With so much news-driven share price moves for your average stock these days, it is often easy to overlook the base financials of a company. To the uninitiated, a company’s financial report can be intimidating, and headlines about revenue or EBITDA can be the extent to which some investors look at the numbers. However, one metric I like to use to gauge a company’s strength is known as the Altman Z-Score.
This calculation is effectively a credit-strength test that gives a listed company a number based on five key financial ratios. As a rule, anything above 3 is pretty solid, while anything below 1.8 is a riskier prospect. Of course, the number needs to be taken in context, and should always be viewed in relation to a sector or industry average.
This calculation is effectively a credit-strength test that gives a listed company a number based on five key financial ratios. As a rule, anything above 3 is pretty solid, while anything below 1.8 is a riskier prospect. Of course, the number needs to be taken in context, and should always be viewed in relation to a sector or industry average.
Below I have calculated the Z-Score for Sirius Minerals (LSE: SXX), compared it to similar firms including CF Industries and Mosaic Co, and the results were very telling. These numbers are based on the financial report ending December 31, 2018.
|
Ratio |
Sirius |
Industry Average |
|
Z-Score |
0.96 |
6.47 |
|
Working Capital/Total Assets |
0.02 |
0.62 |
|
Retained Earnings/Total Assets |
-0.01 |
0.2 |
|
EBIT/Total Assets |
-0.01 |
0.29 |
|
Market Value of Equity/Total Liabilities |
1.66 |
1.32 |
|
Revenue/Total Assets |
0 |
3.71 |
As you can see, Sirius’ Z-Score of 0.96 is not only far below the industry average, but is very much in the danger zone. It is, however, worth noting that this number reflects the company’s lack of revenue, and so may not be an entirely comprehensive assessment of its prospects – if you believe, that is – that it can hold on until its Woodsmith mine goes into production in 2021.
It’s also worth keeping in mind that this number is based on historical data, and with the company expected to raise up to $500m with a bond issue this year (having already raised $425m through the sale of new shares), it will be interesting to reassess the figures once again, with the 2019 year-end results.
What does this mean for investors then? Is this a company with a lot of potential going cheap, or is it just too risky to invest in?
My opinion at this stage is that it’s a gamble. Even with the pressure on its shares as of late, there may still be more room on the downside for the stock as its financing package (which is raising the funding it will need to get the mine dug and the proposed 23-mile conveyor built) comes into play. This, of course, doesn’t take into account any unexpected costs arising as things progress – the need for yet more money is bound to hit the shares hard if and when this happens.
If the company can hold on and go in to production, however, it is sitting on the world’s largest and highest grade deposit of polyhalite, offering a lot of upside for investors the closer we get to the mine going into operation. Sirius certainly isn’t the safest bet I have come across, but it might be worth keeping an eye on as the year continues.