“Zombie companies” may do little harm to the US economy

Too embarrassed to ask what is a zombie company?

Fears that the US is being overrun by corporate zombies may be exaggerated, says Alexandra Scaggs in Barron’s. Many analysts have argued that the US Federal Reserve’s decision to buy junk bonds (debt with a higher risk of default) during the crisis last year helped prop up companies that should have been allowed to fail. “Heavily indebted, cash-strapped firms” have been able to stagger on, “only surviving because of low interest rates”, say critics. Yet the data doesn’t necessarily suggest this is true.

The value of outstanding bonds from firms that don’t currently earn enough to cover their interest costs and aren’t early-stage growth businesses where profits should rise was $30bn at the end of 2020, down from $70bn in 2019, reckons Michael Puempel of Goldman Sachs. Much of the drop was due to struggling firms going bust, implying the pandemic wiped out old zombies rather than creating new ones.

Of course, today’s low rates might still be making firms that could not have covered their interest in 2019 look better, says Tracy Alloway on Bloomberg. But again that’s not obvious: just 17 US junk-bond issuers are expected to be less profitable in 2022 than in 2019, reckons Martin Fridson of Lehmann Livian Fridson Advisors. “It’s true that companies that look viable right now might not necessarily survive the next downturn,” concludes Alloway. But that doesn’t mean there’s harm in them getting a chance to turn things around.

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Cris Sholto Heaton is the contributing editor for MoneyWeek.

He is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is experienced in covering international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers.

He often writes about Asian equities, international income and global asset allocation.