Introduction
The Altman Z-Rating is a method that was created manner again in 1968 by a monetary researcher named Edward Altman. It’s mainly a chapter prediction software that appears at 5 key monetary ratios of an organization and offers a single rating. If that rating is simply too low, it means the corporate is probably going heading in direction of monetary bother. However right here’s the actual query that pursuits us as Indian buyers: did this mannequin truly work for well-known Indian company failures? May it have warned us about Kingfisher Airways and DHFL (Dewan Housing Finance Restricted) earlier than they collapsed?
The stunning reply is sure – the Altman Z-Rating flagged each these corporations as distressed, and typically even years earlier than their precise collapse. However the much more necessary query is: why didn’t anybody hear?
How the Altman Z-Rating System Works
Earlier than diving into Kingfisher and DHFL, you want to perceive how this rating is calculated.
The method makes use of 5 monetary ratios multiplied by particular weights. For a complete overview of the mannequin, together with its historical past and interpretations, confer with my detailed information on the Altman Z-Rating.
Z = 1.2 * CACLTA + 1.4 * RETA + 3.3 * EBITTA + 0.6 * MPATTL + 1.0 * TRTA.
The place:
- CACLTA = Working capital / by whole belongings
- RETA = Retained earnings / whole belongings
- EBITTA = Working Revenue / whole belongings
- MCAPTL = Market worth of fairness over whole liabilities
- TRTA = Gross sales over whole belongings
The interpretation is simple:
- Z-Rating above 2.99: Firm is protected – low chapter danger
- Z-Rating between 1.81 and a pair of.99: Gray zone – reasonable concern
- Z-Rating under 1.81: Misery zone – excessive chapter danger
Consider it like a credit score well being report card. Identical to a health care provider checks your blood strain, sugar ranges, and ldl cholesterol to diagnose well being issues, this rating checks completely different monetary well being indicators.
Kingfisher Airways – Misery Sign From 2008 Onwards
Kingfisher Airways began as a premium airline in India in 2005. It was backed by Vijay Mallya, the founding father of Kingfisher beer.
For a number of years, Kingfisher regarded like successful story. However beneath the flamboyant model and luxurious flying expertise, one thing was severely flawed with the funds.
The Z-Rating Numbers of Kingfisher Airways
A number of analysis research that calculated the Altman Z-Rating for Kingfisher confirmed alarming numbers:
- 2008-09: Z-Rating = -2.14 (deep misery)
- 2009-10: Z-Rating = -1.17 (nonetheless closely distressed)
- 2010-11: Z-Rating = -0.27 (continued misery)
- Common Z-Rating from 2005-2012: -3.43 (versus IndiGo’s 2.38 within the protected zone)
These aren’t borderline numbers. These are screaming crimson flags. A rating of -3.43 isn’t just within the misery zone – it’s gone previous misery into the hazard zone. It’s like a affected person whose blood strain studying is 220/140.
This didn’t occur in a single day both. As early as 2008, the corporate was exhibiting these warning indicators.
What Was Truly Incorrect?
Trying on the particular person elements of the Z-Rating calculation reveals the particular issues:
- Working Capital Ratio: Kingfisher had destructive working capital in each single 12 months from 2010 to 2013. This implies it had extra present liabilities (cash it needed to pay quickly) than present belongings (money it truly had in its pockets). By 2013, this ratio was -2.83. This can be a critical liquidity downside. Since then, Kingfisher couldn’t pay its even short-term payments.
- Retained Earnings Ratio: The corporate had huge collected losses. The ratio was -0.57 in 2010 and collapsed to -5.70 by 2013. This tells us that over time, Kingfisher had misplaced far more cash than it had ever made. There was no revenue buffer to soak up any shock.
- EBIT to Belongings Ratio: This was destructive in all years. The airline wasn’t earning money from its core operations. It was solely burning money.
The Timeline and What Truly Occurred:
The mannequin’s predictions and real-world occasions aligned completely:
- 2008-2011: Z-Rating remained deeply destructive. Throughout this era, Kingfisher began accumulating huge debt (over Rs 9,000 crore by 2011), made big losses, and had fixed money circulation issues.
- March 2012: Kingfisher’s license was suspended, and the airline shut down operations. That is precisely what the -3.43 Z-Rating had been predicting for years.
- 2016: The license was lastly cancelled.
The analysis report in 2013 analyzed Kingfisher’s information from 2005 to 2012 and concluded: “The outcomes confirmed up the poor monetary well being of the Kingfisher Airways.” It confirmed that the airline “was on the verge of chapter.”
One other examine in 2020 discovered that the complete Indian aviation sector (besides IndiGo) was in monetary misery based on the Z-Rating mannequin.
Why No one Acted on This Warning:
A number of educational papers and researchers identified these Z-Rating crimson flags from 2008-2012. However the regulatory our bodies like RBI, SEBI, and MCA appeared to miss these clear monetary misery alerts. Because of this, banks stored lending to Kingfisher even because the Z-Rating stored screaming hazard.
It wasn’t till the injury was catastrophic that licenses had been suspended and operations shut down.
DHFL: The Housing Finance Firm That Imploded
Now let’s take a look at a more moderen instance of DHFL.
DHFL was presupposed to be a secure housing finance firm offering reasonably priced loans to individuals in smaller cities and cities throughout India.
The Disaster Timeline:
- September 2018: The IL&FS disaster. It was one other main Indian firm default. When ILF&S defaulted, it triggered panic within the NBFC sector. Mutual funds like DSP began dumping DHFL papers at 11% reductions (learn right here), signaling critical bother.
- January 2019: An investigative journalist portal alleged that DHFL had funneled Rs 31,000 crore by shell corporations linked to its promoters (learn right here).
- Could 2019: Credit standing businesses began downgrading DHFL. CARE downgraded the Fastened Deposit program from ‘A’ to ‘BBB-‘. A number of businesses downgraded business papers of DHFL to ‘D’ (Default).
- June 2019: DHFL stopped accepting fastened deposits and delayed curiosity funds.
- December 2019: The NCLT (Nationwide Firm Regulation Tribunal) admitted DHFL for chapter proceedings.
The Z-Rating Numbers of DHFL
In line with analysis research that utilized the Altman Z-Rating and different chapter prediction fashions to DHFL:
- Z-Rating in 2019: 0.625 (severely distressed)
A rating of 0.625 is properly under the 1.81 misery threshold. Any rating under 1.10 signifies excessive vulnerability to chapter.
What Was Truly Incorrect at DHFL:
Identical to Kingfisher, DHFL’s issues confirmed up clearly in its monetary ratios:
(a) Asset-Legal responsibility Mismatch: DHFL was borrowing short-term cash (by business papers and inter-corporate deposits) to fund long-term housing loans. This can be a traditional banking construction downside. When short-term borrowing dried up after the IL&FS disaster, DHFL couldn’t refinance its debt.
Let me clarify this extra clearly utilizing a hypothetical instance.
Think about you want Rs. 100 to pay your lease each month. However you solely have Rs. 50 in your pocket proper now. So that you borrow Rs. 50 out of your good friend, however you make a deal that he can ask for it again after 1 month. Now, each time he asks for the cash again earlier than you possibly can earn extra, you borrow Rs 50 from one other good friend to pay again the primary good friend.
This works superb so long as your pals preserve lending to you. However what occurs when your pals hear that another person (IL&FS) couldn’t pay again their money owed? Out of the blue, all your pals get scared and refuse to lend you any more cash.
When your first good friend asks for Rs 50 again, you don’t have any one to borrow from. You’re caught.
That’s precisely what occurred to DHFL. They had been continually borrowing short-term cash that they needed to return rapidly. This fashion, they had been betting that they may all the time borrow once more when the outdated loans got here due. However when IL&FS defaulted, everybody within the lending world panicked and stopped lending to NBFCs like DHFL.
(b) Liquidity Crunch: From April 11, 2019 to April 30, 2019 (simply 19 days), DHFL’s liquidity buffer dropped from Rs 3,982 crore to Rs 2,775 crore. The corporate was hemorrhaging money.
In these 19 days, DHFL misplaced Rs 1,207 crore from its money reserves. This huge money burn in such a short while confirmed DHFL was desperately working out of cash and couldn’t survive for much longer with out discovering new funding.
(c) Mortgage High quality Points: The auditors flagged deficiencies in mortgage documentation for Rs 20,750 crore of loans and uncollected cheques price Rs 16,000 crore.
DHFL’s auditors found big issues. Rs 20,750 crore price of loans had lacking or incomplete paperwork. There have been no correct paperwork to show the loans had been actual. Additionally, Rs 16,000 crore in cheques from debtors hadn’t been collected or deposited.
This meant DHFL couldn’t show it truly had these loans, and it wasn’t even accumulating cash that debtors owed. It was a large crimson flag for a lending firm’s well being.
(d) Fraud Allegations: Rs 31,000 crore of loans had been allegedly siphoned off to shell corporations with hyperlinks to the promoters.
Evaluating to IndiGo (The Success Story):
To indicate the distinction, IndiGo Airways in the identical interval had a Z-Rating of two.38 (protected zone).
Its working capital to belongings ratio was 0.27 (constructive), whereas Kingfisher’s was -1.03 (destructive).
IndiGo’s long-term debt to whole belongings ratio was 0.56, whereas Kingfisher’s was 1.22 (manner above the protected stage of 0.5).
These numbers clarify why IndiGo survived whereas Kingfisher collapsed.
Did the Z-Rating Truly Work?
Sure, However With Caveats
The Altman Z-Rating efficiently predicted each Kingfisher and DHFL’s monetary misery. However success in prediction doesn’t imply success in prevention. Right here’s why:
The place the Z-Rating Labored:
- Early Warning: Each corporations confirmed misery alerts years earlier than precise collapse. Kingfisher’s Z-Rating was destructive from 2008, however the airline didn’t shut down till 2012. DHFL’s issues turned seen in 2019, and the chapter petition was admitted in December 2019.
- Accuracy: Analysis research have discovered that the Altman Z-Rating mannequin has an accuracy fee of 92.5% in predicting chapter one 12 months earlier than it happens, and 77.5% accuracy two years upfront.
- Constant Indicators: As soon as an organization entered the misery zone, it stayed there. There was no short-term dip adopted by restoration. Each Kingfisher and DHFL’s scores constantly worsened.
The place the Z-Rating Had Limitations:
- Timing Uncertainty: The mannequin tells you an organization is prone to fail, however not precisely when. Kingfisher’s Z-Rating was horrible from 2008, nevertheless it took 4 years to truly fail. For brief-term buyers, that is essential – an organization can seem “about to fail” for years earlier than it truly does.
- Exterior Shocks: The mannequin relies on historic monetary information. DHFL’s disaster accelerated dramatically after the IL&FS collapse in September 2018. Whereas the mannequin would have proven misery, the velocity and severity of the collapse might need stunned individuals.
- Fraud Issue: In DHFL’s case, the fraud allegations (Rs 31,000 crore siphoned off) weren’t instantly seen within the monetary statements. The accounting numbers regarded unhealthy, however not as horrible because the precise state of affairs. The Z-Rating would have flagged misery, however not the total extent of the fraud.
- Regulatory and Coverage Responses: The Z-Rating doesn’t account for presidency intervention or coverage adjustments. A authorities might theoretically bail out an organization or present emergency liquidity, turning a chapter sign right into a survival story.
For a depper evaluation of the constraints of the Altman Z-Rating, I need you to learn this text on why this scoring technique won’t be able to anlyze tech gians like Zomato, Paytm, Lenskart, and so on.
Why Didn’t Regulators and Banks Act on These Indicators?
That is maybe a very powerful query for us as buyers.
If lecturers and researchers might see these Z-Rating warning indicators, why didn’t banks, score businesses, and regulators act sooner?
The Kingfisher Story:
A number of papers documented Kingfisher’s Z-Rating issues as early as 2008-2009. But, banks like SBI, IDBI, PNB, and others stored lending to Kingfisher. They practically obtained uncovered to about Rs 9,000 crore.
It wasn’t till 2012 that these banks categorised Kingfisher as an NPA (Non-Performing Asset).
That’s a 4-year delay in recognizing misery that the Z-Rating had already flagged.
Doable causes:
- Kingfisher was a prestigious model backed by a widely known businessman (Vijay Mallya)
- Banks had been reluctant to confess that they had made poor lending choices
- There was hope that enterprise would enhance and the airline would flip round
- Senior administration and promoter credibility masked monetary weak point
The DHFL Story:
Credit standing businesses gave DHFL excessive rankings.
- A- grade long-term and
- A+ short-term rankings.
These score had been ket like that proper up till early 2019.
But, the Z-Rating would have proven misery. Why?
- Score businesses had been caught off guard by the IL&FS collapse, dropping credibility
- DHFL was a longtime participant with 35 years of historical past
- Brief-term liquidity crises are completely different from chapter – score businesses didn’t absolutely account for the asset-liability mismatch danger
- The fraud allegations got here as a shock – one thing not seen in historic monetary information
What’s The Classes for we Buyers?
In the event you’re investing in corporations (shares), listed here are the sensible takeaways:
- Use the Z-Rating however Don’t Rely Solely on It: The Z-Rating is a helpful crimson flag, nevertheless it’s not foolproof. Use it alongside different evaluation. You might want to take a look at the standard of administration, trade developments, aggressive place, and governance.
- Adverse Working Capital is a Main Warning: If an organization has been burning by working capital for multiple 12 months, be very cautious. Each Kingfisher and DHFL confirmed this downside years earlier than collapse.
- Retained Earnings Matter: An organization with collected losses is susceptible. It has no revenue buffer to outlive a disaster. Verify if the corporate is definitely earning money over a few years, not only one or two quarters.
- Look ahead to Liquidity Mismatches: If an NBFC or financial institution is borrowing short-term to lend long-term, and the price of borrowing is rising, it’s in bother. However how one can establish this challenge? There are 3 ways to do it:
- First, test the Stability Sheet. Examine the “Liabilities” part to see what portion is due inside one 12 months (short-term) versus what’s due after one 12 months (long-term). Then examine this to the “Belongings” part to see how a lot of the loans are long-term.
- Second, take a look at the Money Circulate Assertion. In the event you see giant quantities of cash coming in from short-term borrowing (business papers, inter-corporate deposits) however going out as long-term loans, that’s a crimson flag for asset-liability mismatch.
- A less complicated manner: Calculate the ratio of Brief-term Liabilities / Lengthy-term Belongings. If this ratio is excessive (above 0.8-1.0), the corporate is borrowing short-term to fund long-term lending, which is dangerous. This was the issue with DHFL, nevertheless it solely turned acute after IL&FS disaster elevated borrowing prices.
- Watch out for Asset-Heavy, Money-Poor Conditions: Kingfisher had plane (belongings) however destructive money circulation. DHFL had a big mortgage guide however couldn’t accumulate cash and couldn’t refinance. Belongings don’t imply security if they’ll’t generate money.
- Regulatory and Peer Motion is Essential: Whenever you see that regulators are getting nervous (like when RBI steps in), it’s a hazard signal. We should additionally keep watch over the friends. When friends within the sector are getting downgraded concurrently, deal with it as a serious warning signal.
Conclusion
The Altman Z-Rating did efficiently predict each Kingfisher and DHFL’s bankruptcies.
- Kingfisher’s rating of -3.43 was a transparent screaming crimson alert from 2008 onwards.
- DHFL’s rating of 0.625 in 2019 was equally alarming.
What does it imply? The Altman Z-Rating mannequin labored.
However the actual lesson for buyers is that this one thing else. Figuring out that an organization goes to fail is just half the battle. You additionally want to grasp when it’s going to fail. You have to know when to bail-out earlier than its too late.
The Z-Rating is a great tool on your funding evaluation. Each Kingfisher and DHFL buyers and lenders would have benefited immensely if that they had paid consideration to those early warning alerts.
