What is the Altman Bankruptcy model saying about Spice Jet?

The Altman bankruptcy model is widely used to identify companies that are distressed. In this article this model is applied to Spice Jet. The findings suggest that Spice Jet is on the verge of bankruptcy.

The Altman bankruptcy model

The Altman bankruptcy model originally developed by NYU professor Edward Altman in 1967 is a model that determines the credit strength of a company from a series of financial ratios. It is widely used to understand and evaluate financial distress in companies. A Z score is calculated based on five key financial ratios.

These ratios are:
a) Working Capital /Total Assets:
This ratio measures how liquid a company is. Companies in trouble experience rapidly reducing liquidity levels.
b) Retained Earnings /Total Assets:
This ratio measures how much of the profits of a company are reinvested in its own business as a function of its total asset based. Weak companies experience significantly reducing retained earnings year over year.
c) Earnings Before Interest Taxes/Total Assets:
This ratio tells you how profitable a company is at the operating level and whether or not it is leveraging its asset base to generate more profit. Weak companies see significant erosion in this ratio.
d) Market Capitalization / Total Liabilities:
This ratio tells you how much investor confidence is in the company relative to its obligations. Weak companies often experience substantial declines in their share price which translates to lower levels for this measure.
e) Sales/Total Assets:
This ratio measures asset turn over efficiency. It tells you how effective a firm is in monetizing its asset base to generate sale. Weak firms experience significantly lower asset turnover rates when compared to their stronger counterparts.

The Altman Z score is calculated from the above parameters as:
Z = 1.2*T1 + 1.4*T2 + 3.3*T3 + 0.6*T4 + 1.0*T5
Z=Altman Z Score
T1 = Working Capital / Total Assets
T2 = Retained Earnings / Total Assets
T3 = Earnings Before Interest Taxes /Total Assets
T4 = Market Capitalization / Total Liabilities
T5 = Sales / Total Assets

Interpreting the Altman Z Score:

If the Altman Z Score exceeds 3.0 then the company's financial performance is strong and it is said to be in the safe zone. There is no threat of bankruptcy in the immediate future. If the Z score is between 1.81 and 2.99 the company is said to be in the grey zone. This means while the company is not in immediate danger of bankruptcy it could still slip into the bankruptcy zone if certain remedial measures are not taken. If the Z score is below 1.81 the company is said to be in the distressed zone and bankruptcy is highly likely in the immediate future.

Spice Jet:

Spice jet is a private low cost carrier in India that has been experiencing significant financial difficulties. The following annual data is obtained in Crores from the company's income statement and balance sheet as on March 31, 2014 and the National Stock Exchange web site:
Current Assets =206
Current Liabilities =2416
Working capital = current assets – current liabilities =-2210
Retained Earnings = -1588
Total Assets =497
Total Liabilities =497
Earnings Before Interest Taxes = -609
Market Value of Equity as on December 11, 2014 = 902
Sales = 6304

T1 = Working Capital / Total Assets =-2210/497 = -4.45
T2 = Retained Earnings / Total Assets = -1588/497 = -3.20
T3 = Earnings Before Interest Taxes /Total Assets =-609/497 = -1.22
T4 = Market Capitalization / Total Liabilities = 902/497 = 1.82
T5 = Sales / Total Assets = 6304/497 = 12.69
Z = 1.2*T1 + 1.4*T2 + 3.3*T3 + 0.6*T4 + 1.0*T5
Z = 1.2*-4.45 + 1.4*-3.2 + 3.3*-1.22 + 0.6*1.8 + 1.0*12.69 =-0.08

As the calculated Altman Z Score is well below 1.81, the company is in the distressed zone and bankruptcy is likely in the near future. It must be pointed out that this data is done with financials as on March 31, 2014, the financial position of the company has deteriorated further since then and has become more financially distressed as per its Quarterly reports filed as on September 30, 2014. One must also note that the Altman bankruptcy model correctly predicted the demise of Spice Jet's fellow counterpart Kingfisher Air a year ago.

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