonds (%). Therefore, from now, we will only focus on companies that are already high
leveraged, with large amounts of plan assets (as this is the most volatile part of the deficit)
versus market cap. Below we provide a list of the stocks selected.
Our selected stocks

BAE Systems
Aerospace & Defence
Meggitt
Deutsche Post Air Freight & Logistics
Valeo
Continental Auto Components
Michelin
Daimler
Peugeot Citroen Automobiles
BMW
Akzo Nobel Chemicals
Alcatel-Lucent Communication Equipment
GKN
Industrial Conglomerates
Invensys
ThyssenKrupp Metals & Mining
Bayer Pharmaceuticals
BT Group Telecoms
British Airways
Transportation - Airlines
Deutsche Lufthansa
Source: SG Equity Research

16 20 April 2009
 Pension funds

Companies with large pension deficit vs market cap

Initially, we have analysed those companies with high pension liabilities and a pension deficit
versus market capitalisation.

Pension deficit versus Market Cap (%)

Asset Allocation (%) Reco Target Market Pension deficit* 2009 Pension deficit /
Cap. (local currency, mm) Gearing Market Cap (%)
Bonds Equity Property Other (LC, 2007 2008e 2007 2008e
mm)
34.9 50.7 10.3 4.1 GKN Industrial Conglomerates Hold 70p 774 331 Ò 834 83.4% 43% 108%
49.4 39.9 0.0 10.7 British Airways Transportation - Airlines Sell 90p 1,906 437 Ò1,942 70.9% 23% 102%
46.5 38.3 3.2 12.9 Deutsche Lufthansa Transportation - Airlines Buy € 13.0 4,444 2,391 Ò 2,833 28.6% 54% 64%
48.0 44.0 8.0 ThyssenKrupp Metals & Mining Buy € 19.0 8,782 5,854 Ô 5,214 33.2% 67% 59%
33.0 28.0 20.0 19.0 Deutsche Post Air Freight & Logistics Hold € 9.0 11,044 5,757 Ò 6,011 36.6% 52% 54%
30.2 62.2 0.0 7.6 Valeo Auto Components Buy € 12.0 1,146 633 Ô 618 84.9% 55% 54%
29.0 45.0 14.0 12.0 BT Group Telecoms Hold 105p 6,389 389 Ò 2,300 345.8% 6% 36%
28.0 62.0 8.0 2.0 BAE Systems Aerospace & Defence Buy 440p 11,837 2,020 Ò 4,216 1.1% 17% 36%
40.0 53.0 4.9 2.1 Meggitt Aerospace & Defence Hold 120p 1,065 153 Ò 241 75.2% 14% 23%
54.5 31.1 2.4 12.0 Continental Auto Components Hold € 15 2,969 337 Ò 625 188.2% 11% 21%
54.0 15.0 8.0 23.0 Bayer Pharmaceuticals Hold € 38 28,449 4,950 Ò 5,976 44.3% 17% 21%
65.2 12.8 0.0 22.0 Invensys Industrial Conglomerates Sell 120p 1,386 521 Ô288 nm 38% 21%
53.8 24.4 8.2 13.6 BMW Automobiles Buy € 30 16,106 4,602 Ô3,297 nm 29% 20%
46.5 40.1 4.1 9.3 Daimler Automobiles Hold € 24.0 26,301 1,912 Ò 4,934 nm 7% 20%
64.0 36.0 0.0 0.0 Peugeot Citroen Automobiles Buy € 20 4,502 745 Ò 819 50.4% 17% 18%
53.5 34.75 2.75 9 Michelin Auto Components Buy € 42 5,071 324 Ò 867 79.1% 6% 17%
39.0 47.0 8.0 6.0 Akzo Nobel Chemicals Hold € 27 7,901 1,126 = 988 32.6% 14% 13%
63.0 17.0 8.0 12.0 Alcatel-Lucent Commun. Equipment Sell € 1.2 3,876 (2,806) Ò 429 32.0 -72% 12%
*Pension Deficit/(Surplus) = (Principal pension deficit + Other post-employment benefit obligations)-(Fair Value of plan assets).
Source: SG Equity Research, Companies releases, FactSet (Market cap on 14 April)

Gearing and Pension Deficit/Mkt Cap (%)

The companies most at risk are those
with high deficits versus market 350 BT Group GKN
capitalisation and at the same time British Airways
high gearing, namely GKN and British 300
Deutsche Lufthansa
Airways ThyssenKrupp
250 Continental
Deutsche Post
Gearing (%)

Valeo
200
BT Group

150 BAE Systems

Meggitt
Meggitt Valeo
100 Michelin GKN Continental

Peugeot Bayer
Deutsche Post ThyssenKrupp
50 Bayer British Airways Peugeot
Deutsche Lufthansa Michelin
ALU BAE Systems
- Akzo Nobel Akzo Nobel
0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 110% ALU
Mkt Cap / Pension Deficit (%)

Source: SG Equity Research, SG Cross Asset Research

20 April 2009 17
 Pension funds

Companies with large pension deficit vs Enterprise Value

Pension deficit versus EV (%)
Asset Allocation (%) Reco Target 2009e Pension deficit* 2009 Pension deficit /
EV (local currency, mm) Gearing EV (%)
Bonds Equity Property Other (LC, 2007 2008e 2007 2008e
mm)
33.0 28.0 20.0 19.0 Deutsche Post Air Freight & Logistics Hold € 9.0 13,472 5,757 Ò 6,011 36.6% 46% 45%
34.9 50.7 10.3 4.1 GKN Ind. Conglomerates Hold 70p 2,122 331 Ò 834 83.4% 16% 39%
49.4 39.9 0.0 10.7 British Airways Transportation - Airlines Sell 90p 5,285 437 Ò1,942 70.9% 8% 37%
46.5 38.3 3.2 12.0 Deutsche Lufthansa Transportation - Airlines Buy € 13.0 8,749 2,391 Ò 2,833 28.6% 27% 32%
48.0 44.0 8.0 ThyssenKrupp Metals & Mining Buy € 19.0 17,377 5,854 Ô 5,214 33.2% 34% 30%
46.5 40.1 4.1 9.3 Daimler Automobiles Hold € 24.0 17,297 1,912 Ò 4,934 nm 11% 29%
28.0 62.0 8.0 2.0 BAE Systems Aerospace & Defence Buy 440p 15,318 2,020 Ò 4,216 1.1% 13% 28%
30.2 62.2 0.0 7.6 Valeo Auto Components Buy € 12.0 2,659 633 Ô 618 84.9% 24% 23%
Industrial
65.2 12.8 0.0 22.0 Invensys Sell 120p 1,428 521 Ô288 nm 36% 20%
Conglomerates
53.8 24.4 8.2 13.6 BMW Automobiles Buy € 30 17,215 4,602 Ô3,297 nm 27% 19%
54.0 15.0 8.0 23.0 Bayer Pharmaceuticals Hold € 38 46,428 4,950 Ò 5,976 44.3% 11% 13%
40.0 53.0 4.9 2.1 Meggitt Aerospace & Defence Hold 120p 2,078 153 Ò 241 75.2% 7% 12%
29.0 45.0 14.0 12.0 BT Group Telecoms Hold 105p 22,767 389 Ò 2,300 345.8% 2% 10%
63.0 17.0 8.0 12.0 Alcatel-Lucent Commun. Equipment Sell € 1.2 5,035 -2,806 Ò 429 32.0 -56% 9%
39.0 47.0 8.0 6.0 Akzo Nobel Chemicals Hold € 27.0 11,850 1,126 = 988 32.6% 10% 8%
64.0 36.0 0.0 0.0 Peugeot Citroen Automobiles Buy € 20 9,890 745 Ò 819 50.4% 8% 8%
53.5 34.75 2.75 9 Michelin Auto Components Buy € 42 11,740 324 Ò 867 79.1% 3% 7%
54.5 31.1 2.4 12.0 Continental Auto Components Hold € 15 13,413 337 Ò 625 188.2% 3% 5%
*Pension Deficit/(Surplus) = (Principal pension deficit + Other post-employment benefit obligations)-(Fair Value of plan assets).
Source: SG Equity Research, Companies releases, FactSet (Market cap on 14 April)

Gearing and Pension Deficit/EV (%)

Looking at the Pension Deficit versus
EV, the picture is slightly different. 350 BT Group
GKN
Deutsche Post now appears among the
British Airways
risky stocks. GKN, which was the most 300
Deutsche Lufthansa
at risk comparing the deficit to market
ThyssenKrupp
capitalisation, is now behind Deutsche 250
Deutsche Post
Post and just ahead of British Airways
Gearing (%)

200 Valeo
BT Group
150 BAE Systems
Meggitt
Meggitt Valeo
100 Michelin GKN Continental
British Airways
Bayer
ThyssenKrupp Deutsche Post
50 Akzo Nobel Bayer Peugeot
Deutsche Lufthansa
ALU BAE Systems Michelin
-
Akzo Nobel
5% 10% 15% 20% 25% 30% 35% 40% 45%
ALU
EV / Pension Deficit (%)

Source: SG Equity Research, SG Cross Asset Research

18 20 April 2009
 Pension funds

Sensitivity of pension deficit to market variables

Main assumptions to estimate pension asset returns
„ While asset allocation could change during the year, we have assumed that it remains in line
with the target allocation in the table below.
„ We have assumed that the Long Duration Investment Grade bond portfolio was invested to
closely match the liability (so-called Liability Driven Investing).
„We have assumed that equity exposure was invested tracking half the MSCI US and half the
MSCI Europe (total returns).
„ We have assumed that Real Estate exposure was invested tracking the Shiller Home price
index (20-city composite).
„ We have assumed that, in the ‘other’ asset allocation category, half is invested in hedge
funds, tracked by the Tremont hedge fund index and half in cash (US).

Based on these assumptions, the realised return of the funded plan assets in the first quarter
of the year is negative. Note that the return on the bond portfolio depends on government
duration, for our purposes, we have used a total return on Bonds with duration of more than
10 years.
Returns on funded plan assets (data as of 31 March)
Q1 2008 Q2 2008 Q3 2008 Q4 2008 Q1 2009
Bonds 3% -4% 2% 17% -7%
Equity -13% -4% -10% -23% -11%
Real Estate -7% -3% -4% -7% -3%
Hedge Funds -2% 3% -10% -10% 0%
Cash 1% 1% 1% 1% 0%
Source: SG Cross Asset Research

If we carry out the same exercise for the companies in our selection highlighted as being at
risk of suffering pension deficit increases, we notice that those that still have high exposure to
equity are the most at risk of seeing rising deficits. Assuming no change to liabilities, the
deficit should increase in the first quarter by about 7.0%.
Returns on plan asset by company
Plan Assets Allocation (%) Plan Assets returns Plans Assets Expected Changes
Bonds Equity Property Other Q4 2008 Q1 2009 Dec-08 Plan Assets in (LCmm)
(LCmm) Q109 (LCmm)
BT Group 29.0 45.0 14.0 12.0 -6.6% -7.4% 31,500 29,295 -2,205
Akzo Nobel 39.0 47.0 8.0 6.0 -4.6% -8.1% 10,480 9,815 -665
British Airways 49.4 39.9 0.0 10.7 -0.9% -7.7% 14,272 13,658 -614
Daimler 46.5 40.1 4.1 9.3 -1.7% -7.7% 10,110 9,635 -475
Deutsche Post 33.0 28.0 20.0 19.0 -2.8% -5.9% 6,235 5,964 -271
BAE Systems 28.0 62.0 8.0 2.0 3.8% -7.4% 13,070 12,835 -235
Deutsche Lufthansa 46.5 38.3 3.2 12.9 -1.4% -7.4% 4,921 4,704 -217
GKN 34.9 50.7 10.3 4.1 -6.3% -8.3% 2,009 1,862 -147
ThyssenKrupp 48.0 44.0 8.0 -2.1% -8.3% 1,724 1,581 -143
BMW 53.8 24.4 8.2 13.6 2.6% -6.5% 5,491 5,384 -107
Michelin 53.5 34.75 2.75 9.0 0.9% -7.5% 3,200 3,094 -106
Peugeot Citroen 64.0 36.0 0.0 0.0 3.0% -8.3% 2,409 2,345 -64
Continental 54.5 31.1 2.4 12.0 1.7% -7.1% 2,172 2,113 -59
Bayer 54.0 15.0 8.0 23.0 4.4% -5.4% 8683 8,640 -43
Meggitt 40.0 53.0 4.9 2.1 -5.4% -8.8% 452 420 -32
Alcatel-Lucent 63.0 17.0 8 12 6.0% -6.2% 25,069 25,044 -25
Valeo 30.2 62.2 0.0 7.6 -9.1% -9.0% 225 205 -20
Invensys 65.2 12.8 0.0 22.0 7.4% -5.7% 4,722 4,762 40
Average -0.6% -7.5%
Source: SG Cross Asset Research, Factset, Companies release

20 April 2009 19
 Pension funds

Liability calculation: impact of tightening spreads

In company annual reports, we usually find that the discount rate used by actuaries is the AA-
rated corporate bond yield. Depending on the countries where the companies provide
employers with contributions, the yield could be made up of three rates: yields on iBoxx AA
corporate bonds in the UK and Europe; and, an average yield on bonds rated between A and
AAA in the US.

Liability-driven investment
In calculating the sensitivity of liabilities to moves in the discount rate, we assume that the long
duration investment grade bond portfolio is invested to closely match the liability (Liability Driven
Investing, LDI). Therefore, the pension liability and the bond index used as a benchmark are
supposed to have similar sensitivities to interest rates: the performance of the bond portfolio
should be a good proxy for the pension liability. Liability-driven investment strategies are
becoming increasingly popular. The National Association of Pension Funds (NAPF) survey data
indicate that 23% of schemes had implemented an LDI strategy in 2008, up from 17% in 2006.

It is surprisingly easy to overlook the point that pension funds exist to provide the necessary
resources to fund payments to members. Funding allows investment returns to play a role in
the provision of those resources. In an ideal world, investment returns would fulfil three
criteria:
„ ensure that the assets do not lose value over time relative to liabilities;

„ provide a buffer against unforeseen risks such as a rise in life expectancy;

„ and, reduce the need for contributions. In a regulatory environment where the liabilities are
discounted at a fixed rate, the return on the liabilities should be predictable.

However, there is a clear global trend among financial regulators towards market-realistic
valuations of liabilities, as well as the use of risk-based capital principles for the purpose of
assessing solvency and financial requirements. With discount factors driven by market yields,
the liability ‘return’ becomes far from predictable and a high degree of volatility becomes a
factor. This is the essence of Liability Driven Investment: the recognition that investment strategy
should be constructed relative to the liabilities of a fund, and that assessment of risk and return
should combine assets and liabilities. We therefore look at the sensitivity of the pension liabilities
to their discount rates. We take into account three rates depending on the region.

Corporate Bonds performance

Bond performance (%) Changes in spreads (bp)
Q408 Q109 YTD Q408 Q109 YTD
iBoxx € 5.1% -2.4% -4.8% -55bp -10bp 15bp
iBoxx £ 2.8% -8.6% -9.8% -55bp -9bp 5bp
US A-AAA yield 9.9% -5.0% -4.0% -169bp 45bp 17bp
Average performance 5.9% -5.3% -6.2% -93bp 9bp 12bp
Source: SG Cross Asset Research

The table shows that in the fourth quarter of Credit spreads should tighten by year end
the past year the corporate bond yield 8.5

8.0 US Eurozone UK
(liabilities discount rate) decreased by 93bp,
7.5
leading to a rise in pension liabilities of 7.0

about 6%. However, since the beginning of 6.5

6.0
the year, spreads have re-widened again,
5.5
partially offsetting the previous deterioration 5.0

in liabilities. 4.5
Mar-07 Jun-07 Sep-07 Dec-07 Mar-08 Jun-08 Sep-08 Dec-08 Mar-09

Source: Datastream, SG Cross Asset Research

20 20 April 2009
 Pension funds

As SG credit strategists’ forecasts point to tightening credit spreads in the second part of the
year and in 2010e, liabilities may rise again on the back of falling discount rates.

Actuarial rate vs actual rate for our selection

Pension Company Actual rate (%) (2)
liabilities (mm, discount rate* (2) – (1)
LC) (%) (1)
ThyssenKrupp 6,938 6.9% 6.2% -70bp
British Airways 16,214 6.8% 6.2% -60bp
BT Group 33,800 6.8% 6.2% -60bp
Meggitt 693 6.5% 6.2% -30bp Aggressive assumptions,
risk of pension liabilities
BAE Systems 17,286 6.4% 6.2% -20bp
rising by the year-end
Akzo Nobel 11,468 6.3% 6.2% -10bp
Continental 2,797 6.3% 6.2% -10bp
Michelin 4,067 6.3% 6.2% -10bp
Alcatel-Lucent 25,498 6.2% 6.2% 0bp
Invensys 5,010 6.2% 6.2% 0bp Market assumptions
Valeo 843 6.2% 6.2% 0bp
Bayer 14659 6.1% 6.2% 10bp
Deutsche Lufthansa 7,754 6.0% 6.2% 20bp
BMW 8,788 5.8% 6.2% 40bp
Peugeot 3,228 5.7% 6.1% 40bp Cautious assumptions
Daimler 15,044 5.5% 6.2% 70bp
Deutsche Post 12,246 5.3% 6.1% 80bp
GKN 2,843 5.1% 6.2% 110bp
*Average of different rates used in different countries and reported in the annual reports by the companies
Source: SG Equity Research, SG Cross Asset Research, Company releases, Bloomberg

To calculate the impact of interest rate changes on the pension liabilities, we compare the
discount rate of the company, as reported in the annual report, with the actual discount rate,
the latter being calculated as an equally weighted average of corporate yields in Europe, UK
and the US.

Pension liabilities after changes in discount rate assumptions

Local currency mm December 2008 Pension March 2009 Expected Pension Changes in pension liabilities
Liabilities Liabilities
BT Group 33,800 35,490 1,690
British Airways 16,214 17,025 811
BAE Systems 17,286 17,718 432
ThyssenKrupp 6,938 7,285 347
Akzo Nobel 11,468 11,755 287
Michelin 4,067 4,169 102
Continental 2,797 2,867 70
Meggitt 693 710 17
Invensys 5,010 5,010 0
Valeo 843 843 0
Peugeot 3,228 3,147 -81
GKN 2,843 2,701 -142
Deutsche Lufthansa 7,754 7,560 -194
BMW 8,788 8,568 -220
Bayer 14,659 14,293 -366
Deutsche Post 12,246 11,634 -612
Daimler 15,044 14,292 -752
Alcatel-Lucent 25,498 24,223 -1,275
Source: SG Equity Research, SG Cross Asset Research, Companies releases

The table above shows that while BT Group is the most negatively impacted company,
Alcatel-Lucent benefits the most from the rise in the discount rate in the US. However, if
widening spreads since the beginning of the year could reduce the Q1 09 deficit for some
companies, the situation may be different at year-end if SG’s scenario of tightening spreads
were to materialise.

20 April 2009 21
 Pension funds

Expected pension deficit at end Q1 09

When the expected value of the plan assets and the actual value of the pension liabilities are
calculated, it should be a fairly simple exercise to recalculate the deficit (surplus) at the end of
the first quarter.

Expected deficit (surplus) at end Q1 09

Local Currency mm Market Cap Q1 09 Q1 09 Q1 09 expected Q109 expected Rise/Drop
expected expected deficit/surplus deficit/surplus versus Dec-08
assets liabilities vs mkt cap (%)
British Airways 1,906 13,658 17,025 3,366 180% 74.7%
BT Group 6,389 29,295 35,490 6,195 99% 61.0%
Akzo Nobel 7,901 9,815 11,755 1,940 25% 12.1%
BAE Systems 11,837 12,835 17,718 4,883 43% 5.6%
ThyssenKrupp 8,782 1,634 7,285 5,651 65% 5.0%
Meggitt 1,065 420 710 290 28% 4.6%
Continental 2,969 2,113 2,867 754 26% 4.3%
Michelin 5,071 3,094 4,169 1,074 21% 4.1%
Valeo 1,146 205 843 638 55% 1.8%
GKN 774 1,862 2,701 839 110% 0.6%
Deutsche Lufthansa 4,444 4,704 7,560 2,856 65% 0.5%
Peugeot 4,502 2,345 3,147 802 18% -0.4%
BMW 16,106 5,384 8,568 3,184 20% -0.7%
Daimler 26,301 9,635 14,292 4,657 18% -1.1%
Bayer 28,449 8,640 14,293 5,653 20% -1.1%
Invensys 1,386 4,762 5,010 248 18% -2.9%
Deutsche Post 11,044 5,964 11,634 5,670 51% -3.1%
Alcatel-Lucent 3,876 25,044 24,223 (821) -21% -32.2%
Source: SG Cross Asset Research, Companies Annual Reports (Market cap on April 14)

On the eighteen companies initially analysed, only half of them could disappoint the market in
the first quarter of the year, in our view. We see British Airways and BT Group as the most at
risk. There is also room for some positive surprises: Alcatel-Lucent will switch from a deficit to
surplus thanks to the rise in the discount rate.

British airways the most risky company in the SG coverage

British Airways is the most risky company in terms of pension deficit. BA’s last annual report
put the net position of its pension schemes at 31 March 2008 as a deficit of £437m, before
adjustments under the ‘corridor’ rule, or a deficit of £245m after ‘corridor’ adjustments.
However, in September 2008 the pension trustees published an actuarial valuation putting the
deficit on its main scheme, NAPS, at £1.5bn (rather than a deficit of £357m under IAS19) and
the deficit on its second scheme, APS, at £245m (rather than a surplus of £1,236m under
IAS19). BA did not detail the differences between this actuarial valuation and the annual
report, but they related mainly to different discount rates. If BA’s other smaller schemes were
as reported in the accounts, then we estimate that BA’s net position under the actuarial
valuation was a deficit of £1.9bn at 31 March 2008. Assuming that its gross pension liabilities
is discounted at the new actual rate, that the value of plan assets fell by 7.7% (plan assets
allocation: bonds 49.4%; equity 39.9% and other 10.7%), then we estimate that the new net
deficit position could have grown to £4bn at 31 March 2009e (2.3x market cap). The next full
actuarial valuation, which will determine how much BA should put into the schemes and over
what time frame, is due as at 31 March 2009 and is likely to be published by September.

22 20 April 2009
 Pension funds

Pension Deficits/Ageing Workforce

From baby boom to ageing workforce
The problem of a rapidly ageing workforce nearing retirement is a predicament currently faced
by employers around the world. Skilled workers from the “Baby Boom” generation, born
between 1946 and 1964, have already reached or will soon reach retirement age. According to
the US Bureau of Labour Statistics 19 million Baby Boomers, of a national total of 76 million,
will be ready for retirement by 2011. Figures suggest that the average working age in the US is
now 41 up from 35 in 1980. According to the American Association of Retired Persons, one of
every five employees will be at least 55 by 2015. This situation poses several problems for
employers and national social security systems, particularly because the generation following
the baby boomers, born between 1965 and 1983 and often referred to as the “Generation X”,
is significantly less populous than its predecessor. Considering the representative populations
of the baby boom generation and Generation X, 76 million and 41 million respectively, and the
current rates of retirement, it is estimated that there will be a deficit of 7 million skilled workers
by 2010 (Source: industryweek.com).

In the UK, the combination of declining birth rates and greater longevity means that, by 2030,
the number of people aged 50 and over will have reached 46% of the total UK population,
rising from 33% in 2002. These trends are also evident in other developed countries such as
France, Germany, Spain and Japan.

Knowledge gap
The deficit brought on by the retirement of the populous Baby Boom generation is not just one
of manpower, though that is certainly a concern. The most crucial gap left when million of
aging skilled workers retire is that of knowledge. These soon-to-be retirees hold the deep
knowledge of processes and technologies that are vital to the successful operation of
businesses and industries. Industry experts worry that when the Baby Boomers retire they will
take a vast amount of precious and undocumented knowledge with them, which will
effectively be lost to both businesses and future generations.

In sectors heavily afflicted with an aging and rapidly retiring workforces the knowledge deficit
is already being felt. This is in part because older generations of workers were less apt to
change employment than younger generations. Changing jobs less frequently gave employees
the time and experience to accumulate a company-specific or even task-specific body of
knowledge that cannot be achieved if an employee is rapidly changing positions.

Benefits of older employees

Despite the deficits in manpower and knowledge cause by an aging workforce, it seems there
are also benefits for businesses staffed by “graying” employees. First of all, retaining aging
employees reduces staff turnover rates and provides an immediate financial benefit. Additional
financial incentives for organisations to keep older workers engaged, is also given by studies
which suggest older people are better workers. For example, the Canadian Centre for
Occupational Health and Safety reports that older workers exhibit lower turnover, more
dedication to the workplace, and have more positive work values. Absenteeism is less
frequent, although it is longer when it does happen.

However, to take advantage of the aging workforce, organisations need to treat their existing
employees (both young and old) as more than merely “assets”. Long term loyalty can only be
gained through a dedicated approach to ongoing personnel development.

20 April 2009 23
 Pension funds

Retaining retiring-age workers as part-time or contract employees can also benefit businesses
and organizations by allowing more experienced workers to pass on their knowledge to the
new employees who are essentially their replacements. This is one approach to improving the
looming knowledge deficit. For example, in the US public sector, The Chicago Transit
Authority implemented a Phase-In Retirement programme for retiring employees. This
programme gradually acclimatises mature workers to retirement by steadily reducing their
work hours and pay rates, but concurrently gives them their pensions, while encouraging them
to mentor younger employees.

Employee development
To tackle the problem of an ageing workforce and the associated encroaching knowledge
deficit, some companies are pouring resources into recruitment and training programmes for
young employees. The employee deficit, of up to 7 million in the US according to some
studies, is making the job market for skilled professionals very competitive; for companies, not
job seekers necessarily. Many companies are losing a large percentage of their skilled
workforce, essentially all at once, and they are clamouring to recruit new skilled workers to
replace those retiring. However, since there are not enough new, qualified employees to fill
existing positions companies are forced to compete with each other to attract the highest
calibre employees.

Protecting the pension funds: avoiding the Enron failure

The picture is gloomy for some pension funds but there is some room for serenity. Both in UK
and in the US, legislators have decided to tackle the pension bankruptcy threat, especially
after some famous cases like Enron’s. In UK, the Board of the Pension Protection Fund (the
PPF) was created under the Pensions Act 2004. The Board of the PPF is a Statutory
Corporation responsible for managing the Fund and for making payments to members. The
PPF started on 6 April 2005 in response to public concern that when employers sponsoring
defined benefit pension schemes became insolvent, scheme members could lose some or
their entire pension if the scheme was underfunded. All eligible schemes are required to pay
annual levies to the PPF to contribute towards administration and the compensation Fund
itself. The principle is quite simple: any member who is over their normal retirement age or
who retired early due to ill health will receive 100% of the pension they are currently receiving.
Other members will receive the 90% level of compensation capped at a certain level. Yet, as is
understandable, the amount of compensation is often less than a member would have been
entitled to under the rules of their original pension scheme. This is partly due to the
compensation cap and 90% restriction on benefits but also because the indexation provided
by the PPF may not be as generous as that otherwise provided by the scheme.

In the US, there is an equivalent body since 1974 with the Pension Benefit Guaranty
Corporation (or PBGC), an independent agency of the United States government that was
created by the Employee Retirement Income Security Act of 1974 (ERISA) to encourage the
continuation and maintenance of voluntary private defined benefit pension plans, provide
timely and uninterrupted payment of pension benefits, and keep pension insurance premiums
at the lowest level necessary to carry out its operations. However, and despite the changes
introduced in 2006 regarding trustee fiduciary duty, defined contribution plans — by contrast
and by definition with Defined benefit plan — are always "fully funded." Thus, they are not
protected by law, and when a company like Enron strongly encourages workers to massively
invest their 401k plan in shares of their own employer, everything is then lost in the event of
bankruptcy.

24 20 April 2009
 Pension funds

Sectors with ageing workforces

Aerospace sector
The aerospace sector is being hit especially hard by the wave of retirement of skilled workers
from the baby boom generation. A 2008 study estimated that around 25% of the 637,000
aerospace workers in the US would be eligible for retirement that year, raising fears that
America could be facing a serious skills shortage in the factories that churn out commercial
and military aircraft. According to the Aerospace Industries Association (AIA), in 1998, the
industry's largest age group was 35 to 44. In 2007, nearly 60 percent of the workforce was 45
or older. At least 20 percent were between the ages of 55 to 64, and many, if not most, were
already eligible for retirement. An additional 2 percent — or 12,203 employees — were 65 or
older.

The problem is essentially one of supply and demand. Both the commercial and military
segments of the industry are enjoying robust growth, even in light of the global economic
downturn. The growth forecast for 2009 is an enviable 4.8% with total sales expected to
amount to $214 billion. Moreover, the demand for aerospace, electrical, mechanical and
computer engineering disciplines this year is expected to be double what it was 10 years ago.

But, analysts and industry representatives say that colleges and universities are turning out far
too few graduates with engineering and aeronautical credentials to fill upcoming vacancies.
This problem is exasperated by the poor record in math and science instruction in public
schools. And, although the remuneration for production workers in aerospace is significantly
higher than for jobs in other manufacturing industries, the aerospace industry lacks the
recruitment appeal that it once had in the years following the Cold War. Despite the attractive
salaries offered the aerospace sector doesn’t register strongly on the radars of most young
job seekers, many of whom see it as an "old-fashioned industry".

To combat the demographic trends companies in the aerospace industry are aggressively
pursuing strategies to attract the next generation of skilled workers and retain older
employees to act as mentors to new employees. For example, companies are offering
internships and traineeships to students, visiting public schools to increase students’ interest
in math and science, inviting teachers to aerospace plants to gain insight into the industry to
pass along to students and practicing aggressive recruitment in colleges and universities. One
industry initiative in Wichita, Kansas, home to five major aircraft plants in addition to hundreds
of aerospace industry suppliers and vendors, urges the creation of a world-class aviation
training centre to help meet the need for an additional 12,000 aerospace workers by 2018.

NASA has recognized that capturing the knowledge of the experienced workforce, as well as
preparing and supporting the next generation of aerospace workers, is critical to ensure the
success of future military and commercial space operations. To address this issue, NASA and
the state of Florida have funded the development of an entirely web-based virtual learning and
collaboration community.

Public sector
The ageing of the global workforce is hitting government agencies especially hard, since the
average age of public sector employees exceeds that of their private sector counterparts. At
the same time, increasingly fewer people are seeking careers in government. Some of the
main causes for this are the relatively poor public image of the federal government as an
employer, perceptions of non-competitive salaries, length and complexity of the hiring
process, and budget constraints and uncertainties.

20 April 2009 25
 Pension funds

According to a study completed by Accenture’s Public Service Research Division, if

governments around the world fail to make concentrated and long-term efforts to develop and
retain their existing workforce as well as attract new talent, then they will face an increasingly
insufficient pool of skilled employees over the next thirty years. To avoid this scenario,
governments need to make employment in the public sector more appealing to potential
workers. Part of this is about making salaries more attractive but it is also about creating an
engaging and rewarding job experience.

Attracting new employees

Some governments have already tried this approach and experienced positive results. For
example, 37 states in the US have developed new recruitment approaches such as offering
flex-time scheduling, exit interviews to evaluate perceptions of work environments, and
targeted recruiting for certain positions. The Korean government took a step away from the
traditional method of advancement to executive positions; seniority, and opened up about
20% of its top civil service posts to competition from both the public and private sector.
Another example is in Austria, where the government has worked to align the compensation
for public sector jobs with the private sector to increase interest in public sector employment
and avoid losing the best candidates to the traditionally higher-paying private sector. Other
ways to attract potential employees to public sector jobs include promoting jobs to regional
immigrants and pioneering programmes that make it easier for stay-at-home parents to work.

Retaining existing talent

To fight the knowledge gap produced when retiring employees outnumber new employees,
some governments are implementing policies to keep experienced workers longer. One
approach to this is changing retirement policies by either encouraging people to continue
working beyond normal retirement age or to offer disincentives to early retirement. These
types of measures have been implemented to some extent in Sweden and Japan while Italy,
France, the UK and Germany are also considering doing, or have already done so. Changes to
national or public sector retirement policies are often disliked by workers and the public, and
some agencies are working on crafting new policies to soften the blow, such as allowing
workers to draw on their pensions whilst still employed.

Automotive sector
For automotive sector companies operating in developing countries, the effects of ageing in
the workforce are of significant concern. Most of the public debate is focusing on the impact
of changing demographics on social security, workforce shortages and decreased
productivity of the aging workforce. Many companies in the automotive sector are seeing the
average age of their workforce increase to between 55 and 64, raising concerns about
decreased productivity in manufacturing plans where tasks often depend on the speed,
energy and manual dexterity of employees. Moreover, companies may feel increasing
competition from countries such as China and India whose demographic profiles do not mirror
that of wealthy countries and have a surplus in available labour in addition to the fact that they
are quickly advancing in technology and innovation in the sector.

26 20 April 2009
 Pension funds

Auto and ageing workforce: Valeo Auto and ageing workforce: PSA

2%
1%1%
14% 19%
25% 24%

23%
24%

31%
36%

<20 20-29 30-39 40-49 50-59 >60

<20 20-29 30-39 40-49 50+

Source: SG Equity Research, Companies

One study conducted by professors from INSEAD and an employee of German automaker
BMW focused on the problem of the aging workforce at a particular BMW manufacturing plant
in Germany. During the study they conducted an experiment to mimic the demographic shift
that is projected for 2017 at which time the average age of the facility’s workforce will increase
to 47 from the current average age of 39. In the experiment a production line was assembled
with an age distribution amongst line workers similar to that projected for 2017. The expected
outcome was that the experimental line would be less productive due to the increase in
average age of workers and associated decrease in speed, energy and manual dexterity. To
the contrary, the experimental production line achieved the same productivity as the younger
line after three months of consistent improvement and also resulted in a 50% drop in
absenteeism and a defect rate of zero. The improvements in productions made by the
experimental line came as a result of small improvements such as better seats, workbenches
and flooring in the facility, showing that an aging workforce need not be a concern if small
measures are taken to attend to the needs of aging workers, and thus maintain desired levels
of productivity.

Oil and gas sector

Like many other sectors, the oil and gas sector is faced with an ageing workforce. According
to the World Petroleum Council, the average age of employees in Exploration and Production
(E&P) was 50 years in 2005, among the oldest of any industry, with 40-60% of aging
employees set to retire by 2010. And while energy demand is set to increase in the coming
years, there is a growing skills gap that could impede the industry’s ability to operate caused
by fewer students pursuing programs related to E&P. Some reasons for this include the
perceived insecurity of the oil and gas job market, tough working conditions such as
dangerous environmental and political environments and attention to the negative
environmental impacts of the industry. Students are choosing programmes they perceive as
more exciting and preparing them for the “jobs of the future” such as those in the IT sector.

To tackle the problem of an ageing resource nearing retirement and the resulting personnel
and knowledge gap, companies are practicing more aggressive recruitment and outreach to
schools and developing new, electronic, methods of archiving special industry information and
problem solving knowledge. Companies are encouraging employees to store vital information
as to how they resolve problems and make crucial decisions via the use of handheld
computers and other media. The shift to electronic data logging will archive knowledge and
allow employees to communicate with each other as well as with management on a larger

20 April 2009 27
 Pension funds

scale, both in the office and on the field. The shift is also expected to reduce costs associated
with training new employees.

Companies with pension deficits may experience staff growth!

Name 1999 2009 Average 1999-2009 Growth

Akzo Nobel 85 900 42 600 62 807 -

Alcatel-Lucent 118 272 76 410 86 994 -
Bayer 145 100 106 200 114 791 -
British Airways 60 675 45 140 55 896 -
BT Group 124 700 111 900 114 636 -
Daimler 441 502 272 382 372 977 -
Invensys 49 779 26 002 64 300 -
Michelin 127 241 113 529 123 942 -
Valeo 50 400 61 051 64 915 -
BAE Systems 46 500 88 000 72 445 +
BMW 119 913 107 539 106 511 +
Deutsche Lufthansa 54 867 105 261 86 878 +
Deutsche Post 223 863 536 350 389 899 +
GKN 35 517 37 735 37 733 +
Meggitt 4 187 7 360 5 026 +
Peugeot 156 500 207 800 193 518 +
ThyssenKrupp 174 262 199 374 188 492 +
Source: SG Equity Research, Datastream, Worldscope

28 20 April 2009
 Pension funds

Company Profiles

30 Akzo Nobel NV
31 Alcatel-Lucent
32 BAE Systems
33 Bayer AG
34 British Airways
35 BT Group
36 Daimler
37 Deutsche Lufthansa
38 Deutsche Post AG
39 GKN
40 Invensys
41 Meggitt
42 Michelin
43 Peugeot Citroen PSA
44 ThyssenKrupp
45 Valeo

20 April 2009 29
 Pension funds

Chemicals (Netherlands)

Akzo Nobel NV
Pension deficit We do not see pension deficit as a major issue
Q Pension position At end-2008 Akzo Nobel’s pension deficit was €988m down from
Hold (12m) €1,510m in 2007 on a pro forma basis including ICI, there was also €441m of other post
Price 17/04/09 12m target retirement benefits (€286m). In total, funded and unfunded pension plans amounted to
€34.0 €27.0 almost €11.5bn, the largest by far being the ICI Pension Fund and the AkzoNobel (CPS)
Pension scheme in the UK. The plan asset allocation is heavily weighted towards bonds; at
end-2008, 72% of assets were in long-term interest earning investments, versus 23% in
equities. Akzo Nobel and the former ICI have been aggressively topping up the pension
schemes, in 2004 the pro forma net deficit, primarily reflecting under funding at ICI, was
nearer €4bn and Akzo Nobel expects to contribute €304m again in 2009e with additional
Type of investment payments of £172m for the ICI Pension Fund (ICI top-ups are expected to continue at
Value 9
current levels for a few years) and £25m for the UK AkzoNobel (CPS) Pension scheme.
Cost reduction programme 9
High dividend yield 9

1 year Q Impact At end-2008, net debt was only €2,084m (28% gearing), with cash of €1,595m, an
65
Price MA 100
undrawn revolving credit facility of €1.5bn (to 2013) and a commercial paper programme of
US$1bn and €1.5bn. In March the group refinanced €1bn of debt maturing in May 2009,
50
through a €750m 6-year 7.25% bond and a £250m 7-year 8% bond. The next major
35
refinancing of c.€750m is not due until 2011. With a cash generative business model and
the related financial strength that goes with this, we do not see Akzo’s pension deficit as a
20
2008 2009 major issue.
(m)
7.5

2.5
Q Target price & rating Our TP of €27 implies just over 10x our 2009e EPS; 10x P/E is a
0
2008 2009
level that historically has acted as a floor for similar stocks on trough earnings, with Akzo
Source: SG Equity Research
actually seeing an annual average P/E of c.12.5x in the 1990s recession. In this regard, we
note Akzo’s stronger business today, its leading global market positions (and brands), its
ICI synergy and rationalisation programmes (looking at benefits in excess of €0.5bn p.a.),
its strong balance sheet (28% gearing), and a maintained dividend, giving a 5% plus yield.

Q Next events & catalysts Q1 09e results: PPG and Sherwin Williams 16/04, Akzo 23/04.
AKZO NOBEL NV
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC AKZO.AS, Bloom AKZA NA Revenues (€bn) 15.42 14.23 14.46 14.95 P/E (x) 9.8 13.2 11.8 9.9
52-week range 57.1-22.9 EBIT margin (%) 9.2 7.2 7.6 8.2 FCF yield (/EV) (%) -3.8 2.2 2.9 4.9
EV 09 (€m) 12,130 Rep. net inc. (€m) 230 435 492 625 Dividend yield (%) 5.3 5.3 5.6 5.9
Market cap. (€m) 7,897 EPS (adj.) (€) 3.49 2.57 2.90 3.43 Price/book value (x) 2.3 2.2 2.1 2.0
Free float (%) 100.0 Dividend/share (€) 1.80 1.80 1.90 2.00 EV/revenues (x) 0.76 0.85 0.84 0.80
Performance (%) 1m 3m 12m Payout (%) 252.6 95.9 84.9 70.5 EV/EBIT (x) 8.3 11.8 11.0 9.8
Ordinary shares 20.1 12.0 -40.1 Interest cover (x) 4.2 3.0 3.7 5.3 EV/IC (x) 0.9 0.9 0.9 0.9
Rel. Eurofirst 300 5.6 10.5 -4.7 Net debt/equity (%) 26.3 32.6 33.5 32.5 ROIC/WACC (x) 0.9 0.7 0.7 0.8
CAGR 08-11e: -0.6%

Peter Clark
(44) 20 7762 5084
peter.clark@sgcib.com

SG acted as joint bookrunner in the Akzo Nobel's senior bond issue.

30 20 April 2009
 Pension funds

Communications Equipment (France)

Alcatel-Lucent
Pension deficit Future trend in US corporate bond yields will be key
Q Pension position Alcatel-Lucent has the vast majority of its pension plan assets and
Sell (12m) liabilities related to US pensions. As of December 2008 total assets were $34.9bn
Price 17/04/09 12m target compared to $35.5bn liabilities resulting in a $0.6bn deficit. This compares to a $4.3bn
€1.83 €1.20 surplus as of September 2008. Based on our calculations, we estimate that Alcatel-
Sector
Lucent’s pensions will post a $1.5bn surplus in March 2009. The main reasons for the
Weighting
Underweight volatility of this surplus are the recent swings in US corporate bond yields: this directly
Preferred stock impacts around 50% of the asset value (through the estimated corporate bond
Qualcomm
Least preferred stock allocation) and 100% of the liability calculation (though the discount rate).
Alcatel-Lucent
Q Impact The future trend in US corporate bond yields vs government debt will be key.
Since August 2007 this spread has been widening and extremely volatile. The spread in
March was at a historical high, which is favourable to Alcatel-Lucent. However, should
1 year this situation reverse later this year, it could have a negative impact on the pension
6
Price MA 100
surplus again. A deficit in the pensions as of December 2009 would require some cash
funding no later than in September 2011.
4

Q Target price & rating Our target price is €1.20 based on a DCF valuation. We assume
2

normalised growth of 0%, an op margin of 5% and 10% WACC. We believe that current
0
2008 2009
liquidity is adequate. However, we estimate that pension sensitivity to external interest
(m)
105
rates adds further risk to our valuation.
70

35

0 Q Next events & catalysts Alcatel-Lucent will report Q1 09 earnings on 5 May. We expect
2008 2009

Source: SG Equity Research

sales of €3.5bn, down 8% yoy, op margin of -3% and EPS of -€0.10.

Alcatel-Lucent
on www.sgresearch.socgen.com

Share data Financial data 12/07 12/08e 12/09e 12/10e Ratios 12/07 12/08e 12/09e 12/10e
RIC ALUA.PA, Bloom ALU FP Revenues (€bn) 17.79 16.98 14.87 13.61 P/E (x) nm nm nm 16.4
52-week range 4.90-0.91 EBIT margin (%) 0.6 2.7 1.0 5.0 FCF yield (/EV) (%) -45.2 -21.5 -13.2 4.7
EV 08 (€m) 4,528 Rep. net inc. (€m) -443 -703 -867 -247 Dividend yield (%) 0.0 0.0 0.0 2.7
Market cap. (€m) 4,139 EPS (adj.) (€) -0.318 -0.372 -0.118 0.112 Price/book value (x) 0.4 0.9 1.1 1.2
Free float (%) 77.2 Dividend/share (€) 0.000 0.000 0.000 0.050 EV/revenues (x) 0.22 0.27 0.37 0.41
Performance (%) 1m 3m 12m Payout (%) nm nm nm nm EV/EBIT (x) 35.2 9.7 37.2 8.2
Ordinary shares 46.6 21.4 -52.0 Interest cover (x) 0.3 1.2 0.4 1.7 EV/IC (x) 0.3 0.4 0.5 0.6
Rel. Eurofirst 300 28.8 19.8 -23.7 Net debt/equity (%) nm 7.4 32.0 34.6 ROIC/WACC (x) 0.0 0.3 0.1 0.5
CAGR 07-10e: nm

Vincent Rech Andy Perkins Surendran Panicker (Sp. sales)

(33) 1 42 13 85 16 (44) 20 7762 5413 (44) 20 7762 5525
vincent.rech@sgcib.com andy.perkins@sgcib.com surendran.panicker@sgcib.com

20 April 2009 31
 Pension funds

Aerospace & Defence (United Kingdom)

BAE Systems
Pension deficit Strong balance sheet maintained despite £400m-£500m pension top-up
Q Pension position BAE ended 2008 with an IAS pension deficit, excluding the group’s
Buy (12m) share of amounts allocated to equity accounted investments (£891m), of £3,325m (2007;
Price 17/04/09 12m target deficit of £1,570m). The substantial increase in the deficit was due to a combination of
347.3p 440.0p factors, including worse-than-expected investment returns, an increase in real discount
Sector
rates and the inclusion of an allowance for a minimum rate of future improvements in the
Weighting
Neutral mortality assumption. The fair value of group plan assets at end-2008 was £13,070m
Preferred stock and some 60% of the defined benefit pension plan was invested in equities (expected
BAE Systems
Least preferred stock return assumption of 8.5%), which will make for continuing volatility in the valuation of
EADS these assets. BAE contributed £399m (2007; £403m contribution) to the defined benefit
plan in 2008. This year, BAE expects to make regular contributions at a similar level to
those made in 2008 but, in addition, it will make an incremental contribution of £200m in
respect of the UK pension scheme and $250m (£175m) to the US pension schemes.
1 year
510
Price MA 100
Q Impact The group has a strong balance sheet with 2008 year-end net cash of £39m.
We expect the group to generate some £400m net cash, after dividends but before the
440
pension top-up payments. We expect a broadly cash neutral balance sheet after the
370
pension fund contribution. Indeed, the group could benefit from a lump sum payment if
it is able to sign a follow on equipment order from Saudi Arabia on the Salam
300
2008 2009 programme.
(m)
45

30

15
Q Target price & rating We reiterate our ‘Buy’ recommendation with a target price of
0
2008 2009
440p. At our target price, BAE would trade at a 10% premium to the 2009 P/E average
Source: SG Equity Research
for the European Aerospace & Defence sector which we believe is justified by the
group’s robust medium-term prospects, particularly against the civil-biased companies

Q Next events & catalysts BAE should publish an interim management statement with the
AGM on 6 May 2009. We would expect the group to reiterate the ‘good outlook’ for the
group and the strong visibility provided by the order book. It should also note the
BAE Systems relatively favourable outcome for the group of the 2010 US defence budget submission.
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC BAES.L, Bloom BA/ LN Revenues (£bn) 18.54 21.03 22.01 22.99 P/E (x) 9.4 8.4 8.0 7.6
52-week range 487.0-302.5 EBIT margin (%) 9.4 9.7 9.7 9.7 FCF yield (/EV) (%) 7.9 6.3 7.7 10.3
EV 09 (£m) 15,678 Rep. net inc. (£bn) 1.13 1.45 1.52 1.61 Dividend yield (%) 4.2 4.5 4.7 5.0
Market cap. (£m) 12,220 EPS (adj.) (p) 37.1 41.3 43.3 45.9 Price/book value (x) 1.6 1.5 1.3 1.2
Free float (%) 100.0 Dividend/share (p) 14.5 15.5 16.5 17.3 EV/revenues (x) 0.88 0.75 0.66 0.58
Performance (%) 1m 3m 12m Payout (%) 42.2 39.0 39.3 39.0 EV/EBIT (x) 8.6 7.1 6.3 5.6
Ordinary shares -1.1 -8.6 -24.1 Interest cover (x) 17.2 13.6 17.8 24.7 EV/IC (x) 1.2 1.1 1.0 1.2
Rel. Eurofirst 300 -13.1 -9.8 20.7 Net debt/equity (%) nm 1.1 nm nm ROIC/WACC (x) 1.3 1.0 1.0 1.2
CAGR 08-11e: +7.3%

Zafar Khan Colin Campbell

(44) 20 7762 5317 (44) 20 7762 5609
zafar.khan@sgcib.com colin.campbell@sgcib.com

32 20 April 2009
 Pension funds

Pharmaceuticals (Germany)

Bayer AG
Pension deficit Pension liability adds to the company’s net debt but not a big risk
Q Pension position Changes in relevant valuation parameters such as interest rates,
Hold (12m) mortality and rates of increases in compensation may raise the present value of our
Price 17/04/09 12m target pension obligations. This may lead to increased pension costs or diminish stockholders’
€38.2 €38.0 equity due to actuarial losses being recognized directly in equity. A large proportion of
Sector
Bayer’s pension and other post-employment benefit obligations is covered by plan
Weighting
Overweight assets including fixed-income securities, shares, real estate and other investments.
Preferred stock Declining or even negative returns on these investments may negatively impact the
Novartis
Least preferred stock future fair value of plan assets. This again may diminish equity, and/or it may necessitate
Novo Nordisk additional contributions by the company.

Q Impact While the pension liability adds to the company’s net debt (2008: €14.2bn
before pension liabilities) following the 2006 acquisition of Schering, we do not believe it
1 year represents a concern for investors. Bayer generates strong and sustainable cash flows,
75
Price MA 100
notably from its healthcare business, which generated net cash flow of €2.3bn in 2008.
However, we note that the company made a €300m cash contribution to its pension
60
fund in 2008 and is expecting to make a similar contribution in 2009. We also note that
45
the BayerMaterialSciences (BMS) division is highly cyclical, with 2009e EBITDA possibly
falling below EUR300m (vs >€1bn in 2008) according to the company (SG 2009e
30
2008 2009 underlying BMS EBITDA: €265m).
(m)
24

16

8
Q Target price & rating We maintain our sum-of-the-parts based price target of €38, set
0
2008 2009
on 4 March.
Source: SG Equity Research

Q Next events & catalysts We expect the FDA’s decision on the anticoagulant Xarelto for
acute use (VTE prevention in orthopaedic surgery) in Q2 09e, but believe that approval
may be delayed until at least 2010e. On 3 June, Bayer will hold its Meet Management
Seminar in Leverkusen (Germany), which should include an update on demand for its
MaterialSciences products. A demand rebound in H2 09 looks unlikely to us, but could
BAYER AG potentially add >5% to our FY09e core EPS forecast.
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC BAYG.DE, Bloom BAY GR Revenues (€bn) 32.92 32.28 32.98 34.05 P/E (x) 19.3 13.2 10.9 8.3
52-week range 57.5-32.7 EBIT margin (%) 10.8 11.4 12.7 15.5 FCF yield (/EV) (%) 6.3 10.9 12.2 15.2
EV 09 (€m) 46,931 Rep. net inc. (€bn) 0.83 2.20 2.86 3.78 Dividend yield (%) 3.7 3.7 4.2 4.7
Market cap. (€m) 31,486 EPS (adj.) (€) 1.98 2.89 3.50 4.61 Price/book value (x) 1.8 1.5 1.4 1.2
Free float (%) 97.0 Dividend/share (€) 1.40 1.40 1.60 1.80 EV/revenues (x) 1.58 1.45 1.30 0.98
Performance (%) 1m 3m 12m Payout (%) 128.9 50.1 46.1 39.2 EV/EBIT (x) 14.7 12.8 10.3 6.3
Ordinary shares 16.9 -11.3 -25.9 Interest cover (x) 2.9 5.8 9.6 14.1 EV/IC (x) 1.6 1.6 1.6 1.3
Rel. Eurofirst 300 2.7 -12.5 17.9 Net debt/equity (%) 86.6 44.3 22.2 4.3 ROIC/WACC (x) 0.8 0.9 1.1 1.5
CAGR 08-11e: +32.7%

Marietta Miemietz
(44) 20 7762 5074
marietta.miemietz@sgcib.com

20 April 2009 33
 Pension funds

Transportation - Airlines (United Kingdom)

British Airways
Pension deficit Could be twice market cap
Q Pension position BA’s last annual report put the net position of its pension schemes at
Sell (12m) 31 March 2008 as a deficit of £437m, before adjustments under the ‘corridor’ rule, or a
Price 17/04/09 12m target deficit of £245m after ‘corridor’ adjustments. However, in September 2008, the pension
174.0p 90.0p trustees published an actuarial valuation putting the deficit on its main scheme, NAPS,
Sector
at £1.5bn (rather than a deficit of £357m under IAS19) and the deficit on its second
Weighting
Neutral scheme, APS, at £245m (rather than a surplus of £1,236m under IAS19). BA did not
Preferred stock detail the differences between this actuarial valuation and the annual report, but they
Lufthansa
Least preferred stock related mainly to different discount rates. If BA’s other smaller schemes were as
British Airways reported in the accounts, then we estimate that BA’s net position under the actuarial
valuation was a deficit of £1.9bn at 31 March 2008. Assuming that its gross pension
liabilities remained unchanged at 31 March 2009e, that the value of equities in the
pension assets fell by 31% (in line with the fall in the FTS100) and that the value of other
1 year assets in the schemes remained stable, then we estimate that this net deficit position
Price MA 100
370 could have grown to £3.7bn at 31 March 2009e (2x market cap). The next full actuarial
valuation, which will determine how much BA should put into the schemes and over
280

what time frame, is due as at 31 March 2009 and is likely to be published by September.
190

Q Impact The possible magnitude of BA’s deficit position at March 2009 raises the
100
2008 2009 prospect that BA will need to put more cash into the schemes, potentially compromising
(m)
60

40
new fleet capex, and/or take difficult decisions about lowering pension benefits
20 potentially sparking union opposition. It is also possible that BA will be allowed to
0
2008 2009 reduce the deficit over a longer time frame. This issue has added complexity to BA’s
Source: SG Equity Research
merger talks with Iberia by making valuation a more difficult subject.

Q Target price & rating Our 90p target price is derived by applying BA’s historic trough
P/BV of 0.4x to our FY10e forecasts. With 44% downside potential we reiterate our Sell.

Q Next events & catalysts Preliminary FY09 results due 22 May. Newsflow on the Iberia
British Airways merger and pension valuation will also be closely watched.
on www.sgresearch.socgen.com

Share data Financial data 3/08 3/09e 3/10e 3/11e Ratios 3/08 3/09e 3/10e 3/11e
RIC BAY.L, Bloom BAY LN Revenues (£bn) 8.75 9.13 9.07 9.44 P/E (x) 3.0 nm nm 23.8
52-week range 282.5-109.9 EBITDAR margin (%) 18.7 6.8 7.1 10.1 Price/cash flow (x) 4.7 8.5 4.0 2.6
EV 09 (£m) 5,437 EBIT margin (%) 10.0 -1.7 -1.7 1.6 Dividend yield (%) 2.9 0.0 0.0 1.4
Market cap. (£m) 2,021 Rep. net inc. (£m) 682 -277 -153 85 ROIC (%) 10.0 -1.3 -1.2 2.1
Free float (%) 100.0 EPS (adj.) (p) 58.9 -17.1 -13.2 7.3 Price/book value (x) 0.7 0.7 0.8 0.8
Performance (%) 1m 3m 12m Dividend/share (p) 5.0 0.0 0.0 2.4 EV/IC (x) 0.78 0.86 0.88 0.87
Ordinary shares 25.8 4.6 -20.0 Interest cover (x) 4.7 na na 0.9 EV/EBITDAR (x) 3.1 8.7 8.8 5.8
Rel. Eurofirst 300 10.5 3.2 27.2 Net debt/equity (%) 49.8 70.9 84.2 79.2 ROIC/WACC (x) 1.4 -0.2 -0.2 0.3
CAGR 08-11e: -50.1%

Jonathan Wober Matthew O'Keeffe

(44) 20 7762 5270 (44) 20 7762 5385
jonathan.wober@sgcib.com matthew.okeeffe@sgcib.com

34 20 April 2009
 Pension funds

Diversified Telecommunication Services (United Kingdom)

BT Group
Pension deficit Pension risk weights on the equity story
Q Pension position - As of 31 December 2008, BT posted a pension deficit of £1.7bn (net of
Hold (12m) tax). However, the £24.9bn estimated value of the core business pales in comparison to
Price 17/04/09 12m target BT’s £37.6bn of pension liabilities. Thus, anything that increases the latter can have
91.6p 105.0p significant repercussions for the former.
Sector
Weighting Q Impact The upcoming triennial valuation may lead to a tangible increase in the BT
Overweight pension deficit. Easing long-term inflationary pressure could offset pressure from
Preferred stock
France Telecom weakening equity markets on the pension assets in the short term, but two powerful
Least preferred stock drivers could increase liabilities permanently and require additional cash funding, i.e.,
Vodafone lowering discount rates and rising life expectancy. Lowering discount rates. Rising credit
Type of investment spreads for financial institutions boosted AA-rated bond yields and in turn reduced the BT
Pension risk 9 pension deficit (as AA-rated bond yields were used to discount BT future pension
liabilities). As of 31 December, we estimated BT to have used a rate of 3.75% (expressed
1 year
in real terms) to discount its pension liabilities. This rate compares to an average 2.6%
310
Price MA 100 used by actuaries in their last triennial review. The actuaries’ final decision on discount
rates could be significant since any 25bp increase in the discount rate reduces the BT
230 pension deficit by £1.2bn. Rising life expectancy Benchmarking against recent triennial
actuarial reviews by other FTSE100 companies, we estimate BT may need to raise its life
150
expectancy assumptions by 2 to 3 years, raising pension liabilities by an estimated
70
£2.8bn-4.2bn. Value of pension assets risks derating. Finally, during Q3, BT recorded a
2008 2009
(m)
270
£2.9bn drop in the value of its pension assets with £0.9bn shortfall driven by an
180 accelerated deterioration in the value of its ex-equity assets. We therefore see greater risk
90
of further downside should the trustee decide to adopt a more cautious stance on the less
0
2008

Source: SG Equity Research

2009
liquid portion of BT’s pension assets (such as property and alternative assets).

Q Target price & rating We retain a Hold rating on BT, with a SoP-based price target of
105p. We include in the SoP an estimate for BT’s pension deficit of £4.3bn based on a
discount rate of 3.1% (expressed in real terms) and life expectancy assumptions in line
with peers.

Q Next events & catalysts 14 May – Q4 results and triennial pension review.
BT Group
on www.sgresearch.socgen.com

Share data Financial data 3/08 3/09e 3/10e 3/11e Ratios 3/08 3/09e 3/10e 3/11e
RIC BT.L, Bloom BT/A LN Revenues (£bn) 20.70 21.16 21.50 21.83 P/E (x) 5.0 5.8 5.4 5.1
52-week range 235.5-71.4 EBIT margin (%) 14.0 12.3 12.6 12.9 FCF yield (/EV) (%) 15.6 6.8 6.9 6.8
EV 09 (£m) 23,592 Rep. net inc. (£bn) 1.74 1.55 1.62 1.69 Dividend yield (%) 17.2 11.8 7.6 8.1
Market cap. (£m) 7,131 EPS (adj.) (p) 18.3 15.8 16.8 18.0 Price/book value (x) 1.4 1.3 1.1 0.9
Free float (%) 100.0 Dividend/share (p) 15.8 10.8 6.9 7.4 EV/revenues (x) 0.86 1.11 1.09 1.08
Performance (%) 1m 3m 12m Payout (%) 71.1 81.4 42.9 42.4 EV/EBIT (x) 6.1 9.1 8.7 8.3
Ordinary shares 13.6 -25.3 -57.4 Interest cover (x) 7.7 4.7 5.0 5.3 EV/IC (x) 1.1 1.4 1.4 1.4
Rel. Eurofirst 300 -0.1 -26.3 -32.3 Net debt/equity (%) 174.3 204.4 169.5 143.9 ROIC/WACC (x) 1.8 1.5 1.6 1.6
CAGR 08-11e: -0.5%

Ottavio Adorisio Stéphane Beyazian Thierry Cota Saeed Baradar (Sp.Sales)

(44) 20 7762 5761 (33) 1 42 13 45 04 (33) 1 42 13 84 45 (44) 20 7762 5755
ottavio.adorisio@sgcib.com stephane.beyazian@sgcib.com thierry.cota@sgcib.com saeed.baradar@sgcib.com

20 April 2009 35
 Pension funds

Automobiles (Germany)

Daimler
Pension deficit No cash related risk on pension funds
Q Pension position Although many investors are still keeping a close eye on pensions
Hold (12m) and benefit issues at Daimler, the disposal of Chrysler in 2007 considerably reduced the
Price 17/04/09 12m target related risk. Daimler has simply committed to contributing $1bn (€750m) to rescue funds
€26.7 €24.0 should the US company go bankrupt. In 2008, the group reported a deficit of €4.9bn on
Sector
the pension schemes, up €3bn, as the plan assets value decreased by 27% to €10.1bn,
Weighting
Overweight compared with obligations almost stable at €15bn (€37bn in 2006). The bulk is related to
Preferred stock Germany, with a €4.0bn deficit vs c. €1.0bn for the rest of the world (mainly the US). On
Vokswagen pref
Least preferred stock top of this, the healthcare benefits, which are not covered by plan assets, run at a
GM manageable €1bn. On the balance sheet, the provision for pension benefits rose slightly
to €4.1bn due to unrecognized actuarial losses of €1.7bn.

Q Impact As the bulk of the liabilities and deficits are located in Germany, and are not
1 year fully covered by specific assets, Daimler is not obliged to refund the pension funds to
85
Price MA 100
reduce the deficit and does not intend to make special contributions in the coming
years. Indeed, the payments to pensions funds should not exceed €0.2bn in 2009e as
60
indicated in the group’s latest financial report. All in all, pensions and benefits should
35
have no impact on our estimate of net cash at €6.5bn by end-2009e.

10 Q Target price & rating We maintain our Hold rating. The stock looks moderately valued
2008 2009
(m)
60
but we see high short-term risk related to the truck business, with tougher than
40

20
expected conditions in Europe and no quick rebound likely in the US. The recent change
0
2008 2009
in share ownership structure after the €1.95n capital increase reserved for the Abu Dhabi
Source: SG Equity Research
Aabar investment fund could also reduce scope for a break-up (cars and trucks) and
limit M&A conjecture. Our €24 TP is obtained from a SoP approach, including a €2bn
negative impact from ‘miscellaneous’ items, o/w €1bn related to Chrysler.

Q Next events & catalysts Q1 results due in April (no date yet, Wed 29 April in 2008), with
investors likely to be highly sensitive to the depth of losses.
Daimler
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC DAIGn.DE, Bloom DAI GR Revenues (€bn) 95.87 85.30 89.90 94.60 P/E (x) 10.9 19.3 9.8 7.6
52-week range 52.9-17.4 EBIT margin (%) 2.8 2.3 4.7 5.8 FCF yield (/EV) (%) 8.9 2.8 10.6 17.7
EV 09 (€m) 19,514 Rep. net inc. (€bn) 1.41 1.33 2.86 3.67 Dividend yield (%) 2.3 2.3 4.5 5.6
Market cap. (€m) 26,978 EPS (adj.) (€) 2.45 1.38 2.73 3.51 Price/book value (x) 0.6 0.7 0.7 0.6
Free float (%) 88.4 Dividend/share (€) 0.60 0.60 1.20 1.50 EV/revenues (x) 0.24 0.23 0.18 0.15
Performance (%) 1m 3m 12m Payout (%) 40.9 45.7 43.9 42.8 EV/EBIT (x) 8.4 10.0 3.8 2.6
Ordinary shares 24.9 11.4 -46.4 Interest cover (x) nm nm nm nm EV/IC (x) 0.3 0.2 0.2 0.2
Rel. Eurofirst 300 9.8 9.9 -14.7 Net debt/equity (%) nm nm nm nm ROIC/WACC (x) 0.3 0.2 na na
CAGR 08-11e: +12.6%

Philippe Barrier Eric-Alain Michelis

(33) 1 42 13 84 42 (33) 1 42 13 50 95
philippe.barrier@sgcib.com eric.michelis@sgcib.com

36 20 April 2009
 Pension funds

Transportation - Airlines (Germany)

Deutsche Lufthansa
Pension deficit On course to reduce provision to zero
Q Pension position Lufthansa reported a pension provision of €2,400m as of
Buy (12m) 31 December 2008, although the underlying figure was €2,833m before adjustments
Price 17/04/09 12m target allowed under the ‘corridor’ rule. Equities accounted for 38% of the combined assets of
€9.78 €13.0 its schemes in Germany and abroad. Pension schemes in Germany are typically
Sector
unfunded and, in the event of bankruptcy of the sponsoring company, supported by a
Weighting
Neutral state-backed insurance scheme (Pensionssicherungsfond). Nevertheless, in 2004
Preferred stock Lufthansa decided to create a pension trust to build up assets to fund future pension
Lufthansa
Least preferred stock payments. The aim is to reduce the provision to zero over a 10-15 year horizon through
British Airways annual transfers of €565m into the trust.

Q Impact The key point to stress is that Lufthansa’s annual transfers are voluntary and so
Lufthansa has considerable flexibility regarding the cash flow consequences of its
1 year pension position. It has indicated that it may not transfer the usual €565m in 2009.
19
Price MA 100
Lufthansa only transferred €283m in 2008, but transferred €1.6bn in 2007 and has
transferred €3.5bn since 2004. It remains on course to achieve its aim of funding its
15
pension obligations over a 10-15 year horizon (from 2004) in our view.
11

Q Target price & rating Our TP remains €13, derived by applying LHA’s historic trough
7
2008 2009
P/BV multiple of 0.8x to our FY2009e forecasts. With 41% upside potential, we reiterate
(m)
16.5
our Buy rating. Longer-term potential is substantial: our SOP points to €19, and the 1.5x
11

5.5
P/BV on which it traded 12m after the last trough would imply €23.
0
2008 2009

Source: SG Equity Research

Q Next events & catalysts Lufthansa shares go ex-dividend after the AGM on 24 April,
and Q1 earnings are due on 30 April.

Deutsche Lufthansa
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC LHAG.DE, Bloom LHA GR Revenues (€bn) 26.99 24.87 24.91 26.87 P/E (x) 6.8 17.5 19.9 7.1
52-week range 18.3-7.86 EBITDAR margin (%) 10.8 8.9 9.2 11.0 Price/cash flow (x) 1.8 2.4 2.3 1.7
EV 09 (€m) 8,917 EBIT margin (%) 5.0 2.3 2.3 4.2 Dividend yield (%) 7.2 4.1 4.1 8.2
Market cap. (€m) 4,503 Rep. net inc. (€m) 599 256 226 629 ROIC (%) 9.9 4.1 3.8 6.5
Free float (%) 100.0 EPS (adj.) (€) 1.45 0.56 0.49 1.37 Price/book value (x) 0.7 0.6 0.6 0.6
Performance (%) 1m 3m 12m Dividend/share (€) 0.70 0.40 0.40 0.80 EV/IC (x) 0.74 0.71 0.72 0.70
Ordinary shares 19.4 -8.4 -44.1 Interest cover (x) 25.5 6.7 3.1 5.2 EV/EBITDAR (x) 2.8 4.0 4.2 3.3
Rel. Eurofirst 300 4.9 -9.6 -11.1 Net debt/equity (%) 5.2 28.6 39.9 39.7 ROIC/WACC (x) 1.3 0.6 0.5 0.9
CAGR 08-11e: -1.8%

Jonathan Wober Matthew O'Keeffe

(44) 20 7762 5270 (44) 20 7762 5385
jonathan.wober@sgcib.com matthew.okeeffe@sgcib.com

SG acted as joint bookrunner in the Lufthansa's senior bond issue (6.75% 24/03/2014 EUR).

20 April 2009 37
 Pension funds

Air Freight & Logistics (Germany)

Deutsche Post AG
Pension deficit Pension liabilities
Q Pension position Deutsche Post is the largest employer in Germany (with 456,716
Hold (12m) employees as of the last year-end) so it is understandable that questions about its
Price 15/04/09 12m target pension liabilities arise from time to time. The pension deficit was around €5bn as of the
€9.30 €9.00 last year-end which is equivalent to around 59% in relation to its market capitalisation.
Sector
However, for the purposes of our own forecasts we have always treated the pension
Weighting
liabilities as essentially additional debt so the liabilities are already captured in our
Preferred stock numbers.
Dubai Ports
Least preferred stock
Kuehne & Nagel Q Impact Deutsche Post is also in the happy position that it will receive a windfall this
Type of investment year large enough to offset most of its pension liabilities. In connection with the sale of
Change in management 9 Postbank to Deutsche Bank, the group received €3.1bn in early January with a further
Debt reduction 9
High dividend yield 9 €1.1bn now received to give a sub-total of €4.2bn. On top of this, the group plans to
1 year dispose of the 50m Deutsche Bank shares (received as part consideration) over the next
25.5
Price MA 100
couple of months. We have not included the paper component in our forecasts, but, on
the assumption that these shares can be sold at market value, this would add an
19
additional €1.9bn to the disposal proceeds thereby bringing the grand total to €6.1bn.
12.5

Q Target price & rating In relative terms, DP trades at a 7% premium to its closest peer
6
2008 2009
TNT on the basis of earnings multiples for next year. In absolute terms, our sum-of-parts
(m)
30
approach points to an unchanged target price of €9. This suggests that the shares are
20

10
fairly valued. However, until the outlook is clearer we see the risk of further cuts to EPS.
0
2008 2009

Source: SG Equity Research

Q Next events & catalysts On 6 May 2009, DP is to host a Capital Markets Day at the
same time as releasing its interim report for Q1. The company has also promised at this
stage to give some guidance for the full year: it is to be hoped things will be clearer then.

Deutsche Post AG
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC DPWGn.DE, Bloom DPW GR Revenues (€bn) 54.47 52.60 53.65 55.80 P/E (x) 6.1 11.0 8.9 6.6
52-week range 22.1-6.65 EBIT margin (%) -1.0 1.5 3.6 4.2 FCF yield (/EV) (%) 12.7 3.2 4.2 na
EV 09 (€m) 13,955 Rep. net inc. (€bn) -1.69 0.22 1.27 1.70 Dividend yield (%) 6.5 6.5 6.5 6.5
Market cap. (€m) 11,237 EPS (adj.) (€) 1.53 0.85 1.05 1.40 Price/book value (x) 1.3 1.3 1.2 1.1
Free float (%) 70.0 Dividend/share (€) 0.60 0.60 0.60 0.60 EV/revenues (x) 0.34 0.27 0.23 0.19
Performance (%) 1m 3m 12m Payout (%) nm 335.5 57.1 42.8 EV/EBIT (x) nm 17.5 6.4 4.5
Ordinary shares 22.9 -2.9 -53.4 Interest cover (x) na 2.3 13.0 na EV/IC (x) 0.6 0.5 0.5 0.4
Rel. Eurofirst 300 9.5 -1.9 -24.2 Net debt/equity (%) 89.4 36.6 16.3 nm ROIC/WACC (x) -0.2 0.2 0.4 0.4
CAGR 08-11e: -2.8%

Matthew O'Keeffe Jonathan Wober

(44) 20 7762 5385 (44) 20 7762 5270
matthew.okeeffe@sgcib.com jonathan.wober@sgcib.com

SG acted as Co-Lead Manager of Deutsche Postbank rights issue

38 20 April 2009
 Pension funds

Industrial Conglomerates (United Kingdom)

GKN
Pension deficit Pension liabilities and high debt bring risk
Q Pension position Pension liabilities ballooned to £834m in FY08, an increase of £503m
Hold (12m) yoy. Around half of this reflected the impact of currency movements on unfunded pension
Price 17/04/09 12m target liabilities in Europe and North America and the other half reflected the dual impact of both
107.0p 70.0p falling discount rates and lower equity prices on the UK fund. We believe that the UK
Sector
pension fund is around 42% weighted to equities. Besides, Quantitative easing in the UK
Weighting
Underweight may further widening the gap between UK pension assets and liabilities. GKN has agreed
Preferred stock to inject £2m funding in FY09e and £20m in 2010e into the Filton scheme to protect
Siemens
Least preferred stock existing employees. The company has indicated that the notional interest cost of pensions,
Emerson charged to the P&L, is likely to leap from £3m in 2008 to £45-50m in 2009.

Q Impact We believe debt is a significant issue for GKN. FY08 year-end net debt stood at
£708m. £95m was paid on completion for the Filton acquisition in January 2009, with a
1 year further $36m to be paid in instalments beyond 2010. But this has been partially offset by a
335
Price MA 100
£40m payment from EADS for R&D sunk into the A400m. Management is running the
business for cash; capital expenditure is to be around 0.7x in FY09e, and could even reach
240
a run rate of 0.4x towards the end of the year. Our forecasts assume that GKN’s
145
EBITDA/net interest ratio falls to 4.9x in FY09e compared to its bank covenant of 3.5x.

50
2008 2009
Q Target price & rating The equity market cap representing 31% of EV should mean that
(m)
45
the shares will remain volatile. But, pension deficits can prove to be an ephemeral problem
30

15
caused by movements in financial markets. We have a Hold rating with a 12-month target
0
2008 2009
price of 70p. This is based on our EV/EBIT model and assumes that the group can
Source: SG Equity Research
generate a 6.5% margin through the cycle, achieve cash conversion of 80%, a WACC of
10.6% and growth of 1%.

Q Next events & catalysts An interim management statement should accompany the AGM
on 7 May 2009. GKN shares are likely to remain volatile and highly sensitive to
expectations for global car production, where we are now seeing some early signs that the
GKN destocking process may become less acute.
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC GKN.L, Bloom GKN LN Revenues (£bn) 4.38 4.92 4.91 5.25 P/E (x) 4.9 nm 5.8 3.4
52-week range 320.8-56.8 EBIT margin (%) 4.6 2.7 5.3 7.1 FCF yield (/EV) (%) -5.6 5.8 12.0 14.6
EV 09 (£m) 2,186 Rep. net inc. (£m) 2 -79 131 223 Dividend yield (%) 4.2 0.9 6.9 11.8
Market cap. (£m) 755 EPS (adj.) (p) 21.7 -11.2 18.6 31.6 Price/book value (x) 0.8 0.9 0.8 0.7
Free float (%) 100.0 Dividend/share (p) 4.5 1.0 7.4 12.6 EV/revenues (x) 0.50 0.44 0.41 0.35
1,588.
Performance (%) 1m 3m 12m Payout (%) nm 39.8 39.9 EV/EBIT (x) 12.3 194.9 7.7 5.0
0
Ordinary shares 70.5 18.6 -63.5 Interest cover (x) 4.3 2.0 4.0 6.2 EV/IC (x) 0.7 0.7 0.7 0.6
Rel. Eurofirst 300 49.8 17.0 -41.9 Net debt/equity (%) 76.5 84.7 56.6 33.2 ROIC/WACC (x) 0.7 0.4 0.1 0.0

Roderick Bridge Gael de-Bray Gerard Moore

(44) 20 7762 5086 (33) 1 42 13 84 14 (33)1 42 13 99 76
roderick.bridge@sgcib.com gael.de-bray@sgcib.com gerard.moore@sgcib.com

20 April 2009 39
 Pension funds

Electrical Equipment (United Kingdom)

Invensys
Pension deficit Restated pension deficit worth more than a third of the market cap
Q Pension position As at 30 September 2008, Invensys faced a pension deficit of £288m
Sell (12m) under IAS. The value of the pension obligation is £4,864m, while the company has
Price 17/04/09 12m target recognisable assets of £4,576m. The largest obligation for the company is its UK
177.8p 120.0p scheme, which has obligations worth £3.8bn and a deficit of £98m. However, this
Sector
scheme is subject to a triennial actuarial review with scheme trustees. The latest
Weighting
Underweight assessment dated 31 March 2008 pointed to a deficit of £285m. This is the valuation
Preferred stock that determines future cash flows for the company and we use this deficit in our
Siemens
Least preferred stock valuation model. As such, we estimate that Invensys has a total pension deficit of £475m
Emerson (£285m from UK scheme + £190m form other obligations using the IAS definition).

Q Impact Invensys’ estimated pension deficit (£475m) represents 36% of the company’s
market capitalisation, while the total IAS obligation represents 365% of the company’s
1 year market capitalisation. Any changes to this deficit could obviously have a significant
345
Price MA 100
impact on the group’s valuation. Using the sensitivity analysis from the FY March 2008
annual report we see that by decreasing the discount rate applied to the UK pension
270
scheme for example by 1% would lead to a £540m increase in the obligation (67p per
195
share). Invensys’ pension assets are relatively well funded. The latest data available from
the annual report FY March 2008 showed that only 13% of the fund’s assets were
120
2008 2009 invested in equities. It is also reasonable to assume that such a decline in discount rates
(m)
45

30
would coincide with a rise in the value of fixed rate assets, reducing the overall volatility.
15

0
2008 2009
Q Target price & rating We reiterate our Sell recommendation and target price of 120p.
Source: SG Equity Research
Our valuation relies on a simplified DCF, with an EV/EBIT derived terminal value, using a
WACC of 11.4%, cash conversion rate of 85%, tax rate of 30% and long term growth
rate of 2%.

Q Next events & catalysts FY results on 14 May. We are looking for EBITA before
restructuring charges of £234m vs guidance of £240m.
Invensys
on www.sgresearch.socgen.com

Share data Financial data 3/08 3/09e 3/10e 3/11e Ratios 3/08 3/09e 3/10e 3/11e
RIC ISYS.L, Bloom ISYS LN Revenues (£bn) 2.11 2.38 2.53 2.53 P/E (x) 5.0 12.4 13.5 14.2
52-week range 343.8-122.0 EBIT margin (%) 15.0 7.2 6.3 6.1 FCF yield (/EV) (%) 11.2 14.0 1.3 3.2
EV 09 (£m) 1,507 Rep. net inc. (£m) 334 115 106 101 Dividend yield (%) 0.0 2.0 2.2 2.1
Market cap. (£m) 1,431 EPS (adj.) (p) 35.9 14.3 13.1 12.5 Price/book value (x) 3.8 2.9 2.6 2.4
Free float (%) 100.0 Dividend/share (p) 0.0 3.6 3.9 3.8 EV/revenues (x) 0.78 0.63 0.58 0.55
Performance (%) 1m 3m 12m Payout (%) 0.3 0.0 50.9 55.4 EV/EBIT (x) 5.2 8.7 9.1 9.0
Ordinary shares 2.2 11.4 -36.3 Interest cover (x) 7.0 nm nm nm EV/IC (x) 0.2 0.2 0.2 0.2
Rel. Eurofirst 300 -10.2 9.9 1.3 Net debt/equity (%) nm nm nm nm ROIC/WACC (x) 0.3 0.1 0.1 0.1
CAGR 08-11e: -29.6%

Gerard Moore Gael de-Bray Roderick Bridge

(33)1 42 13 99 76 (33) 1 42 13 84 14 (44) 20 7762 5086
gerard.moore@sgcib.com gael.de-bray@sgcib.com roderick.bridge@sgcib.com

40 20 April 2009
 Pension funds

Aerospace & Defence (United Kingdom)

Meggitt
Pension deficit Debt and pension liabilities increased in 2008
Q Pension position Meggitt’s net pension liabilities moved from £153.3m in 2007 to
Hold (12m) £241.2m in 2008. £69.2m of the deficit is related to unfunded overseas healthcare
Price 17/04/09 12m target schemes acquired with the K&F Industries acquisition. The deficit is large relative to
167.3p 120.0p scheme assets of £451.9m. The main shift in the present value of the scheme liabilities
Sector
(now £693.1m) was exchange rate adjustments which added £95.8m to liabilities. 52%
Weighting
Neutral of the scheme assets are invested in equities, with the UK scheme looking for a 7.75%
Preferred stock and the overseas scheme a 9.5% expected return on the equities. In 2008, the group
BAE Systems
Least preferred stock made a deficit reduction payment of £22.5m, this may increase after the next formal
EADS valuation of the Meggitt scheme which will take place this year with the outcome likely in
Type of investment March 2010.
Overvalued 9

Q Impact For 2009e & 2010e, we assume that civil aerospace revenues will fall by
1 year around 5% in each year with the mix being impacted by a larger drop in the high-margin
335
Price MA 100
aftermarket activities. However, assuming the £/$ rate remains around the current 1.42
level there will be a benefit of £120m to revenues and £40m to profit. Our forecasts
260
assume EPS will be below the 2008 level in both years. Net debt is £1,048m (up from
185
£815m), as forex moves added £312m to debt, but ratios remain within bank covenants.
Management is keen to stress that the balance sheet remained strong and that there is
110
2008 2009 absolutely no need for a rights issue. We forecast the group should have positive cash
(m)
13.5

9
flow in 2009e of £50m. Therefore, we believe debt will not be a major impediment to
4.5 maintaining the dividend, the yield of 5.6% offers some support.
0
2008 2009

Source: SG Equity Research

Q Target price & rating We maintain our TP and Hold rating. At our target price, the
shares would trade on only 6.3x P/E for 2010. This is supported by our DCF model
output value of 119p, using WACC of 9%, terminal margin of 23.7%, and 1% perpetuity
growth rate.

Q Next events & catalysts The group will hold its AGM on 23 April, which may include
Meggitt some comments on current trading. The next results are the interims due on 4 August.
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC MGGT.L, Bloom MGGT LN Revenues (£bn) 1.16 1.20 1.16 1.19 P/E (x) 8.3 9.0 8.8 7.6
52-week range 304.3-113.0 EBIT margin (%) 25.5 24.1 23.2 23.7 FCF yield (/EV) (%) 7.6 7.0 7.0 8.4
EV 09 (£m) 2,166 Rep. net inc. (£m) 79 139 123 130 Dividend yield (%) 5.1 5.1 5.2 5.5
Market cap. (£m) 1,113 EPS (adj.) (p) 20.2 18.6 19.0 22.1 Price/book value (x) 0.9 0.8 0.8 0.8
Free float (%) 100.0 Dividend/share (p) 8.5 8.5 8.7 9.1 EV/revenues (x) 1.91 1.81 1.83 1.72
Performance (%) 1m 3m 12m Payout (%) 51.1 40.3 47.3 46.8 EV/EBIT (x) 8.0 8.1 8.4 7.7
Ordinary shares 26.9 8.6 -38.3 Interest cover (x) 5.6 5.6 5.4 5.6 EV/IC (x) 0.7 0.7 0.7 0.6
Rel. Eurofirst 300 11.5 7.2 -1.9 Net debt/equity (%) 81.5 75.2 69.7 62.0 ROIC/WACC (x) 1.0 0.8 0.7 0.7
CAGR 08-11e: +2.9%

Colin Campbell Zafar Khan

(44) 20 7762 5609 (44) 20 7762 5317
colin.campbell@sgcib.com zafar.khan@sgcib.com

20 April 2009 41
 Pension funds

Auto Components (France)

Michelin
Pension deficit Limited cash risk on pensions deficit
Q Pension position As at 31 December 2008, the deficit of the defined benefits pension
Buy (12m) schemes for the Michelin group stood at €867m, against €324m in 2007, due to a 33%
Price 17/04/09 12m target reduction in the value of plan assets (about half of which is in equities) from €4.7bn to
€38.1 €42.0 €3.2bn. Thanks to a higher discount rate, the liabilities went down from €5.1bn to
Sector
€4.1bn. The total provision in the balance sheet, including all pensions and employee
Weighting
Overweight benefit-related items, was slightly down at €2.4bn, as €452m of actuarial losses are not
Preferred stock recognised. This provision takes into account a €1.6bn deficit related to non-covered
Michelin
Least preferred stock liabilities, essentially medical care benefits paid to the US employees and retirees.
Continental
Q Impact The only effective risk concerns the cash that could be used to refund the
pension schemes to meet the local regulations if there is no rebound in the stock market
in 2009. According to the company’s calculation, the cash payments might increase by
1 year about €200m in 2010, then by a further €100m in 2011. This is based on maintained
95
Price MA 100
funding requirements in the US. These payments are not factored into our net financial
debt estimate of €3.9bn in 2010e. As all US employees hired in the recent years benefit
70
from defined contribution schemes, the liabilities relating to previous pension schemes
45
should progressively decline, hence lower risk. The medical care benefits, which affect
the P&L, are not a concern and the company has also implemented limitations on
20
2008 2009 expenses.
(m)
6

2
Q Target price & rating Buy rating confirmed. Despite our recent earnings downgrade,
0
2008 2009
particularly for 2009e, we believe there will be a gradual market upturn. Moreover, the
Source: SG Equity Research
company’s quick reaction to adjusting operating expenses, capex and production
adjustments justify our assumption that margins will improve sharply from 2010. Our €42
target price is based on 2009e EV/sales moving back to the historic average of 0.82.

Q Next events & catalysts Q1 sales on 28 April. While volumes are likely to drop by
around 20%, we believe the market will appreciate the very positive price/mix effect
Michelin (+6%e).
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC MICP.PA, Bloom ML FP Revenues (€bn) 16.41 15.17 15.85 16.56 P/E (x) 12.9 19.5 9.3 6.3
52-week range 67.2-23.1 EBIT margin (%) 5.1 2.3 5.4 7.9 FCF yield (/EV) (%) -0.5 7.0 4.7 4.0
EV 09 (€m) 12,116 Rep. net inc. (€m) 360 80 445 770 Dividend yield (%) 2.6 2.6 3.7 5.3
Market cap. (€m) 5,723 EPS (adj.) (€) 2.96 1.95 4.10 6.03 Price/book value (x) 1.0 1.0 1.0 0.9
Free float (%) 87.9 Dividend/share (€) 1.00 1.00 1.40 2.00 EV/revenues (x) 0.76 0.80 0.76 0.73
Performance (%) 1m 3m 12m Payout (%) 63.8 179.6 32.3 26.1 EV/EBIT (x) 14.8 34.6 14.2 9.3
Ordinary shares 34.9 6.9 -40.4 Interest cover (x) 2.6 1.4 3.7 5.9 EV/IC (x) 1.0 1.1 1.0 1.0
Rel. Eurofirst 300 18.5 5.5 -5.2 Net debt/equity (%) 83.6 79.1 73.8 67.8 ROIC/WACC (x) 0.5 0.2 0.5 0.8
CAGR 08-11e: +26.8%

Philippe Barrier Eric-Alain Michelis

(33) 1 42 13 84 42 (33) 1 42 13 50 95
philippe.barrier@sgcib.com eric.michelis@sgcib.com

SG is acting as joint bookrunner in the MICHELIN's senior bond issue.

42 20 April 2009
 Pension funds

Automobiles (France)

Peugeot Citroen PSA

Pension deficit Cash outflows to refund pension deficits is the only concern
Q Pension position PSA Peugeot Citroen’s defined-benefit plans concern mainly France
Buy (12m) and the UK. At the end of December 2008, the deficit increased slightly to €819m from
Price 17/04/09 12m target €745m in 2007, of which €321m (vs. €222m) in France and €229m (vs. €300m) in the UK
€19.3 €20.0 and represents roughly 19% of its market cap. Thanks to a higher discount rate, the
Sector
liabilities went down from €3,768m to €3,228m. Meanwhile, the fair value of external
Weighting
Overweight funds decreased by 20% to €2,409m, due to the deterioration of the financial markets.
Preferred stock The last year, the actual return on external funds was -10% for French plans (23% of
Volkswagen
Least preferred stock equities vs. 34% in 2007) and -9.5% for UK plans (53% of equities vs. 55%). On the
GM balance sheet, the provision for pensions reduced to €699m, due to unrecognised
actuarial gains of €122m.

Q Impact As defined-benefit plans are used by PSA, the group must provide benefits to
1 year employees no matter how the funds perform. If financial market turmoil continues in
70
Price MA 100
2009, the biggest concern by far will be cash outflows which could be brought to refund
the pension deficits. According to the company’s calculation, pension benefits payable
50
in 2009 are estimated at €230m (vs. €238m in 2007 and €302m in 2006).
30

Q Target price and rating Target price and rating unchanged. Peugeot has a fairly
10
2008 2009
straightforward investment case; it has no exposure both to the US car market and to
(m)
9
trucks market. We believe, that all the bad news is now fully discounted, PSA offers an
6

3
excellent opportunity to fully benefit from a recovery which we believe could come
0
2008 2009
sooner than the market expects.
Source: SG Equity Research

Q Next event & catalysts On 22 April, PSA will release its Q1 unit sales and turnover before
market hours. We anticipate fairly weak numbers but we do not expect much of a
reaction from the shares. We forecast group sales to decline by roughly 26% to around
€11.28bn. We expect management will give more precise guidance regarding H1 09
earnings.
Peugeot Citroen PSA
on www.sgresearch.socgen.com

Share data Financial data 12/07 12/08e 12/09e 12/10e Ratios 12/07 12/08e 12/09e 12/10e
RIC PEUP.PA, Bloom UG FP Revenues (€bn) 58.68 54.36 45.95 50.50 P/E (x) 3.7 73.2 nm 4.5
52-week range 47.7-11.4 EBIT margin (%) 2.5 0.1 -1.7 2.9 FCF yield (/EV) (%) 125.3 -129.7 -15.2 14.5
EV 08 (€m) 6,492 Rep. net inc. (€bn) 0.89 -0.34 -0.74 1.00 Dividend yield (%) 7.8 0.0 0.0 8.3
Market cap. (€m) 4,536 EPS (adj.) (€) 5.26 0.26 -2.94 4.26 Price/book value (x) 0.3 0.3 0.4 0.3
Free float (%) 56.8 Dividend/share (€) 1.50 0.00 0.00 1.60 EV/revenues (x) 0.04 0.12 0.22 0.18
Performance (%) 1m 3m 12m Payout (%) 35.8 nm nm 0.0 EV/EBIT (x) 1.5 170.9 nm 6.4
Ordinary shares 26.1 42.7 -58.2 Interest cover (x) 36.7 0.1 na 7.2 EV/IC (x) 0.1 0.3 0.4 0.4
Rel. Eurofirst 300 10.8 40.9 -33.5 Net debt/equity (%) nm 21.9 50.4 41.0 ROIC/WACC (x) 0.5 0.0 -0.3 0.4
CAGR 07-10e: -6.8%

Eric-Alain Michelis Philippe Barrier

(33) 1 42 13 50 95 (33) 1 42 13 84 42
eric.michelis@sgcib.com philippe.barrier@sgcib.com

SG is acting as global coordinator, lead manager and bookrunner of the planned rights issue of Faurecia

20 April 2009 43
 Pension funds

Metals & Mining (Germany)

ThyssenKrupp
Pension deficit Lower discount rate increases pension liabilities
Q Pension position As of September 2008 the accrued pension liability was €5,227m, the
Buy (12m) defined benefit obligation was €6,938m, the fair value of plan assets was €1,724m
Price 17/04/09 12m target resulting in a deficit of about €5,214m. Following significant changes, in particular
€18.2 €19.0 regarding interest rates compared to 30 September 2008, an updated valuation was
Sector
performed as of 31 December 2008. Therefore, the accrued pension liability increased
Weighting
Overweight from €5,227m (as of 30 September 2008) to €5,775m (as of 31 December 2008). The
Preferred stock discount rate for the accrued pension liability was reduced from 6.75%
ArcelorMittal
Least preferred stock (Germany)/6.44% (outside Germany) as of 30 September 2008 to 6.00%
Antofagasta (Germany)/5.94% (outside Germany) as of 31 December 2008.

Q Impact The future trend in corporate bond yields will be very important for the total
amount of the pension liabilities. In general, the group’s funding policy is to contribute
1 year amounts to the plan sufficient to meet the minimum statutory funding requirements
55
Price MA 100
relevant in the country in which the plan is located.

40
Q Target price & rating We keep a Buy rating and €19 target price. In H2, TK should
benefit the most from a sharp drop in input costs while a recovery in apparent demand
25

should also enter into play. Therefore, the company could make additional contributions
10
2008 2009
during the next years.
(m)
15

Q Next events & catalysts

10
To adapt to further deteriorating economic conditions, TK also
5

0 announced the reorganization of its operating segments into two divisions: Materials
2008 2009

Source: SG Equity Research

(Steel, Stainless and Services) and new Technologies (Technologies, Elevator). This will
yield additional cost savings of up to €500m when the new group structure is
implemented as of the beginning of FY09/10. We see TK’s reorganisation as a way to
increase the group’s efficiency by reducing management layers, optimising support
functions and accelerating decision making. We think that this could also increase
flexibility for M&A moves (disposals, restructuring, JV’s). Q2 08/09 results on 13 May.
ThyssenKrupp
on www.sgresearch.socgen.com

Share data Financial data 9/08 9/09e 9/10e 9/11e Ratios 9/08 9/09e 9/10e 9/11e
RIC TKAG.DE, Bloom TKA GR Revenues (€bn) 53.43 46.63 50.31 54.74 P/E (x) 4.0 35.8 10.7 3.8
52-week range 46.6-12.1 EBIT margin (%) 6.7 2.4 3.9 7.4 FCF yield (/EV) (%) 0.7 -5.2 14.2 15.8
EV 09 (€m) 18,466 Rep. net inc. (€bn) 2.20 0.24 0.79 2.25 Dividend yield (%) 7.1 2.2 3.6 5.5
Market cap. (€m) 8,449 EPS (adj.) (€) 4.61 0.51 1.70 4.84 Price/book value (x) 0.8 0.8 0.8 0.7
Free float (%) 51.7 Dividend/share (€) 1.30 0.40 0.65 1.00 EV/revenues (x) 0.30 0.40 0.22 0.20
Performance (%) 1m 3m 12m Payout (%) 28.2 78.5 38.1 20.6 EV/EBIT (x) 4.5 16.7 5.8 2.6
Ordinary shares 25.9 7.6 -53.1 Interest cover (x) 6.6 1.8 3.0 6.0 EV/IC (x) 0.7 0.7 0.4 0.4
Rel. Eurofirst 300 10.6 6.1 -25.5 Net debt/equity (%) 14.7 33.2 25.2 16.6 ROIC/WACC (x) 1.1 0.3 0.5 1.0
CAGR 08-11e: +1.7%

Alain William
(33) 1 58 98 12 61
alain.william@sgcib.com

44 20 April 2009
 Pension funds

Auto Components (France)

Valeo
Pension deficit High exposure to the equity market
Q Pension position At 31 December 2008, Valeo posted a deficit of €618m on the pension
Buy (12m) plans, down €15m and this represents roughly 50% of its market cap. Owing to current
Price 17/04/09 12m target financial market turmoil, the value of the plan assets decreased to €225m (vs. €300m in
€15.2 €12.0 2007). Last year the actual return on asset plans was a negative €75m, compared with a
Sector
gain of €23m in 2007. Meanwhile, obligations decreased from €933m in 2007 to €843m
Weighting
Overweight thanks to higher average discount rate. The bulk is related to Europe (mainly Western
Preferred stock Europe) with a deficit of €344m (vs. €435m in 2007) and North America with a deficit of
Michelin
Least preferred stock €220m (vs. €155m in 2007). On the balance sheet, the provision for pensions and other
Continental employee benefits rose slightly to €611m from €608m, mainly due to actuarial gains of
€56m and a negative impact from changes in the scope of consolidation (€12m).

Q Impact If the collapse in stock markets continues in 2009, the only concern will be cash
1 year outflows which could be used to refund the pension deficits. When we look closely at the
35
Price MA 100
breakdown of plan assets, Valeo is very exposed to shares, which represent 62% of the
total plan (vs. 72% in 2007) and particularly where the group is the most exposed in terms
26
of pension liabilities (Europe and North America). However, with the average age of the
17
group’s workforce at around 35-37, equity securities are typically the best class of asset
for long-term plan benefit obligations (best returns on LT compared with bonds). The
8
2008 2009 payment to pension funds should be around €28m in 2009e, up €11m, as indicated in the
(m)
2.25

1.5
most recent group financial report.
0.75

0
2008 2009
Q Target price and rating Target price and rating unchanged. 2009 should be a very tough
Source: SG Equity Research
year for the Group but it should benefit from its innovative products and from its global
presence to come out of the crisis stronger than its main competitors. Valeo is still booking
new contracts that should provide additional sales on the top of the cyclical recovery.

Q Next event & catalysts On 24 April, Valeo will report Q1 09 earnings. No doubt Q1 will see a
severe loss, but it should also be the worst quarter of the year. We expect management to
Valeo give us more precise guidance for 2009 when reporting Q1 figures.
on www.sgresearch.socgen.com

Share data Financial data 12/08 12/09e 12/10e 12/11e Ratios 12/08 12/09e 12/10e 12/11e
RIC VLOF.PA, Bloom FR FP Revenues (€bn) 8.82 7.31 7.78 8.34 P/E (x) nm nm 10.3 6.0
52-week range 27.5-8.13 EBIT margin (%) -0.6 0.2 2.9 4.3 FCF yield (/EV) (%) 8.3 2.1 7.6 10.2
EV 09 (€m) 2,816 Rep. net inc. (€m) -206 -90 105 195 Dividend yield (%) 0.0 0.0 3.3 5.3
Market cap. (€m) 1,296 EPS (adj.) (€) -2.19 -0.81 1.48 2.54 Price/book value (x) 0.9 0.9 0.9 0.8
Free float (%) 61.8 Dividend/share (€) 0.00 0.00 0.50 0.80 EV/revenues (x) 0.29 0.39 0.35 0.31
Performance (%) 1m 3m 12m Payout (%) nm nm 0.0 19.2 EV/EBIT (x) nm 226.0 11.9 7.2
Ordinary shares 45.0 64.1 -37.0 Interest cover (x) na 0.3 4.5 7.9 EV/IC (x) 0.5 0.5 0.5 0.4
Rel. Eurofirst 300 27.4 61.9 0.1 Net debt/equity (%) 60.3 84.9 69.7 54.4 ROIC/WACC (x) -0.1 0.0 0.3 0.5
CAGR 08-11e: nm

Eric-Alain Michelis Philippe Barrier

(33) 1 42 13 50 95 (33) 1 42 13 84 42
eric.michelis@sgcib.com philippe.barrier@sgcib.com

20 April 2009 45
 Pension funds

Appendices – Definitions

Defined contribution plan

A defined contribution plan will provide a payout at retirement that is dependent upon the
amount of money contributed and the performance of the investment vehicles utilised. In a
defined contribution plan, contributions are paid into an individual account for each member.
The contributions are invested, for example in the stock market, and the returns on the
investment (which may be positive or negative) are credited to the individual's account. On
retirement, the member's account is used to provide retirement benefits, often through the
purchase of an annuity which then provides a regular income. Defined contribution plans have
become widespread all over the world in recent years, and are now the dominant form of plan
in the private sector in many countries. For example, the number of defined benefit plans in
the US has been steadily declining, as more and more employers see pension contributions as
a large expense avoidable by disbanding the defined benefit plan and instead offering a
defined contribution plan. Money contributed can either be from employee salary deferral or
from employer contributions. The portability of defined contribution pensions is legally no
different from the portability of defined benefit plans. However, because of the cost of
administration and ease of determining the plan sponsor's liability for defined contribution
plans, in practice, defined contribution plans have become generally portable. In a defined
contribution plan, investment risk and investment rewards are assumed by each
individual/employee/retiree and not by the sponsor/employer. Despite the fact that the
participant in a defined contribution plan typically has control over investment decisions, the
plan sponsor retains a significant degree of fiduciary responsibility over investment of plan
assets, including the selection of investment options and administrative providers.

Defined benefit plan

A defined benefit plan guarantees a certain payout at retirement. A traditional defined benefit
plan is a plan in which the benefit on retirement is determined by a set formula, rather than
depending on investment returns.

Defined benefit plans may be either funded or unfunded.

„ In an unfunded defined benefit pension, no assets are set aside and the benefits are directly

paid to the retired employees. Pension arrangements provided by the state in most countries
in the world are unfunded, with benefits paid directly from current workers' contributions and
taxes.

„ In a funded plan, contributions from the employer, and sometimes also from plan members,
are invested in a fund towards meeting the benefits. The future returns on the investments and
the future benefits to be paid are not known in advance, so there is no guarantee that a given
level of contributions will be enough to meet the benefits. Typically, the contributions to be
paid are regularly reviewed in a valuation of the plan's assets and liabilities, carried out by an
actuary to ensure that the pension fund will meet future payment obligations. This means that
in a defined benefit pension, investment risk and investment rewards are typically assumed by
the sponsor/employer and not by the individual. If a plan is not well funded, the plan sponsor
may not have the financial resources to continue funding the plan.

The pension deficit (or surplus) should be treated as debt (or financial assets) on an after-tax
basis and added back to enterprise value and capital employed. To do so, we use the

46 20 April 2009
 Pension funds

difference between the companies’ benefit obligations and the fair value of the plan assets (as
detailed in the notes to the balance sheet).

Adjusting debt for pension liabilities – an example

(€m, unless otherwise stated) Philips
Amounts recognised in the balance sheet
Prepaid pension costs (2,000)
Provisions for pensions 1,000
Other post-retirement benefits 300
Total obligations recognised in the balance sheet (700)

Amounts presented in appendices

Benefit Obligation (1) (20,000)
Fair Value of plan assets (2) 19,000
Underfunded pension liabilities =(1)+(2) (1,000)
Other post-retirement benefits 300
Total liability treated as debt on a pre-tax basis (700)

Unrecognised gains/losses in the balance sheet (+) / (-) 0

Source: SG Equity Research

Objective of IAS 19
The objective of IAS 19 (Revised in 1998) is to prescribe the accounting and disclosure for
employee benefits (that is, all forms of consideration given by an enterprise in exchange for
service rendered by employees). The principle underlying all of the detailed requirements of
the Standard is that the cost of providing employee benefits should be recognized in the
period in which the benefit is earned by the employee, rather than when it is paid or payable.
IAS 19 applies to (among other kinds of employee benefits):
„ wages and salaries
„ compensated absences (paid vacation and sick leave)
„ profit sharing plans
„ bonuses
„ medical and life insurance benefits during employment
„ housing benefits
„ free or subsidised goods or services given to employees
„ pension benefits
„ post-employment medical and life insurance benefits
„ long-service or sabbatical leave
„ 'jubilee' benefits
„ deferred compensation programmes
„ termination benefits.

Minimum funding requirements: IAS 19

It provides the guidance on assessing the limit on the amount of the surplus that can be
recognized as an asset. It also explains how the pension asset or liability may be affected by a
statutory or contractual minimum funding requirement. This interpretation does not have any
impact on the group’s financial statements.

20 April 2009 47
 Pension funds

Types of post-employment benefit plans

The accounting treatment for a post-employment benefit plan will be determined according to
whether the plan is a defined contribution or a defined benefit plan. Under a defined
contribution plan, the enterprise pays fixed contributions into a fund but has no legal or
constructive obligation to make further payments if the fund does not have sufficient assets to
pay all of the employees' entitlements to post-employment benefits. A defined benefit plan is
a post-employment benefit plan other than a defined contribution plan. These include both
formal plans and those informal practices that create a constructive obligation to the
enterprise's employees.

Projected unit credit method valuations

The present value of the defined benefit obligation should be determined using the Projected
Unit Credit Method Valuations which should be carried out with sufficient regularity such that
the amounts recognised in the financial statements do not differ materially from those that
would be determined at the balance sheet date. The assumptions used for the purposes of
such valuations should be unbiased and mutually compatible. The rate used to discount
estimated cash flows should be determined by reference to market yields at the balance sheet
date on high quality corporate bonds.

On an ongoing basis, actuarial gains and losses arise that comprise experience adjustments
(the effects of differences between the previous actuarial assumptions and what has actually
occurred) and the effects of changes in actuarial assumptions. In the long term, actuarial gains
and losses may offset one another and, as a result, the enterprise is not required to recognise
all such gains and losses immediately. The standard specifies that if the accumulated
unrecognised actuarial gains and losses exceed 10% of the greater of the defined benefit
obligation or the fair value of plan assets, a portion of that net gain or loss is required to be
recognised immediately as income or expense. The portion recognised is the excess divided by
the expected average remaining working lives of the participating employees. Actuarial gains
and losses that do not breach the 10% limits described above (the 'corridor') need not be
recognised - although the enterprise may choose to do so. Over the life of the plan, changes
in benefits under the plan will result in increases or decreases in the enterprise's obligation.

48 20 April 2009
 Pension funds

IMPORTANT DISCLOSURES
AKZO NOBEL SG acted as joint bookrunner in the Akzo Nobel's senior bond issue.
NV
Deutsche SG acted as joint bookrunner in the Lufthansa's senior bond issue (6.75% 24/03/2014 EUR).
Lufthansa
Deutsche Post SG acted as Co-Lead Manager of Deutsche Postbank rights issue
AG
Michelin SG is acting as joint bookrunner in the MICHELIN's senior bond issue.
Sandvik SG acted as joint bookrunner in the Sandvik's senior bond issue (6.875% 25/02/2014 EUR).

US THIRD PARTY FOREIGN AFFILIATE RESEARCH DISCLOSURES:

SG and its affiliates beneficially own 1% or more of any class of common equity of Aegis Group plc, Alcatel-Lucent, BAYER AG, BT Group, Michelin, Norbert
Dentressangle, Valeo.
SG or its affiliates act as market maker or liquidity provider in the equities securities of Alcatel-Lucent, Daimler, Michelin, Pirelli, Siemens.
SG or its affiliates expect to receive or intend to seek compensation for investment banking services in the next 3 months from Aegis Group plc, Alcatel-Lucent,
Delhaize, Deutsche Lufthansa, Gazprom, Michelin, Norbert Dentressangle, Sandvik, Siemens, Valeo.
SG or its affiliates have received compensation for investment banking services in the past 12 months of AKZO NOBEL NV, BMW, BT Group, Daimler, Deutsche
Lufthansa, Michelin, Sandvik.
SG or its affiliates managed or co-managed in the past 12 months a public offering of securities of AKZO NOBEL NV, BMW, BT Group, Daimler, Deutsche
Lufthansa, Michelin, Sandvik.

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http://www.sgcib.com. Copyright: The Société Générale Group 2009. All rights reserved.

20 April 2009 3
 A unique and innovative approach

Global coverage
from Europe
Does it make sense to cover EADS without covering Boeing? GDF
Suez without Gazprom? Or SAP without Oracle? No
Does it make sense for Renault and Nissan to be covered by
different analysts in different countries? Or H&M without Esprit? No

BARR ranking for some of our recent global recommendations *

Didier SolarWorld and Anne H&M and

Laurens Sunpower # 4 BARR Critchlow Esprit # 1 BARR

Tom Tesco and Thierry GDF Suez and

Gadsby Safeway # 5 BARR Bros Gazprom # 1 BARR

Emmanuelle Axa and Gerard ABB and

Cales AIG # 1 BARR Moore Emerson # 1 BARR

Richard SAP and Muriel Holcim and

Nguyen Oracle # 1 BARR Fellous Cemex # 4 BARR

Philippe Renault and Zafar EADS and

Barrier Honda # 3 BARR Khan Boeing # 2 BARR

# BARR = Bloomberg reco. Ranking at 30/03/09