Is yours a zombie company without you realising it?
Well might it be said that any directors unsure whether the companies they’re running are zombies, shouldn’t be running a company. But that could be a hasty and unwise judgement, because it depends on how “zombie” is defined.
Research applying one definition, indicates at least 10% of Australian companies -- about the same percentage in the US -- can be assessed as zombies, yet assessment using other entirely reasonable definitions, almost quadruples that. But irrespective of categorisation, the day of reckoning is at hand for unknown thousands of zombie companies, many more than many people imagine.
Independently, a major Australian investment organisation applying one of its own definitions has concluded that more than 13% of all ASX-listed companies are zombies, but it could be up to 39% if realistic alternative versions of the definition are applied.
And the research also indicates that as interest rates normalise and government stimulus of pandemic times becomes a distant memory, “there will be waves of corporate defaults the likes of which have not been seen in Australia since the 1991 recession and during the GFC in the US”.
Adding weight to this researched-based opinion are rate rises and the Australian Taxation Office’s (ATO’s) acceleration of its debt recovery campaign -- suspended during the worst days of COVID-19).
The ATO is increasing the daily dispatch of scores of thousands of warning letters about imminent Director Penalty Notices (DPNs) – which notify company directors that tax officers are about to pursue company debt incurred by non-payment of PAYG withholding tax, the superannuation guarantee charge and GST.)
Even though your company may not be classified technically as a zombie, if it has long standing tax debts, its directors could nevertheless receive DPNs and intent-to-disclose letters that flag the ATO’s intention to notify credit reporting bureaus of the company’s indebtedness.
However, putting aside any consideration of the level of companies’ debts and the nature of them, the fact remains business insolvencies in Australia are already back to pre-pandemic levels that will soon be substantially higher than they are now.
The technicalities of zombieism
For many Australians, zombie companies are seen as those having, in the face of imminent financial collapse, been stripped of their assets by unscrupulous directors to avoid creditors’ claims. Although unviable commercially, these companies for one reason or another, have managed to survive temporarily as “walking dead”.
However, many zombie companies, unviable as businesses but not necessarily stripped of assets, have nonetheless also had survival prolonged during the past couple of years essentially because of government largesse throughout the pandemic.
So, what technically is a zombie company? Traditionally investors of all kinds have tended to regard it as a company that has existed for about a decade and has had an interest coverage ratio (ICR) of less than one for three successive years. This is the ratio of a company’s earnings before interest and tax (EBIT), relative to required interest repayments on debt – not principal.
If a company’s ICR is less than one, this means its income isn’t even enough to repay interest due on debt, and so it’s “walking dead”, a zombie.
Is age (or anything else) an issue?
Macks Advisory doesn’t believe a company’s age should be a consideration in any worthwhile assessment of whether it is, or is likely to become, a zombie. If yours is a young, high-growth firm not generating profit sufficient to service debt, then technically, in our opinion it could reasonably be rated a zombie company.
And when Coolabah Capital, in doing research referred to above removed the 10-year criterion (or any age) from any consideration of zombieism and left only an ICR of less than one for three years in a row as the sole zombie test, then ASX companies that were technically zombies jumped from 13% to a disconcerting 34%.
This leapt to a most disconcerting 39% if the only consideration was data from a company’s last financial year that showed an ICR of less than one (or in other words, showed the company had not made enough profit in its most recent full year of operation to cover interest only on debt).
Applying comparable criteria, the corresponding percentage in the US is 37, and given that in many ways the American and Australian economies are interdependent, the possibility that anywhere between 10% and 37% of US companies could be classed as zombies (with inflation rising both there and here) is a very serious issue for many Australians. Also read https://www.macksadvisory.com.au/engage/practical-information/news/2020/december/business-owners-beware-the-tantalising-lure-of-easy-money/
Where the zombies lurk
An analysis of companies defined as zombies by any definition widely accepted as reasonable, indicates zombies are most prolific among SMEs.
If you look at them by size and market capitalisation, zombie SMEs lurk among technology, energy, healthcare, real estate, and materials industry sectors.
Analysis of ICRs of SMEs across all sectors reveals a stark contrast between high risk companies likely to be, or to become zombies, and businesses that are obviously low risk.
This seems to suggest either that the viability of companies tends to depend on whether they’re being run by good or bad directors, or it’s simply the case that among many deep value stocks is a multitude of dicey growth wannabes.
Be that as it may, given the upward trend of interest rates, there is widespread expectation there’ll be little growth in the global economy for a couple of years, and that recessions in many countries are looking more likely than they did a couple of months ago.
Indeed, economists are predicting likelihood of Australia’s first interest rate-led default cycle since 1991 – when Westpac and ANZ faced bankruptcy because of exposure to the commercial property sector.
Since then, there’s been a proliferation of non-bank lenders, many of whom, lacking the risk management of traditional lenders of three decades ago – or of even the GFC -- have provided finance to zombies.
Which is yet another reason we suggest the day of reckoning is at hand for many thousands more zombie companies than most Australians would imagine. We hope you can make sure your company isn’t one of them.
