Credit Tracker

Weekly Credit Report – An Oldie But Goodie – The Altman Z-Score Applied to Cannabis

• • Those of us who have been working in credit for a very long time remember the Z-
  • Score, the original bankruptcy prediction model created by NYU professor Ed Altman in 1968. The model attempts to triage companies into high bankruptcy risk (Z<1.81), indeterminate risk (1.81<Z<2.99), and low risk (Z>2.99) using five financial and market-based ratios:

  Z=1.2X₁+1.4X₂+3.3X₃+.6x₄₊1.0X₅

  _Where:

  _{X1= Working Capital / Total Assets    A measure of liquidity}

  _{X2=Retained Earnings / Total Assets    A measure of historical financial policy as well as the age of the company (older companies tend to have more RE)}

  _{X3=Earnings Before Interest and Taxes (EBIT) / Total Assets    A measure of profitability}

  _{X4=Market Value of Equity / Total Liabilities    A version of Viridian’s favorite leverage indicator. It also measures financial flexibility/access to capital mkt}

  _{X5= Sales / Total Assets   A measure of asset productivity}

  • Note: Altman performed his original statistical analysis on manufacturing companies to determine the variable weights. Its applicability to cannabis companies is inexact. Indeed, the z-scores ranges need to be applied “loosely,” while the relative values still hold relevance.
  • Viridian calculates the Z-Score each week for the 31 companies for which we maintain credit. The Z-score is not directly utilized in the Viridian Model, but Altman’s work informs some aspects of our ranking system. Viridian’s system uses 11 different ratios to resolve four key credit factors: Liquidity, Leverage, Profitability, and Size.
  • (The graph below shows the Z-Score (red line) against a reversed Viridian Credit rank (green line) (usually, our ranking places #1 as the strongest credit and #31 as the weakest).
  • Note the calculated z scores show distress readings for all of the companies on the list except Grown Rogue and GTI. While we disagree that these are the only two credit-worthy companies on the list, there is a relatively strong correlation between the Z-Score and the Viridian Credit Rank (r=.60, p<.01).
  • The Z score is another relatively easy-to-calculate credit metric that investors should follow, which is why we publish it weekly. The absolute level is not critical, but changes in the ratio over time and relative ratings are important to watch.