Halloween is just over a week away, which means it’s a good time to talk about a spooky-sounding new term being used in finance circles: zombie companies.
With low interest rates and easy borrowing terms, and some supportive jaw-boning and incremental buying by the Federal Reserve, new corporate debt issuance in the United States is reaching record highs. For the year-to-date through September 30, a total of $1.95 trillion in U.S. corporate bonds have been issued, according to SIFMA, an industry trade group. For perspective, this compared to a total of $1.4 trillion for all of last year and a five-year annual average of $1.5 trillion.
High yield bond issuances have been just as popular. According to Bloomberg, $330 billion in high yield corporate bonds were issued through September 23, the most recent data available. This also exceeds any previous full-year issuance, including the $329 billion prior record set in 2012.
Easy financing terms have allowed zombie companies (this now is apparently a legitimate word in the finance and academic communities, as it was recently used in a Bank of International Settlements research paper) to comprise 15% of all listed companies across 14 advanced economies in 2017, up from only 4% in the late 1980s. While there may be a variety of definitions, it’s fairly clear that there are a lot more zombie companies stumbling around today.
What is a Zombie Company?
Generally, a zombie company is a company that has a persistently insufficient profitability to cover its interest payments, is cash-poor, and has a low market value indicating a lack of market confidence in its prospects.
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Like the movie zombies, these companies are effectively dead, yet not quite. In a more traditional (less generous) bond market, higher interest rates and tighter credit terms would force these companies into bankruptcy. But in today’s yield-reaching market, these companies continue to issue high yield bonds that are then rolled over at maturity, yet never (or rarely) succumb to the inevitable.
How can one evaluate the credit condition of their companies? One method is to look at the credit rating, usually issued by Standard & Poor’s or Moody’s. Any rating below BBB- (S&P) or Baa3 (Moody’s) is considered “below investment grade” or “junk.” Zombie companies might have ratings in the single-B range or C-range.
In my Cabot Undervalued Stocks Advisor portfolio, we avoid stocks with companies with single-B or C ratings, and generally prefer companies with investment grade balance sheets. This financial strength provides them the time to endure through their current struggle to emerge stronger later.
The market remains in Limbo-Land this week, as it has for several weeks now. The factors weighing on investors haven’t changed much, except that the issues (pandemic, election, lack of stimulus) are being felt slightly more acutely. With “nothing going on,” it’s a bit like a winner-take-all playoff game that is tied at about the halfway point, and there is now a long commercial break. There isn’t much to do right now, but a lot could happen soon.
It’s a time to check your investment positions, make sure you are not too over-extended or under-extended, look for new opportunities, think about the range of possible outcomes, and be ready to make a move.
And for goodness sakes, purge your own investment portfolio of any zombie stocks – especially now that it’s “spooky season” on Wall Street.
Editor’s Note: This post was excerpted from the latest issue of Cabot Undervalued Stocks Advisor.
Bruce has more than 25 years of value investing experience, managing institutional portfolios, mutual funds, and private client accounts. He has led two successful investment platform turnarounds, co-founded an investment management firm, and was principal of a $3 billion (AUM) employee-owned investment management company. Now he is helping his Cabot Undervalued Stocks Advisor readers find those undervalued stocks that let you buy low and sell high!Learn More >>