Could BP (LON:BP.) have the profile of a financially distressed company?

BP p.l.c (LON:BP.) is a company well-known to investors - the integrated oil and gas company is a global giant, with both upstream and downstream operations as well as a stake in Rosneft. The Upstream segment is engaged in oil and natural gas exploration, field development and production, as well as midstream transportation, storage and processing, while the Downstream segment has global manufacturing and marketing operations.

For the fiscal year ended 31 December 2018, BP plc revenues increased 24% to $298.76B and net income applicable to common stockholders excluding extraordinary items more than doubled from $4.25B to $9.26B thanks to a surge in oil prices.

It might come as a surprise, then, that BP fails to pass one of the most highly-regarded financial safety checklists in the investment community. This checklist - the Altman Z-Score - was found to be:

• 72% accurate in predicting bankruptcy two years prior to the event in its initial test
• 80-90% accurate in predicting bankruptcy one year before the event in the 31 years up until 1999

A Z-Score of more than 2.99 is considered to be a safe company. Those with a Z-Score of less than 1.8, on the other hand, have been shown to have a significant risk of financial distress within two years. Unfortunately, BP fails Altman’s test, scoring 1.73.

What does the Altman Z-Score flag up about BP (LON:BP.)?

The Z-Score was developed by New York University finance professor and leading academic, Edward I. Altman. It measures how closely a firm resembles other firms that have filed for bankruptcy by considering the following areas:

• Current assets as a proportion of total assets,
• Cumulative profitability and use of leverage,
• Productivity of assets, and
• Firm value compared to liabilities

We can see which of these areas BP is currently struggling with by looking at the graphic below.

BP's low Z-Score doesn't mean that it is definitely heading for financial distress, but it does mean this fate is more of a risk for BP than it is for most. At the very least, the areas of BP's Z-Score marked as "risk" deserve further investigation.

A quick glance at the group's StockReport shows that net debt, at c$44bn, has nearly doubled over the past five years to just under half of BP's market cap, while broker EPS estimates have been falling over the past couple of months. Bearing this in mind, and the fact that BP's fortunes are so closely tied to commodity prices, it is worth considering how well prepared the group is to weather any volatility in future.

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