Zombies aren’t just out for brains—they’re devouring financial gains as well.
That’s the conclusion of a recent report from the International Monetary Fund, which found that zombie firms—so called because their long-term unprofitability, high debt loads, and negative real sales growth make them “unproductive and unviable”—are not only proliferating around the world, but can hamper the performance of non-zombie peers.
The problem was exacerbated by Covid-19, writes the report’s lead author Bruno Albuquerque, because of “unprecedented” support governments offered both public and private businesses: “While this initial (mostly) untargeted support was essential to mitigating the negative shock on the economy, it may have helped zombie firms stay afloat.”
Yet it’s not simply a product of the pandemic, as zombies have been steadily increasing over the past two decades. Moreover, zombies have been staggering on longer than before, now existing an average of four years after a firm is first classified as a zombie.
Zombie companies afflict both advanced economies and emerging markets, although Albuquerque notes that there is “greater zombification among industries that produce durable goods, and are more subject to boom-busts in asset prices and large swings in demand, such as real estate, energy, and consumer discretionary. These (mostly) nontradable industries have been found to be more financially vulnerable, less productive, and face weaker growth opportunities.”
This might all sound like nothing more than a reminder that caveat emptor applies to all potential investors in any new business they come across. However it’s a much broader problem than that, Albuquerque writes, as “the presence of zombie firms dampens investment, productivity, and employment of nonzombies,” all while the latter are also competing with zombie firms for limited credit supply.
In other words, zombie companies continue to suck up resources, financial, and otherwise, long past the point of no return, leaving less available to successful companies that are the main driver of growth. The question of which companies get loans becomes all the more pressing at a time of tightening monetary policy, as we’re seeing at present.
The upshot is that, particularly in industries where many zombie companies exist, conditions are less favorable for viable businesses, which therefore “tend to exit the market at a faster rate, and firm entry rates are lower. These congestion effects are quite persistent, indicating that zombie firms may cast a long shadow on the economy,” Albuquerque writes.
That said, it’s not a hopeless situation. The IMF report concludes that zombies can be identified by their weaker balance sheets than peers: Looking for companies, particularly smaller ones, that are significantly less profitable, have less liquidity, and are at a higher risk of default can highlight potential zombies. “Furthermore, when studying the evolution of new zombies’ balance sheets, we document that the performance of a new zombie firm starts deteriorating considerably several quarters before it is classified as zombie. This suggests that it may be possible to anticipate to some degree the future incidence of zombification.”
In addition, policy can reduce banks’ financial incentives to limit to zombies (as banks often do, to avoid notching those losses on their balance sheets): The report finds that debt levels and investment in zombies is lower in countries that require higher regulatory capital buffers or lower nonperforming loan levels. Those reforms go hand-in-hand with improved bankruptcy laws that efficiently tackle the restructuring of insolvent firms.
Here at least, the U.S. is in the forefront, Albuquerque writes. “In particular, an efficient resolution of financial distress in the U.S. bankruptcy code may explain…[why] zombie lending is not a prominent feature of the U.S. economy, as zombie firms exit the market through bankruptcy.”
Investors can also be wary of certain industries that are more prone to zombies. Among publicly listed firms, the report found that zombies globally make up a higher percentage of real estate, energy, and information-technology sectors; so while the U.S. isn’t as afflicted by zombies, investors might be cautious of companies that share characteristics with those in exchange-traded funds such as the
SPDR Dow Jones Global Real Estate
(ticker: RWO),
Energy Select Sector SPDR Fund
(XLE), and the
Technology Select Sector SPDR Fund
(XLK).
Write to Teresa Rivas at teresa.rivas@barrons.com
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