Recently I saw a post about possibility of Ni Hsin growing into bankruptcy in the long term by a fellow forumer. It was an interesting read and I have decided to test it out for myself. To properly determine the financial health of a company, Altman Z-Score is the widely used formula to predict the probability of a company going into bankruptcy within 2 years. Therefore, I am putting this formula to good use and share the outcome for learning purposes.

But first, let's know a little more about this formula. Altman Z-Score was devised in 1968 by Edward Altman to predict the probability of a company going into bankruptcy within 2 years. During initial testings, this formula was found to be 72% accurate in predicting bankruptcy. Since the 80s, this formula was found to be 80-90% accurate and has been widely used by auditors and management accountants.

There are cons with this formula, first, it cannot be used with financial companies such as banks. Second, it is not 100% accurate. But 80-90% accuracy is pretty darn good if you ask me.

The formula for Altman Z-Score is as below:

Z-score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E

whereby:

• A = Working Capital/Total Assets
• B = Retained Earnings/Total Assets
• C = Earnings Before Interest & Tax/Total Assets
• D = Market Value of Equity/Total Liabilities
• E = Sales/Total Assets

A Z-score of less than 1.8 means a company is more likely headed for bankruptcy while Z-score of more than 3 means it is less likely to go bankrupt. Anything in between (1.8 < Z-score < 3) is considered a 'grey' area.

So, to start off with our calculations, I will extract data from Ni Hsin's 2014 Annual report (all figures in '000).

Working Capital = Current Asset - Current Liability = 32524 - 8766 = 23758

Total Assets = 70165

Retained Earnings = 2329

Earning Before Interest & Tax (a.k.a Operating Profit) = 778

Market Value of Equity = Total Outstanding Shares x Trading Price Of Each Share = 230958 x RM 0.17 (price in 2014) = 39263

Total Liabilities = 10904

Sales = 40727

Therefore, we will get:

• A = 23758/70165 = 0.34
• B = 2329/70165 = 0.03
• C = 778/70165 = 0.01
• D = 39263/10904 = 3.6
• E = 40727/70165 = 0.58

And therefore;

Z-score = (1.2 x 0.34) + (1.4 x 0.03) + (3.3 x 0.01) + (0.6 x 3.6) + (1.0 x 0.58) = 0.41 + 0.4 + 0.3 + 2.2 + 0.58 = 3.89

The final score that we get is 3.89, which is above the score of 3. What about for year 2015? Well, we definitely can use the 9-month financial report that is available to determine the score.

From Q3 2015 report:

Working Capital = 25190

Total Assets = 72250

Retained Earnings = 4399

EBIT = 2606

Market Value of Equity = 84300

Total Liabilities = 10976

Sales = 36096

Therefore;

• A = 25190/72250 = 0.35
• B = 4399/72250 = 0.06
• C = 2606/72250 = 0.04
• D = 84300/10976 = 7.68
• E = 36096/72250 = 0.5

Z-score = (1.2 x 0.35) + (1.4 x 0.06) + (3.3 x 0.04) + (0.6 x 7.68) + (1.0 x 0.5)  = 7.59

The final score is 7.59, further away from the score 3 and certainly improved from year 2014 result. Why do I use 9-month result instead of trailing 12-months? Because I have tested that even using retained earnings, EBIT, and sales of 12-month trailing results, it will not affect the score by a huge sum. But of course using the TTM results give a more accurate score.

So what can we take away from this result? It looks as if though Ni Hsin has gone healthier in financial terms and nowhere near the financial distress zone. But please, do take this result with a slight pinch of salt. After all, there is a 10-20% chance of error. Plus, we cannot predict deep into the future, so perhaps it's best to revisit in a years time to check the score again.

Disclosure: This post serve as an example for learning to use the Altman Z-score. I do not currently or previously own any shares of Ni Hsin; my holdings remain the same as the one I posted here: http://klse.i3investor.com/blogs/shinado/86117.jsp

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