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Datawatch

Asia's 'zombies' concentrated in India, Indonesia and South Korea

Debt-laden companies kept alive by easy credit have doubled in decade

Asia has not been insulated from the risk of surging corporate debt. 

TOKYO -- Zombie companies, or corporate underachievers overdosed on cheap credit, are proliferating across the globe, threatening to derail the weakening world economy.

Worldwide, the number of companies that do not generate sufficient profits to cover their interest payments and survive only by repeatedly refinancing their loans has doubled in a decade to constitute a fifth of all corporations, Nikkei research shows.

Readily available low-cost debt financing helps keep highly indebted, poor-performing companies alive that would have otherwise gone under.

Things could become even worse, as the U.S. Federal Reserve has cut interest rates for the first time in 10 and a half years, prompting many other central banks to follow suit and ease their monetary policies.

The ranks of zombies have grown especially fast in the U.S., Europe and some countries in Asia.

Nikkei examined the financial health of about 26,000 listed companies in Japan, the U.S., Europe, China and Asia, excluding financial institutions, using data from QUICK FactSet. The findings are ominous. The number unable to cover debt-servicing costs from operating profits for at least three consecutive years hit about 5,300 in fiscal 2018, accounting for 20% of the total, compared to 14% of the total of 18,000 listed companies in 2008.

In Asia, where debt has risen markedly over the past several years, India is the leader with 617 zombie companies in 2018, followed by China with 431, South Korea with 371 and Taiwan with 327. In Japan, the number of zombie companies is relatively low at 109 because Japanese companies tend to have low debt levels.

The ratio of zombie companies has risen especially fast in India, Indonesia and South Korea. They accounted for 26% of the total in India, up 13 points from a decade earlier; 24% in Indonesia, up 11 points; and 18% in South Korea, up 4 points.

In India, many power companies of major conglomerates have loaded up on debt, including Adani Power, a member of Adani Group, and Reliance Power, a unit of Reliance ADA Group.

Similarly, in South Korea, a number of companies belonging to such leading conglomerates as Samsung and Hyundai have become zombies.

The figure for China, however, rose only 1 point to 11%, while the figure for Japan dipped to 3.3% due to the fact that many Japanese companies are debt-shy and inclined to build up cash reserves.

Nevertheless, in China the ratio of zombie companies is particularly high in the retail sector at 20%. Notably over-borrowed Chinese groups in this industry include e-commerce player JD.com and Suning.com, which operates a nationwide chain of consumer electronics stores.

Europe has the largest number of zombie companies with 1,439. The U.S. is second with 923 companies. This apparently reflects the financial environment, in which it is easier to issue corporate bonds even with low ratings.

The ratio of excessively indebted companies is especially high in the medical, pharmaceutical, nonferrous metals, energy and information technology industries.

U.S. IT group Dell Technologies, for instance, piled on debt to finance its acquisition of EMC in 2016 and has been unable to earn enough operating profit to cover interest payments.

Genesis Healthcare, which mainly provides rehabilitation services for elderly patients, has saddled itself with so much debt through a flurry of acquisitions as to remain in a zombie state since fiscal 2014.

After the global financial crisis broke out in 2008, central banks around the world began aggressively printing money to restore high growth.

Easy credit started sloshing around in the world, eroding corporate financial discipline. Corporate spending has been outpacing revenue for as long as eight straight years.

In fiscal 2018, the global total of operating cash flows -- cash earned by companies through business operations -- hit a record $5.7 trillion. But the total of investment cash flows, or money spent on facilities and equipment and on mergers and acquisitions, plus cash returned to investors through dividends and share buybacks, was even bigger at $6.6 trillion.

While investment cash flows are showing signs of flattening out amid slowing global growth, companies are returning far more of their profits to shareholders through share buybacks and other means.

The gap between spending and revenue has caused the corporate debt burden to grow. The amount of interest-bearing corporate debt reached $22 trillion in fiscal 2018, almost double the level a decade earlier.

Extremely low interest rates in most major countries have not just made financial institutions and investors more willing to finance junk-rated companies but also pushed up corporate debt to dangerously high levels.

While the ratio of interest payments to debt stood at 3.9% in fiscal 2018, down about 1 point from a decade earlier, the actual amount of interest payments grew 40% to $800 billion due to sharply increased indebtedness. This borrowing dynamic explains the rise of zombie companies.

Aggressive corporate investment, fueled by strong economic growth, has made some healthy companies look like zombies in numbers. But they are exceptions rather than the rule.

The average revenue growth rate among financially healthy companies over the three years to fiscal 2018 was 22%. Only about 20% of the zombies outperformed the rate.

The rise in the number of zombie companies indicates that free market forces supposed to drive out losers have weakened, impairing the health of the corporate sector.

If earnings deteriorate due to the economic slowdown, zombies will struggle to bear the interest burden. Even if interest rates are held down overall through monetary easing, borrowing costs for financially frail companies could rise, leading to a series of corporate failures. This adds to the risks facing the world economy.

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