Eastman Kodak Co (EK) finds itself in dire financial straits, with rumors swirling that the company will have no alternative but to file for bankruptcy court protection. (Read the latest Reuters News article on the company’s battle to avoid such an outcome here.) Given this state of affairs, it’s hardly surprising that Eastman Kodak’s share price has plunged almost 90% over the last 12 months, to a mere 65 cents a share, putting it firmly in the category of a penny stock. The question on bargain-hunters’ minds now is whether at that price the stock is worth buying, in hopes that the company manages to avert bankruptcy.
For EK to survive, it needs a fresh infusion of cash in order finance its operations; analysts have pointed to the company’s patents as one potential source of that much-needed cash. Still, even an influx of cash may simply delay the inevitable default, a thesis that is given weight by Eastman Kodak’s dismal score on the new StarMine SmartRatios Credit Risk (SRCR) model. This analytical tool combines financial ratios and metrics that are predictive of credit risk into five components: profitability, leverage, debt coverage, liquidity, and growth; companies score anywhere from 1 to 100, with 100 indicating the strongest credit rating. Eastman Kodak, however, earns only the lowest possible score, 1, on the SRCR model and only 4 on the StarMine Earnings Quality (EQ) model. That places the company firmly in the bottom decile ranked relative to all other companies in North America in terms of earnings sustainability. How did EK end up in such a dire position, and given the forces aligned against it, can it really be seen as a viable candidate for a turnaround.
The chart below shows all too clearly the alarming rate at which EK’s operating profit margin has fallen over the course of the last five fiscal quarters. Whenever the operating profit margin of a mature company (certainly the case for Eastman Kodak, which was founded in 1892 by George Eastman) falls below the industry median and into negative territory, that’s a sign the company is in distress. That is exactly what happened to EK, as can be seen by the sharp slide in the blue line representing the company’s operating profit margin after it slipped below the gold line that represents the industry median. Annual cash flow turned negative in 2009, remained so in 2010 and will no doubt end this year in the red. Although capital spending levels are half what they were three years ago, that’s still more than the company can afford to spend.
Source: Thomson ONE / StarMine
As the table below shows, the StarMine SRCR model puts EK’s default probability at 7.4%; in other words, there is a 7.4% chance that the company will default on its debt or file for bankruptcy within the coming 12 months. Although at first glance this number may seem low, especially when seen in absolute terms, on a relative basis it is worrying: the median SRCR default probability for the Russell 3000 companies is a mere 0.1% currently. Translating its default probability into the terms rating agencies use, Kodak’s SmartRatios Implied Rating of CCC-, EK is only a few tiny steps away from an actual default level. It scores in the bottom decile on when it comes to profitability, leverage and coverage inputs to its rating. None of this should come as a surprise to any investor who has examined EK’s financial statements: the company is battling negative margins, and mounting debt levels while it struggles to make interest payments. There’s a reason there’s so much red all over the table below.
Of course, there’s always the chance of a bailout. But StarMine analytics suggest the need for one is growing increasingly acute. Put your cameras away – this isn’t the kind of “Kodak moment” anyone will want to recall, regardless of the outcome.
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