Credit Tracker

Weekly Credit Report – Viridian’s Bespoke Leverage and Liquidity Ratios

• • Weekly Credit Report –Viridian’s Bespoke Leverage and Liquidity Ratios
    • If you were to tell us that we could only calculate two ratios that would best allow us to judge the credit quality of any company, the two we would calculate appear in the chart below for 26 of the 30 MSOs we credit rank each week. (Four companies, AYR, 4FFNT, TILT, and Schwazze, have total Liabilities / Market cap ratios off the chart on the high side)
    • The two ratios are:
      • Total Liabilities / Market Cap is our favorite leverage ratio for several reasons: it can be rescaled via option modeling into a measure of asset value coverage of liabilities, and it responds instantly to market information. The ratio and its variants have a long and storied career, appearing in Altman’s Z-score bankruptcy prediction model and as a key ratio in Drexel Burnham Lambert’s analysis of junk bonds. The dotted red line at 5x shows the level at which we typically see an indication of Asset Value coverage dipping below 1x. It is our first warning level, with 10x becoming our second and most serious indicator of potential distress.
      • Annualized FCF Adjusted Current Ratio is our updated version of the current ratio. It calculates the annualized Free Cash Flow (in a manner that minimizes the impact of seasonality) and adds it to the current assets in the current ratio. When this ratio drops below 1x (the dashed green line), it indicates that the company is likely to require additional funding to settle its current liabilities over the course of the annual cycle.
      • Taken together, these two provide a powerful indication of financial flexibility. For example, adverse liquidity can be mitigated by low leverage. The two together suggest that the company may need to borrow additional money, but it is likely in a decent enough financial shape to do so. Similarly, if the company has high leverage but also high liquidity, it indicates that the market views the company as overleveraged, but it has time to deal with the situation due to its stronger liquidity.
      • The region of most concern is companies with less than one times liquidity and more than five times leverage. They require additional funding, but may face difficulties in obtaining it because the market already perceives them as having too much leverage. Companies that fall in this category include: Cannabist, Body & Mind, Red White & Bloom, Gold Flora, and Vibe Growth. Gold Flora is already in receivership, so this warning indicator is a bit too late.