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Altman Z: An indicator for determining the financial health of shipping companies

Capt. Ashwani Jhingan


Shipping companies have been struggling for a while. Charter rates are lower than they were after the global economic crisis, although showing upwards trend lately.


Baltic Dry Index (BDI) was highest at 11,793 on May 20, 2008 and slumped to 663 on December 5, 2008. BDI remained on the lower side thereafter, at around 1,500, but kept vacillating up and down till it plunged to a historic low of 290 on February 10, 2016. It was around 1,147 on March 15, 2017.


Baltic Dirty Tanker Index and Baltic Clean Tanker Index were 2,165 and 1,086, respectively, on December 1, 2007. Today, in March 2017, they are hovering around 850 and 650, respectively. These two indexes have been relatively flat in the last few years because of the peculiar inherent nature of the "oil" cargo and the "tanker" market.


Post-2008 crisis, the recovery was relatively fast and the damage was not as much because the decline in economy in the developed world, viz. the US, Europe, Japan and others, was offset and compensated by the surge in Chinese demand. In the recent period, China, accounting for close to 40 per cent of the global trade, has seen its GDP contracting from 7.8 per cent in 2013 to 6.9 per cent in 2015. IMF expects it to fall further to 6.2 per cent by 2017. Presently, China is sitting on huge capacities.


Within the shipping sector, dry bulk, which accounts for close to 50 per cent of the global seaborne trade, is seeing the most pain, with all-time low freight rates. There is huge supply pressure which is unlikely to alleviate soon. At current rates, almost half of the industry capacity is idle. Companies are not even able to recover the cost.


Like bulk carriers, similar effects have been visible in container shipping liner industry also in the last one year. Several mergers and acquisitions, and bankruptcies, have taken place in 2016 in the ship owning as well as the ship management industry.


Among these are CMA CGM’s acquisition of NOL (with APL); merger of Cosco Container Lines and China Shipping Container Lines; merger of Hapag-Lloyd and UASC; Hanjin going bankrupt; announcement of the Japanese Big 3, MOL, NYK Line and "K" Line, merging their container businesses; and Maersk Line acquiring Hamburg Süd.


Latest management companies’ acquisitions


1. Acquirer : Anglo Eastern; Acquired : Univan : Aug. 2015


2. Acquirer : V.Ships Group; Acquired : Bibby : March 2016


3. Acquirer : V.Ships Group; Acquired : Selandia : Nov. 2016.


4. Acquirer : Advent Int’l; Acquired : V.Ships Group. : Dec. 2016.


A big question is how do we know when a company is at the risk of corporate collapse? To know the financial health of a company, investors calculate and analyse all kinds of financial ratios: working capital, profitability, debt levels and liquidity, etc. The trouble is, each ratio is unique and tells a different story about a firm’s financial health. At times, they can be confusing and even appear to, or may, contradict each other.

Altman Z


In a bid to resolve the perplexities of this type, the Z-score formula concept was developed by Edward Altman, Assistant Professor of Finance at New York University, in 1968 as a quantitative balance sheet method of determining a company’s financial health. Altman calculated 22 common financial ratios for all of them and then used multiple discriminant analysis to choose a small number of those ratios that could best distinguish between a bankrupt firm and a healthy one. Rather than search for a single best ratio, Altman built a model that distilled five key performance ratios into a single Z-score. The estimation was originally based on data from "publicly held manufacturers", but later on modified to other type of businesses.


Zones of discriminations (for a non-manufacturing company):


Z" > 2.6 - "Safe" Zone


1.1 < Z" < 2.6 - "Grey" Zone


Z" < 1.1 - "Distress" Zone


The probability of success of the Altman Z-score: The score predicts bankruptcy two years prior to its occurrence. From about 1985 onwards, the Z-scores gained wide acceptance by auditors, management accountants and database systems used for loan evaluation. The effectiveness of this model has been tested abroad and in India.


In its initial test, the Altman Z-score was found to be 72 per cent accurate in predicting bankruptcy two years before the event, with a Type II error (false negatives) of 6 per cent (Altman, 1968).


In a series of subsequent tests covering three periods over the next 31 years (up until 1999), the model was found to be approximately 80-90 per cent accurate in predicting bankruptcy one year before the event, with a Type II error (classifying the firm as bankrupt when it does not go bankrupt) of approximately 15-20 per cent (Altman, 2000).


The Z-score company ratings shown here are objective calculations based on the well-known Z-score methodology and are provided to the readers in good faith, based on the available "financial information". They do not necessarily reflect the future prospects of the companies, which depends upon several subjective and non-subjective factors.


The Z-score is not perfect and needs to be calculated and interpreted with care. At times, it may not give the true picture. The Z-score is not immune to false accounting practices and window dressing of the Annual Reports, which is a norm in the corporate world. "Transparency" is a noble word but the companies do get tempted to misrepresent financials. The Z-score is only as accurate as the data that goes into it. One time "write-offs" and one time "windfalls" may tend to distort the true picture.


Many carriers disguise their results by consolidation of subsidiary companies. Many companies have different accounting periods because of the state regulations. Hence, it is very difficult to compare apple with apple. Apparently, there may be very limited financial transparency in the annual reports of some of the shipping lines.


Altman Z-scores of Indian shipping companies in 2015-16, 2014-15, 2013-14, 2012-13 and 2011-12:


SCI 2.18 2.00 2.12 2.59 3.39
Great Eastern 4.24 3.66 3.55 3.66 3.94
Essar 2.56 2.37 3.33 2.93 2.74
Shreyas 3.24 5.01 1.37 2.73 3.69
Mercator -1.85 -0.14 1.37 1.18 1.82


Interpretation on the basis of "Zone of Discrimination": Apparently, SCI is halfway in the "Grey" zone. Great Eastern has been consistently doing well. Essar is on the border of "Grey/Safe" zone. Shreyas has bounced back to "Safe" zone subsequent to 2013-14. Mercator is in the "Distress" zone.


Altman Z-scores of international shipping


Subsequent to the bankruptcy of Hanjin Shipping in mid-2016, it has been noticed that only two of the many selected international large-sized shipping companies scored high enough to make it to the cautionary ‘Grey Zone’ on Z-score.


The 2 carriers in the "grey zone" have Z-scores of 2.2 for A.P. Moller-Maersk and 2.0 for OOIL, respectively. None of the shipping companies made it to the "safe zone". Hanjin had Z-score of -0.7 just before bankruptcy.


It may be prudent for exporters and importers to know about the financial health of the shipping company on their level of indebtedness and balance sheet strength.


Shippers can insist on financial transparency and carry out due diligence of the carrier. Carriers will risk losing shippers’ trust if they do not provide such data.


No carrier or a corporate is insulated from failure. Hence, it will be prudent on the part of the company to undertake risk assessment from time to time and take appropriate action at an appropriate time.


(Article compiled and contributed by Capt. Jhingan, Chairman and Managing Director of Malaxar. He is also an Advocate of Bombay High Court. Capt. Jhingan can be contacted at Views expressed here are his own.)


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