Recognizing Bankruptcy Risk in a Struggling Industry
We all know the coal industry is – and has been – struggling. Major challenges, including lower global demand, price competition from natural gas and increased regulation, have led to a string of bankruptcy filings, including coal giant Peabody Energy, in April, 2016.
Financial professionals need to keep a close eye on the financial health of coal companies they do business with. Here’s a look at one coal company’s slide towards Chapter 11, with a special focus on early signs of financial distress.
Walter Energy, a producer and exporter of metallurgical coal for the global steel industry, faced Peabody’s fate less than a year ago.
After receiving a FRISK® score of “1” for 12 consecutive months, Walter Energy declared bankruptcy in July 2015. As with other coal companies, asset retirement obligations and costs associated with unprofitable ”zombie mines” created a dire financial picture. But the score, which indicates a high probability of bankruptcy within a 12-month horizon, tells a complex story.
The industry average FRISK® score has hovered near a ‘5’, and many mining companies are at a heightened risk of bankruptcy. When it comes to Walter Energy, though, there were additional signs of financial trouble leading up to business failure.
Early Signs of Failure
If you were monitoring financial indicators in the coal industry a year ago, the usual suspects would have steered you wrong. In the months leading up to bankruptcy, Walter Energy consistently made timely payments, suggesting that all was well.
And while the Altman Z” did indicate that the company was in fiscal danger, that red flag came way too early – in December 2012. A credit professional acting on that information would have missed out on almost two years of sales.
A closer look at Walter Energy’s financials turns up several definitive, if less obvious, markers of the company’s decline within 12 months of business failure, including:
- Operating margins and free cash flow in the red
- Dramatic increase in leverage, and a missed interest payment
- Sudden reclassification of long-term debt as short-term, a telltale precursor to bankruptcy.
And if you keep digging, there’s more.
Picking one failing company out of a struggling industry can be difficult. But to avoid becoming entangled in a customer bankruptcy settlement, you can’t be caught off guard. You need to know when customer financial stress is increasing beyond hope of recovery, and adjust your company’s credit practices accordingly.
In the case of Walter Energy, increased debt, diminishing cash flow and a bottom quartile position on a wide range of financials indicated severe stress in an already risky industry.
Every public company that finds itself in financial distress got there through unique circumstances. Yet bankruptcy itself is predictable, when you take the right financial data into account.
To learn how to detect a failing company in a struggling industry, read the full Walter Energy case study
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At the core of CreditRiskMonitor’s service is its 96% accurate FRISK® score, which is formulated to predict public company bankruptcy risk. One of four key components calculated in the FRISK® score is crowdsourced subscriber activity. This unique system tracks subscribers' patterns of research activity, capturing and aggregating the real-time concerns of what are essentially the key gatekeepers of corporate credit. Other features of CreditRiskMonitor’s service include timely news alerts, the Altman Z” score, agency ratings, financial ratios and trends. CreditRiskMonitor’s network of trade contributors provides more than $135 billion in trade data on their counterparties every month, giving them visibility into their biggest dollar risks.