Up to one-third of all Australian and US companies could be "Zombies"

Christopher Joye

Coolabah Capital

Since 2019, we have been warning about the rise of "zombie companies" kept alive by perpetually cheap money care of the near-zero interest rate and QE-to-infinity policies of profligate central banks in the period following the GFC. The worry is that as interest rates now normalise, many of these zombies could fail to survive, creating waves of corporate defaults the likes of which has not been seen since the 1991 recession in Australia and during the GFC in the US.

We have, therefore, updated our quantitative zombie detection models to cover both Australia and the US. And we have stress-tested some of the definitions of what is, and is not, a zombie. The standard definition for a zombie is a company that meets two tests:

  • They have existed for more than 10 years, and
  • They have an interest coverage ratio (ICR) of less than 1 for 3 years in a row.

There are other more complex definitions that we employ, but this will suffice for our public research. So the ICR is defined as the ratio of a company's earnings before interest and tax (EBIT) relative to the interest (note, not principal) repayments on their debt. If the firm's ICR is less than one, it is not earning sufficient income to repay the interest due on its debt. Hence the "zombie" moniker.

Using this definition, Coolabah finds that over 13% of all ASX companies are zombies, which is actually slightly above the number of zombies we find in the US, which is just under 10% of all listed firms. Our US analysis includes all NYSE and NASDAQ listed companies.

1-in-10 Aussie and US companies are "zombies"

The age constraint on a zombie does not make a great deal of sense. Just because you are a young, high growth firm, if you are not generating sufficient profit to service your debts you are still technically a zombie. So in our first adjustment, we remove the minimum 10-year age criterion, and simply focus on all firms that have reported ICRs less than one for 3 years in a row. The first panel in the table below summarises the results.

In Australia, an incredible 34% of all ASX companies would be classified as zombies as judged by their ability to produce sufficient EBIT to cover their interest repayments. This is up from the 13% of zombies we estimated in the table above, albeit imposing a minimum 10-year age requirement (ie, accounting for companies of all age, the zombie penetration jumps from 13% to 34%). In the US there is also a jump in the market share of zombies from 9.6% to 18.9% once we remove the age criterion. 

As a final exercise, we classify companies as zombies only using the data from their last financial year alone, as opposed to requiring them to have ICRs less then 1 for 3 years in succession. The final panel of the table below shows that the zombie share rises further to 39% in Australia and 37% in the US.

There are more zombies than you think

After identifying the zombies, we then studied their propagation across both industry sectors and by size or market capitalisation. The charts below summarise the findings. This analysis reveals that zombies tend to be small-to-medium-sized companies. 

They are also found in greater numbers in the technology, energy, healthcare, real estate, and materials industry sectors. One final point is that if you distribute firms by their ICRs, you find that there are a lot of very risky zombies contrasted against a significant number of incredibly low-risk firms, and not as much in between. It seems that in the corporate world, you are either a good guy or a bad guy! Or maybe what we are saying is that there are a lot of deep value stocks and also loads of junk-like growth wannabes. Given the outlook for interest rates, it is hard to imagine that there will be much global growth for the next year or two - recessions are more likely.

This has implications for markets. As interest rates continue to climb, we are likely to see the first interest rate-led default cycle in Australia since 1991. In the early 1990s, ANZ and Westpac almost went bankrupt because of their loan exposures to the commercial property sector. 

Since the 1991 recession, we have also seen a big increase in "non-bank" lenders, many of whom provide finance to zombies, and don't have the risk management experience of lending during the 1991 recession, the tech-wreck, or even the GFC. 

Whereas highly rated bond markets (eg, BBB to AAA rated securities) have generally repriced substantially, and are trading on credit spreads that are starting to look quite cheap compared to historical benchmarks, high-yield and sub-investment grade debt markets still appear dear or rich. As one example, consider the current credit spreads on US high-yield bonds rated B and BB, as highlighted below. Observe that current spreads remain well inside the much wider levels that emerged in all prior shocks, including 2020, 2015-2016, 2011-12, 2008, and 2002.

Coolabah has developed and uses automated global high-yield bond default forecasting models, and they are currently pointing to a substantial increase in high-yield defaults. Our US recession forecasting models are likewise signaling a very strong likelihood of a US recession, as they have been doing for many months. All of this means that high yield spreads are likely to have  to move a lot higher, crushing many of their zombie companies...


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Investment Disclaimer Past performance does not assure future returns. All investments carry risks, including that the value of investments may vary, future returns may differ from past returns, and that your capital is not guaranteed. This information has been prepared by Coolabah Capital Investments Pty Ltd (ACN 153 327 872). It is general information only and is not intended to provide you with financial advice. You should not rely on any information herein in making any investment decisions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information. The Product Disclosure Statement (PDS) for the funds should be considered before deciding whether to acquire or hold units in it. A PDS for these products can be obtained by visiting www.coolabahcapital.com. Neither Coolabah Capital Investments Pty Ltd, EQT Responsible Entity Services Ltd (ACN 101 103 011), Equity Trustees Ltd (ACN 004 031 298) nor their respective shareholders, directors and associated businesses assume any liability to investors in connection with any investment in the funds, or guarantees the performance of any obligations to investors, the performance of the funds or any particular rate of return. The repayment of capital is not guaranteed. Investments in the funds are not deposits or liabilities of any of the above-mentioned parties, nor of any Authorised Deposit-taking Institution. The funds are subject to investment risks, which could include delays in repayment and/or loss of income and capital invested. Past performance is not an indicator of nor assures any future returns or risks. Coolabah Capital Institutional Investments Pty Ltd holds Australian Financial Services Licence No. 482238 and is an authorised representative #001277030 of EQT Responsible Entity Services Ltd that holds Australian Financial Services Licence No. 223271. Equity Trustees Ltd that holds Australian Financial Services Licence No. 240975. Forward-Looking Disclaimer This presentation contains some forward-looking information. These statements are not guarantees of future performance and undue reliance should not be placed on them. Such forward-looking statements necessarily involve known and unknown risks and uncertainties, which may cause actual performance and financial results in future periods to differ materially from any projections of future performance or result expressed or implied by such forward-looking statements. Although forward-looking statements contained in this presentation are based upon what Coolabah Capital Investments Pty Ltd believes are reasonable assumptions, there can be no assurance that forward-looking statements will prove to be accurate, as actual results and future events could differ materially from those anticipated in such statements. Coolabah Capital Investments Pty Ltd undertakes no obligation to update forward-looking statements if circumstances or management’s estimates or opinions should change except as required by applicable securities laws. The reader is cautioned not to place undue reliance on forward-looking statements.

Christopher Joye
Portfolio Manager & Chief Investment Officer
Coolabah Capital

Chris co-founded Coolabah in 2011, which today runs $7 billion with a team of 33 executives focussed on generating credit alpha from mispricings across fixed-income markets. In 2019, Chris was selected as one of FE fundinfo’s Top 10 “Alpha...

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