Razorbak:
I have been thinking about the "Altman's Bankruptcy Predictor", and the more I think about it, the more I believe it is a "great predictor" for oil and gas companies - especially if you value the assets (reserves) at "current" prices. You hit both the balance sheet and the income statement - a double whammy. In fact, that is exactly what the banks do, and what SFAS 69 requires you to quarterly and report fully annually. In some respects, the oil industry is a great example because it is relatively easy to value assets regularly. In truth, every industry should do so, but for most it is just too onerous a task.
In rising markets, oilmen often leverage-up their assets as they drill up reserves, then, when prices drop, the asset value also drops. Companies often cannot shoreup their balance sheets, as the value of their asset has declined along with the revenues. The key is to try and avoid fully leveraging your balance sheet during times of high commodity prices. Many companies may have a very difficult time maintaining their current production rates from existing cash flows -
as they cannot afford to keep the drill bit ahead of the decline curve. A formula that can spell disaster!
Applying the formula to "floating commodity prices" is actually a useful tool. When prices reverse, I would also recommend "writing-up" the asset accordingly. One just needs to remember it is actually highlighting trouble spots rather than telling people that a company will actually fail.
Another thing to consider is that although a company may look like it is "dead in the water", it may survive because it has substantial leverage to improving prices - a form of call.
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