Revisiting The Coal Sector With An Alternate Altman Z-Score Model

by: Paulo Santos

This past Wednesday I got curious and decided to analyze several stocks in the coal (NYSEARCA:KOL) sector in terms of their insolvency risk. For this, I used the Altman Z-score. I couldn't have been more surprised, every stock I analyzed came up as very risky. Patriot Coal (PCX), Arch Coal (NYSE:ACI), Alpha Natural Resources (ANR) even Peabody Energy (BTU) were deemed at risk of insolvency.

Sure, there were mitigating factors that could explain some of it, I identified several:

  • A very unfavorable point in the coal cycle;

  • These companies being very capital intensive;

  • The Altman Z-score not giving any weight to the coal companies' ability to generate a large cash flow, from the fact that depreciation and depletion of the coal reserves is a large non-cash cost that these companies have.

But still, I was floored. After all, I was long some of these equities. Indeed, all of them except for Patriot coal. This prompted me to try and see if things were so dire as they seemed. Since I believed that the Altman Z-score model itself was probably overstating the insolvency risk, this also prompted me to see if there was any other version that might be more adequate to gauge capital intensive businesses like mining. It turns out that there was.

Alternate Altman Z-Score, for non-manufacturing companies

Given that the original Z-score can be biased in the case of capital-intensive non-manufacturing companies, such as mining companies, an alternate model was created. This model has a few differences versus the original, namely:

  • The alternate model does not include T5;

  • In the alternate model, T4 = Book Value of Equity / Total Liabilities;

  • The weights are different, with Z = 6.56T1 + 3.26T2 + 6.72T3 + 1.05T4 ;

  • The interpretation of the results is done according to a different set of values (Z > 2.6 is safe; 1.1 < Z < 2.6 is the grey zone; Z < 1.1 is the distress zone);


The following data was sourced from Patriot Coal, Arch Coal, Alpha Natural Resources and Peabody Energy's earnings reports:

With this data, we obtained the following results:


This time, the results are much, much more realistic. And once again, I can breathe more easily. The results show ACI (alt Z = 1.31), ANR (alt Z = 1.31) and BTU (alt Z = 2.50) in the "grey" area of risk. None of these equities shows up as distressed any longer. BTU is even close to the safe zone (Z > 2.6) as we'd expect.

PCX (alt Z = -0.23), on the other hand, is still clearly in the danger zone (Z < 1.1). PCX is basically weaker than every other equity considered on all regards, with a particular focus on its lack of profitability and its always-dangerous working capital deficit.


Using the alternate non-manufacturing Altman Z-score, one can breathe a sigh of relief. The model seems quite a bit more realistic for the mining industry, and as expected, shows BTU as being the safest by far; nearly safe, as per the model. ACI and ANR no longer show as distressed, either.

Again, and confirming previous fears, PCX continues to show as a deeply speculative equity. PCX has clear insolvency risk, and as such is not appropriate even for rather aggressive investors. For those considering PCX, it might make more sense to look at its deeply-discounted debt.

Disclosure: I am long ACI, ANR, BTU.