When it comes to analyzing balance sheets, there are
retailers, and there is everyone else.
Retail-based businesses need to worry aboutinventory
levels,sales markdowns,cash balances and many otherbalance sheet
items throughout theyear , especially as many are profitable only
during the holidays.
||Edward Altman developed the "Z-Score " methodology in
That's why Edward Altman, professor of New York University's
Stern School of Business, devised a broad measure of a retailer's
financial health. Ever since he developed his "Z-Score"
methodology in 1968, investors have been using his gauge to see
how their own retailinvestments are stacking up.
Red , Yellow And Green
Altman's Z-Score gives one simple number that tells you how a
retailer is faring. Any reading above 3.0 implies good health
interms of balance sheet strength andprofit results. Indeed, the
vast majority of retailers get the thumbs-up using the
But a reading of 3.0 and below should be cause for concern.
The lower the number, the greater the risk that this retailer
won't be around in a few years. Indeed, retailers such as Circuit
City, Bombay, Ames and others showed declining Z-Scores before
Let's start with a look at retailers with mediocre Z-Scores,
in the 2.5 to 3.0 range.
These companies are in the process of either boosting or
weakening their Z-Scores, so it's wise to see how this number
trends over time. For example, electronics retailer
Conns (Nasdaq: CONN)
was in weak shape a few years ago but has recently posted
improving sales and profit trends. If those trends continue, then
its Z-Scorewill eventually move into safer territory.
Before looking at companies with truly concerning Z-Scores,
let's look at how this number is determined. Altman takes a wide
variety of variables from the balance sheet,income statement
andcash flow statement , creates a set of ratios for various
metrics, and then assigns weights to those ratios.
Here's the formula:
Z-Score = 1.2A + 1.4B + 3.3C + 0.6D + 1.0E
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
I ran these variables through a screening tool (provided by
Thomson Reuters), eliminating any retailer with a Z-Score of 4.0
or higher. You can see how all retailers fared.
Now, let's take a look at the retailers that may soon hit
awave of financial distress.
Here again, it's wise to dig into the numbers and confirm the
trend as some retailers' financial pictures are changing quickly.
For example, supermarket chain
has raised much-needed cash through asset sales and is out of
intensive care -- for now. On the other hand, women's apparel
Coldwater Creek (Nasdaq: CWTR)
appears headed for further losses in the years ahead, which is
bound to weaken its financial foundation even more.
||Thoughshares of Sears Holdings are off more than 10%
since a month ago, there is considerably moredownside to
A retailer showing deep warning signs:
Sears Holdings (Nasdaq: SHLD)
, which I profiled on our sister site ProfitableTrading.com.
Though shares are off more than 10% since I panned thestock a
month ago, there is considerably more downside to go as cash
flies out the door in comingquarters .
It's also important for investors to track theturnaround
J.C. Penney (
. The struggling retailer is expected to keep losingmoney at a
furious pace, which may eventually create deepeningliquidity
concerns. Then again, if the company can stabilize and actually
turn a profit (compared with a current projected loss of $1.25 a
share), then this might shape up as a nice turnaround play.
Risks to Consider:
As anupside risk, a strengthening U.S.economy will likely
give a solid boost to retail sales, aiding many of these
Action to Take -->
The ongoing shift toward e-commerce is likely to create further
pressure on brick-and-mortar retailers. For example,
Barnes & Noble (
recently noted very weak sales trends, which could trigger a wave
of further store closings, pushing this retailer even closer to
the brink. A number of retailers will report monthlysame-store
sales trends in the coming days, and if youspot any weak sales
trends, be sure to calculate the firm's Z-Score to see if it
might be headed for deeper distress.