Top

Commodity Masters

  /  News   /  A huge number of ‘Zombie’ companies are drowning in debt. This CEO sees a reckoning as interest rates soar

A huge number of ‘Zombie’ companies are drowning in debt. This CEO sees a reckoning as interest rates soar

S&P 500

3,585.62

-54.85(-1.51%)

 

Dow 30

28,725.51

-500.10(-1.71%)

 

Nasdaq

10,575.62

-161.89(-1.51%)

 

Russell 2000

1,664.72

-10.21(-0.61%)

 

Crude Oil

79.74

-1.49(-1.83%)

 

Gold

1,668.30

-0.30(-0.02%)

 

Silver

19.01

+0.30(+1.62%)

 

EUR/USD

0.9801

-0.0018(-0.19%)

 

10-Yr Bond

3.8040

+0.0570(+1.52%)

 

GBP/USD

1.1166

+0.0043(+0.38%)

 

USD/JPY

144.7200

+0.2770(+0.19%)

 

BTC-USD

19,295.01

-31.81(-0.16%)

 

CMC Crypto 200

443.49

+0.06(+0.01%)

 

FTSE 100

6,893.81

+12.22(+0.18%)

 

Nikkei 225

25,937.21

-484.84(-1.83%)

 

Getty Images

Zombies are real. Well, at least “zombie companies” are real.

Loosely defined as economically unviable firms that need to borrow to stay alive, an era of cheap money and high-risk investing has fueled the rise of the walking dead in the business world over the past decade.

David Trainer, the CEO of the investment research firm New Constructs, believes there are now roughly 300 publicly-traded zombie companies.

And with interest rates soaring, money isn’t as cheap as it used to be, which means zombie companies are facing a reckoning that will affect both investors and the economy as a whole as recession fears mount.

“When economic reality hits these companies, and they do go to zero or close to it, which we’re going to see in spades, a lot of investors are going to get crushed,” Trainer told Fortune. “We’re going to see a potentially huge impact on consumer demand…there’s going to be a lot of people that are ticked off.”

What is a zombie company?

What exactly makes a zombie company, and how many there are in the U.S., is a matter of debate.

Goldman Sachs recently estimated that some 13% of U.S.-listed companies “could be considered” zombies, which it called “firms that haven’t produced enough profit to service their debts.”

But in a study last year, the Federal Reserve found that only roughly 10% of public firms were zombie companies in 2019 using slightly more rigorous criteria. And in an even more confusing turn,Deutsche Bank Strategist Jim Reid conducted a study in April 2021 that found that over 25% of U.S. companies were zombies in 2020.

For comparison, in the year 2000, only about 6% of U.S. firms were in the same situation, according to Reid’s findings.

Trainer, who has made his name with a few prescient predictions about zombie companies in recent years, also believes that the number of these failing firms in the U.S. has risen dramatically over the past few decades.

But he defines zombie companies using a more holistic method. In Trainer’s view, zombies are firms with less than two years of “lifeline” available based on their average free cash flow burn that also struggle to differentiate themselves from competitors, have poor margins, and lack options for future profitable growth.

“So there’s a very low likelihood that the cash burn is ever going to get better,” he said.

Trainer and his team have built a list of roughly 300 publicly-traded zombies that they closely track, and while most of them are smaller firms, some have been in the public eye of late.

Stocks like the online car retailer Carvanaand the once-high flying stationary bike maker Peloton made the list, along with the meme-stock favorites AMC and GameStop.

Carvana declined Fortune’s request for comment. AMC, Peloton, and GameStop did not immediately respond to requests for comment.

In Trainer’s view, many of these zombie companies will eventually see their stock prices drop to $0 as the market recognizes they can’t survive rising interest rates.

The Federal Reserve has raised rates five times this year to combat near 40-year high inflation, leading to soaring borrowing costs for corporations. That affects zombie companies, who are already struggling to pay their interest expenses, far more than most.

But while the potential downfall of zombie companies could be painful for investors and the economy in the short term, Trainer made the case that it won’t be the worst thing in the long run.

Instead, he argued it represents a necessary cleansing of the financial system.

The rise of zombies and their effects on the economy

How did this zombie invasion happen in the first place?

In the years following the Great Financial Crisis of 2008, central banks around the world were desperate to reignite economic growth and reduce unemployment. To do this, many decided to slash interest rates and institute other loose monetary policies designed to spur lending and investment.

It was the beginning of an era of “free money” that put cash in the hands of speculators, who quickly turned around and bought risky financial assets, sending them to new heights.

The S&P 500, for example, rose more than 545% between its post-GFC low in Feb. 2009 and its Nov. 2021 high. And over the same period, the average sales price of U.S. homes jumped nearly 110%, while cryptocurrencies transformed into a trillion-dollar-plus asset class.

The speculative era hit its peak in 2021, after stimulus checks fueled a boom in retail investing, according to Trainer. At the time, cryptocurrencies like Bitcoin were soaring, the IPO and SPAC markets were on fire, and meme stock traders were pushing zombie companies’ stocks like AMC and GameStop ever higher.

Trainer believes that this era of speculative investing increased the number of zombie companies in the U.S. dramatically, hurt productivity, and made the economy more vulnerable during recessions.

“I think, long term, zombies have caused a meaningful reduction in growth and prosperity,” he said. “Because effectively, what a zombie stock is, is a waste of capital. To the extent that the capital is wastefully employed in these businesses that have actually never produced any real economic value, we are losing the opportunity to invest that in more productive areas.”

Echoing Trainer’s comments, Deutsche Bank Strategist Jim Reid said last year that zombie companies weaken economies by minimizing the growth of firms in the industries in which they operate.

“The survival of zombie firms is likely a drag on productivity growth as these firms congest markets and divert credit, investment, and skills from flowing to more productive and successful firms,” he said in his 2021 study, referencing data from the BIS.

Trainer goes a step further than Reid, arguing that the survival of zombie companies is a threat to the U.S. in an increasingly competitive global economy.

“If we don’t have efficient and productive capital markets, we lose probably one of the biggest competitive advantages that we have as a country, which is our ability to allocate capital more efficiently and rapidly to its highest and best use,” he said. “And that’s part of the problem. People forgot that this is what the capital markets are about. They’re about allocating capital to its highest and best use, period, end of paragraph.”

The fall of the zombies and lessons for investors

The era of zombie companies may be coming to an end as interest rates rise, forcing unprofitable firms to burn more and more cash. But according to Trainer, the downfall of zombie companies will ultimately be beneficial for the economy and help teach younger investors who have lived through an era of speculative excess about the importance of risk management.

“There’s been an environment where people have grown up and they don’t understand risk. Take meme stocks for God’s sake,” Trainer said, referencing the Reddit favorite AMC. “You’re buying a movie company whose biggest competitor just went bankrupt…Then you see all of the competitive forces squeezing margins, and management is talking about buying a goldmine and how they’re going to sell popcorn at grocery stores? Yeah, I’m sure they’re gonna build a competitive advantage around popcorn.”

The CEO went on to make the case that the young investors who pumped zombie stocks during the pandemic would benefit from understanding the difference between speculating and investing, which was so eloquently laid out by Warren Buffett’s mentor, Benjamin Graham, in his 1949 book “The Intelligent Investor.”

Graham distinguished between investors, whose “primary interest lies in acquiring and holding suitable securities at suitable prices,” and speculators, who merely care about “anticipating and profiting from market fluctuations.”

He also warned, over 70 years ago, of the dangers of allowing speculation to run rampant in the stock market.

“The distinction between investment and speculation in common stocks has always been a useful one and its disappearance is a cause for concern. We have often said that Wall Street as an institution would be well advised to reinstate this distinction and to emphasize it in all its dealings with the public. Otherwise, the stock exchanges may someday be blamed for heavy speculative losses, which those who suffered them had not been properly warned against,” Graham wrote.

Trainer argues we are seeing the impact of ignoring Graham’s warning today with the rise (and coming fall) of zombie stocks.

This story was originally featured on Fortune.com

Advertisement

MarketWatch

Mortgage rates recently hit their highest level since 2007. Here’s what 5 economists and real estate pros say will happen next with rates

MarketWatch Picks has highlighted these products and services because we think readers will find them useful; the MarketWatch News staff is not involved in creating this content. Since the start of the year, mortgage rates have been trending upwards — and according to many experts, this trend will likely continue through October. Echoing that sentiment, Kate Wood, home expert at NerdWallet, says interest rates for 30-year fixed-rate loans appear to be staying over 6% and products like the 15-year fixed and the 5-year ARMs are averaging over 5%.

Bloomberg

Fed Begins to Split on the Need for Speed to Peak Rates

(Bloomberg) — Sign up for the New Economy Daily newsletter, follow us @economics and subscribe to our podcast.Most Read from BloombergGazprom Halts Gas Supplies to Italy in Latest Energy BattleMarjorie Taylor Greene’s Husband Files for Divorce After 27 YearsMacKenzie Scott Files for Divorce From Science Teacher HusbandWalmart, CVS Face Suits Blaming Common Painkiller for AutismTop Apple Executive Is Leaving After Making Crude Remarks in TikTok VideoFederal Reserve officials are starting to stak

Reuters

‘Evidence of a slowdown’: US consumers spurn big-ticket items like cars, couches, cruises

U.S. consumers are exhibiting fragility ahead of the peak period for corporate results next month, as some are struggling to pay bills and others are slowing purchases of cars, sneakers, and household goods, the week’s earnings show. Data released on Friday showed U.S. consumer spending increased more than expected in August, but aggressive interest rate hikes from the Federal Reserve as it battles stubbornly high inflation are slowing demand. Nike, maker of Air Jordan and Converse sneakers, saw its shares tumble to the lowest level in 2-1/2 years on Friday, a day after the company said it needed bigger discounts to clear a build-up of inventory.

Barrons.com

The Fed Is Starting to Break Things. The Stock Market Is Paying the Price.

The stock market desperately wants to put in a low. The Federal Reserve won’t let it. On the one hand, U.S. economic data remains strong, as jobless claims fell below 200,000 for the first time since May, a sign that the Fed will have to keep raising interest rates to slow down inflation.

The Wall Street Journal

Three Ways You Can Cash In on Cash

Keeping a portion of your portfolio safe and liquid no longer means settling for nothing—as long as you’re ready to move your money out of your bank account.

TheStreet.com

Why Royal Caribbean and Carnival Stock Will Recover

Yes, Carnival reported a bigger-than-expected loss but in this case, unlike taking a cruise, it’s the destination not the journey for the cruise lines.

Reuters

German court rejects investors’ damages claims against Porsche SE

BERLIN (Reuters) -A German court on Friday rejected claims by investors for billions of euros in damages over a failed attempt by Porsche SE to take over Volkswagen. Porsche SE’s Oct. 2008 notification, in which it declared that it had already secured almost three quarters of Volkswagen through purchases and option transactions, was not grossly misleading or false, Judge Matthias Wiese said in his ruling. Hedge funds and private investors accused Porsche’s management of concealing its true intentions prior to the Oct. 2008 announcement that made it clear it wanted to take control of the much larger Wolfsburg-based automaker.

Bloomberg

Runaway Bear Market Blows Past Everything Meant to Slow It Down

(Bloomberg) — Unwavering profit projections. Benign chart patterns. Big hedges in the options market. Most Read from BloombergGazprom Halts Gas Supplies to Italy in Latest Energy BattleMarjorie Taylor Greene’s Husband Files for Divorce After 27 YearsMacKenzie Scott Files for Divorce From Science Teacher HusbandWalmart, CVS Face Suits Blaming Common Painkiller for AutismTop Apple Executive Is Leaving After Making Crude Remarks in TikTok VideoAll the things that bulls expected to put a brake on t

Insider Monkey

Why These 10 Stocks Trended This Week

In this article, we will take a look at 10 stocks that trended this week. If you want to see some more stocks that made their way into the headlines this week, go directly to Why These 5 Stocks Trended This Week. It was another volatile week on Wall Street as the major indexes each […]

Reuters

EMERGING MARKETS-Latin American stocks, FX set to outperform EM peers

* Latam currencies up 0.1%; stocks add 1.1% * Investors confident Brazil to stay on course after vote * Polls suggest Lula will beat incumbent Bolsonaro on Oct. 2 * Latam stocks, FX set for slim quarterly gains By Bansari Mayur Kamdar Sept 30 (Reuters) – Currencies and stocks of resource-heavy Latin American countries are set for slim gains this quarter, outperforming their emerging market peers, while Brazil’s real slipped on Friday ahead of the country’s general elections. Regional currencies advanced 0.1% in early trading on Friday, and 0.2% for the quarter. “It’s a combination of higher commodity prices and also attractive interest rate carries in Latin America,” said Brendan McKenna, international economist and FX strategist at Wells Fargo Securities.

Post a Comment