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Part 1: Are 25% of S&P Companies at a High Risk of Bankruptcy?

By July 31, 2020No Comments

By Charlie Strout, CFA

Professor Edward Altman recently warned of an impending spate of “mega” bankruptcies that will break all the records.[1] As the author of the well-known bankruptcy-predicting Z-Score, Altman knows a thing or two about financial distress, and he doesn’t like what he is seeing. Investors perk up when people start talking about bankruptcy—especially of big companies. Names like Enron and Lehman Brothers spring to mind and remind us the real damage mega-firm failures cause and some truly mammoth companies have that gone bust when the economy goes into a tailspin.  If Professor Altman is ringing the alarm, it is worth it to see what his Z-Score is telling him.

The Z-Score

The Z-Score has been around since 1968. There have been a variety of other methods developed since it was first published that seek to improve on its predictive results (Campbell, Hilscher, Szilagyi (CHS) Model, the Ohlson O-Score, and Merton’s Distance to Default) . Altman himself developed Zeta Analysis back in 1977.  However, despite these new methodologies—and more than a few analysts urging that we adopt them—the Z-Score is still widely used as an indicator of financial distress.

The original 5-parameter Z-Score was developed specifically for manufacturing companies.  Later, a 4-parameter score was developed for non-manufacturing and emerging-markets companies.  Each has a slightly different scale as follows:

Z-Score Scale High Risk Grey Area Low Risk
Manufacturing < 1.81 Between 2.99 and 1.81 > 2.99
Non-Manufacturing < 1.1 Between 2.6 and 1.1 > 2.6

Z-Score Parameters [2]

Parameter Description
X1 working capital / total assets Measures liquid assets in relation to the size of the company.
X2 retained earnings / total assets Measures profitability
X3 earnings before interest and taxes / total assets Measures operating efficiency
X4 market value of equity / book value of total liabilities (manufacturing) OR

book value of equity / total liabilities (non-manufacturing)

Adds market dimension (in manufacturing model)
X5 sales / total assets (manufacturing model only) Standard measure for total asset turnover

It is important to note that the data from the Z-Score is based mostly on companies’ SEC filings.  At the time of writing, most companies had only reported on Q1 2020.  This means that much of the really bad news may not be reflected in this analysis.  It will likely get worse, much worse. We will be releasing Part 2 of this analysis in August with the Q2 financial results. That should be interesting…

Methodology

For this analysis, I grabbed the list of S&P 500 tickers and divided it into three groups.  First, I removed all the companies where the Z-Score didn’t return a value when applied to my data set.  (Most of the companies were financial firms where the Z-Score isn’t appropriate.)  Then, I put all the companies listed in the manufacturing sector into the manufacturing group (164 firms) and all the remaining 276 firms into the non-manufacturing group.  I ran the appropriate Z-Score against each of these groups. Granted, this is a bit “best-effort.”  To really know which Z-Score is appropriate for an individual firm you would need to dive in deeper.  However, I am comfortable that this is a reasonable approach for a first pass.

Data

Manufacturing Companies

Distribution of Results for S&P 500 Manufacturing Companies

The 25 S&P 500 Manufacturing Companies with the Highest-Risk Z-Score

Rank Ticker Company Industry Z-Score Risk Ended
1 COTY COTY INC. Consumer Goods (0.29)  High 2020-03-31
2 NWL NEWELL BRANDS INC. Consumer Goods 0.37  High 2020-03-31
3 KHC KRAFT HEINZ CO Food, Beverage & Tobacco 0.83  High 2020-03-28
4 F FORD MOTOR CO Automotive 0.84  High 2020-03-31
5 GM GENERAL MOTORS CO Automotive 0.90  High 2020-03-31
6 TAP MOLSON COORS BEVERAGE CO Food, Beverage & Tobacco 1.02  High 2020-03-31
7 MYL MYLAN N.V. Healthcare Products 1.08  High 2020-03-31
8 IR INGERSOLL RAND INC. Industrial Goods 1.10  High 2020-03-31
9 TPR TAPESTRY, INC. Consumer Goods 1.16  High 2020-03-28
10 PRGO PERRIGO CO PLC Healthcare Products 1.28  High 2020-03-28
11 PVH PVH CORP. /DE/ Consumer Goods 1.29  High 2020-05-03
12 BA BOEING CO Industrial Goods 1.36  High 2020-03-31
13 TDG TRANSDIGM GROUP INC Industrial Goods 1.38  High 2020-03-28
14 IP INTERNATIONAL PAPER CO /NEW/ Consumer Goods 1.47  High 2020-03-31
15 JCI JOHNSON CONTROLS INTERNATIONAL PLC Industrial Goods 1.58  High 2020-03-31
16 JNPR JUNIPER NETWORKS INC Technology Hardware 1.59  High 2020-03-31
17 WDC WESTERN DIGITAL CORP Technology Hardware 1.61  High 2020-04-03
18 IQV IQVIA HOLDINGS INC. Healthcare Products 1.71  High 2020-06-30
19 WAB WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORP Industrial Goods 1.72  High 2020-03-31
20 CAG CONAGRA BRANDS INC. Food, Beverage & Tobacco 1.78  High 2020-05-31
21 SJM J M SMUCKER CO Food, Beverage & Tobacco 1.79  High 2020-04-30
22 BMY BRISTOL MYERS SQUIBB CO Healthcare Products 1.83  Medium 2020-03-31
23 AVGO BROADCOM INC. Technology Hardware 1.87  Medium 2020-05-03
24 MCHP MICROCHIP TECHNOLOGY INC Technology Hardware 2.04  Medium 2020-03-31
25 NTAP NETAPP, INC. Technology Hardware 2.05  Medium 2020-04-24

 

 

The 25 S&P 500 Manufacturing Companies with the Lowest-Risk Z-Score

Rank Ticker Company Industry Z-Score Risk Ended
1 ABMD ABIOMED INC Healthcare Products 55.89  Low 2020-03-31
2 ISRG INTUITIVE SURGICAL INC Healthcare Products 38.03  Low 2020-06-30
3 MNST MONSTER BEVERAGE CORP Food, Beverage & Tobacco 27.75  Low 2020-03-31
4 IPGP IPG PHOTONICS CORP Technology Hardware 19.96  Low 2020-03-31
5 VRTX VERTEX PHARMACEUTICALS INC / MA Healthcare Products 19.59  Low 2020-03-31
6 AMD ADVANCED MICRO DEVICES INC Technology Hardware 18.53  Low 2020-03-28
7 SWKS SKYWORKS SOLUTIONS, INC. Technology Hardware 18.05  Low 2020-06-26
8 NVDA NVIDIA CORP Technology Hardware 17.85  Low 2020-04-26
9 WST WEST PHARMACEUTICAL SERVICES INC Healthcare Products 17.78  Low 2020-06-30
10 DXCM DEXCOM INC Healthcare Products 17.07  Low 2020-03-31
11 INCY INCYTE CORP Healthcare Products 15.71  Low 2020-03-31
12 ILMN ILLUMINA, INC. Healthcare Products 15.21  Low 2020-03-29
13 ALGN ALIGN TECHNOLOGY INC Healthcare Products 14.67  Low 2020-03-31
14 IDXX IDEXX LABORATORIES INC /DE Healthcare Products 13.98  Low 2020-03-31
15 REGN REGENERON PHARMACEUTICALS, INC. Healthcare Products 13.85  Low 2020-03-31
16 TXN TEXAS INSTRUMENTS INC Technology Hardware 12.96  Low 2020-06-30
17 GRMN GARMIN LTD Technology Hardware 12.31  Low 2020-03-28
18 HRL HORMEL FOODS CORP /DE/ Food, Beverage & Tobacco 10.15  Low 2020-04-26
19 MTD METTLER TOLEDO INTERNATIONAL INC/ Technology Hardware 9.17  Low 2020-03-31
20 XLNX XILINX INC Technology Hardware 8.65  Low 2020-03-28
21 WAT WATERS CORP /DE/ Technology Hardware 8.32  Low 2020-03-28
22 MXIM MAXIM INTEGRATED PRODUCTS INC Technology Hardware 8.26  Low 2020-03-28
23 ITW ILLINOIS TOOL WORKS INC Industrial Goods 7.27  Low 2020-03-31
24 EW EDWARDS LIFESCIENCES CORP Healthcare Products 7.25  Low 2020-03-31
25 SNPS SYNOPSYS INC Technology Hardware 7.19  Low 2020-04-30

 

Non-Manufacturing Companies

In the sample, the Z-Score rated the a full 35% (91 of 276) of non-manufacturing companies to high risk.  Fewer than half were rated low risk.

Distribution of Results for S&P 500 Manufacturing Companies

The 25 S&P 500 Non-Manufacturing Companies with the Highest-Risk Z-Score

Rank Ticker Company Sector Industry Z-Score Risk Quarter Ending
1 VRSN VERISIGN INC/CA Services Technology Services (25.24)  High 2020-06-30
2 APA APACHE CORP Resources Energy (6.14)  High 2020-03-31
3 CXO CONCHO RESOURCES INC Resources Energy (5.53)  High 2020-03-31
4 DPZ DOMINOS PIZZA INC Services Hospitality (2.76)  High 2020-06-14
5 EXR EXTRA SPACE STORAGE INC. Financial REITs (2.69)  High 2020-03-31
6 VTR VENTAS, INC. Financial REITs (2.48)  High 2020-03-31
7 SBAC SBA COMMUNICATIONS CORP Financial REITs (2.41)  High 2020-03-31
8 YUM YUM BRANDS INC Services Hospitality (2.31)  High 2020-03-31
9 NBL NOBLE ENERGY INC Resources Energy (2.21)  High 2020-03-31
10 NOV NATIONAL OILWELL VARCO INC Resources Energy (2.14)  High 2020-03-31
11 BKR BAKER HUGHES CO Resources Energy (1.90)  High 2020-06-30
12 ADSK AUTODESK, INC. Services Technology Services (1.53)  High 2020-04-30
13 DXC DXC TECHNOLOGY CO Services Business Services (1.41)  High 2020-03-31
14 O REALTY INCOME CORP Financial REITs (1.23)  High 2020-03-31
15 LB L BRANDS, INC. Trade Retail (1.09)  High 2020-05-02
16 SLB SCHLUMBERGER LIMITED/NV Resources Energy (0.96)  High 2020-03-31
17 AAL AMERICAN AIRLINES GROUP INC. Services Transportation (0.95)  High 2020-06-30
18 SBUX STARBUCKS CORP Services Hospitality (0.78)  High 2020-03-29
19 NLOK NORTONLIFELOCK INC. Services Technology Services (0.71)  High 2020-04-03
20 EXPE EXPEDIA GROUP, INC. Services Technology Services (0.56)  High 2020-03-31
21 NLSN NIELSEN HOLDINGS PLC Services Business Services (0.42)  High 2020-03-31
22 CAH CARDINAL HEALTH INC Trade Wholesale (0.39)  High 2020-03-31
23 HLT HILTON WORLDWIDE HOLDINGS INC. Services Hospitality (0.34)  High 2020-03-31
24 AIV APARTMENT INVESTMENT & MANAGEMENT CO Financial REITs (0.29)  High 2020-03-31
25 CCI CROWN CASTLE INTERNATIONAL CORP Financial REITs (0.25)  High 2020-03-31

 The 25 S&P 500 Non-Manufacturing Companies with the Lowest-Risk Z-Score

Rank Ticker Company Sector Industry Z-Score Risk Quarter Ending
1 NVR NVR INC Services Construction 12.77  Low 2020-03-31
2 MKTX MARKETAXESS HOLDINGS INC Financial Financial Services 12.32  Low 2020-06-30
3 TROW PRICE T ROWE GROUP INC Financial Financial Services 10.30  Low 2020-03-31
4 FAST FASTENAL CO Trade Wholesale 9.44  Low 2020-06-30
5 ANET ARISTA NETWORKS, INC. Services Technology Services 9.35  Low 2020-03-31
6 INTU INTUIT INC Services Technology Services 9.22  Low 2020-04-30
7 FB FACEBOOK INC Services Technology Services 8.57  Low 2020-03-31
8 GWW W.W. GRAINGER, INC. Trade Wholesale 8.36  Low 2020-06-30
9 GOOGL ALPHABET INC. Services Technology Services 8.28  Low 2020-03-31
10 BEN FRANKLIN RESOURCES INC Financial Financial Services 8.10  Low 2020-03-31
11 BKNG BOOKING HOLDINGS INC. Services Technology Services 7.93  Low 2020-03-31
12 MA MASTERCARD INC Financial Financial Services 7.90  Low 2020-03-31
13 ODFL OLD DOMINION FREIGHT LINE, INC. Services Transportation 7.80  Low 2020-03-31
14 EXPD EXPEDITORS INTERNATIONAL OF WASHINGTON INC Services Transportation 7.63  Low 2020-03-31
15 DHI HORTON D R INC /DE/ Services Construction 7.60  Low 2020-03-31
16 EA ELECTRONIC ARTS INC. Services Technology Services 7.48  Low 2020-03-31
17 CPRT COPART INC Trade Wholesale 7.28  Low 2020-04-30
18 LEN LENNAR CORP /NEW/ Services Construction 7.16  Low 2020-05-31
19 JKHY HENRY JACK & ASSOCIATES INC Services Technology Services 7.12  Low 2020-03-31
20 ANSS ANSYS INC Services Technology Services 7.00  Low 2020-03-31
21 CTSH COGNIZANT TECHNOLOGY SOLUTIONS CORP Services Business Services 6.66  Low 2020-03-31
22 SPGI S&P GLOBAL INC. Services Business Services 6.55  Low 2020-03-31
23 NUE NUCOR CORP Resources Metals & Mining 6.22  Low 2020-04-04
24 TYL TYLER TECHNOLOGIES INC Services Technology Services 6.20  Low 2020-03-31
25 CTAS CINTAS CORP Services Business Services 5.97  Low 2020-02-29

Additional Breakdowns

Not too surprising to find Facebook and Google on this list of companies at low risk of going bankrupt given all of the cash that they have stashed away. Just for the fun of it, I took a look at some selected retail companies and airlines.

Retail

Airlines

Results of Altman Non-Manufacturing Z-Score Analysis
Filings Data from Quarter Ending March 31, 2020

The full set of parameters can be found on the supporting Excel document in GitHub.

Analysis

As an initial step we are going to compare the five highest-risk manufacturing firms with the lowest risk.

Comparison of Low vs. High Risk Manufacturing

Ticker COTY NWL KHC F GM ABMD ISRG MNST IPGP VRTX SWKS
X1    0.04    0.08    0.04    0.14   0.05     0.50     0.59     0.33     0.75     0.53     0.46
X2  (0.37)  (0.37)  (0.04)    0.09   0.15     0.69     0.36     1.52     1.08   (0.20)     1.29
X3  (0.53)  (0.45)    0.10  (0.03)   0.02     0.68     0.37     0.98     0.25     0.61     0.56
X4    0.12    0.43    0.49    0.07   0.11   54.45   37.37   24.81   18.03   18.12   15.67
X5    0.43    0.69    0.24    0.57   0.49     0.69     0.43     0.88     0.47     0.54     0.64
Z-Score  (0.30)    0.38    0.85    0.84   0.81   57.01   39.12   28.53   20.57   19.60   18.60
Risk High High High High High Low Low Low Low Low Low

 

Review of the above chart shows how much influence X4 (market value of equity / book value of total liabilities) has.  This makes sense as it gives a view of what people think the company is worth vs. how much it owes.  However, also note that X1, X2, and X3 are also all consistently lower for the high-risk companies.  Notice both Ford and GM have made this list.  It may be worth digging into whether there is a particularity of in capital structure in the automotive industry that results in these high-risk scores.

Comparison of Low vs. High Risk Non-Manufacturing

Ticker  VRSN  APA  CXO  DPZ  EXR  NVR  MKTX  FAST  ANET  INTU
X1      0.83   (0.06)    0.58    1.94  (3.53)     2.63     3.25     3.17     4.41     1.82
X2  (28.64)   (2.45)   (1.44)   (6.82)  (0.14)     6.78     2.21     2.23     1.35     4.44
X3      3.02   (3.61)   (6.34)    2.83    0.50     1.65     2.08     1.82     1.24     1.33
X4     (0.45)   (0.02)    1.66   (0.70)    0.47     1.71     4.78     2.22     2.35     1.63
Z-Score  (25.24)   (6.14)   (5.53)   (2.76)  (2.69)   12.77   12.32     9.44     9.35     9.22
Risk High High High High High Low Low Low Low Low

 

For non-manufacturing companies the profitability measure (X2: retained earnings / total assets) drive the differences.  However, X4 also is a significant factor even though it is calculated differently for non-manufacturing companies.

Other items that show through is the large number of REITs that are listed as the highest risk companies.  This is particularly troubling given that the full impacts of COVID are likely not reflected in the filings data at this time.

Conclusion

Of the 440 companies analyzed, 112—a full 25%—were rated as high risk by the Altman Z-Score.  A full third of non-manufacturing companies rated as high risk.  This does give one pause. This analysis is just a first pass, but it certainly does explain why Professor Altman is ringing the alarms.  Research is always a journey where one analysis lead to more questions to explore.  The questions that come to mind when viewing the results of this quick Z-Score analysis are:

  1. Do other measures of financial distress produce similar results?
  2. If they do, is this information truly priced into the market?
  3. What will this look like when the full set of second quarter earnings are in?
  4. Where are the risks and opportunities?

More to come…

Data Provided by TagniFi.  More at https://tagnifi.com/.

Charlie Strout is founder of Seven Shadow LLC, and independent research and consulting firm.  More on Charlie can be found at https://charliestrout.com/.

DISCLAIMER: This article is for informational purposes only.  Nothing in it is intended as advice to buy or sell a security.