New analysis from KPMG UK finds the rising prominence of so-called ‘zombie firms’ – companies under sustained financial strain - is threatening to cause a significant drag-effect on the UK economy.
‘Zombies’ are a major drag on the UK economy – KPMG analysis
A look at the last three annual accounts of listed UK companies (FTSE and AIM) reveals that 8% of UK companies currently display zombie-like symptoms. But based on the latest data from 2018, and taking account of the recent increase in BoE interest rates, the share of zombie companies spanning the whole of UK plc could be as high as 14%.
KPMG’s analysis also focused on the prevalence of zombie firms by sector, highlighting the high risk of contagion for lenders exposed to the worst-affected industries.
Through a detailed look into publicly traded accounts, it found that the highest concentration of zombie firms is in the energy (23%), automotive (17%) and utilities (15%) sectors. The fact that almost a quarter of energy businesses show zombie symptoms highlights the long investment horizon of the industry and is somewhat explained by the oil market only recently emerging from a significant downturn. While the automotive and utilities sectors face substantial levels of disruption as incumbent industry leaders face fierce competition from new technologies, trends and innovative start-ups.
[Note on Chart 1: ‘Wide definition’ classifies a company as zombie if its Interest Coverage Ratio was less than one in the last three years and the company was older than ten years; ‘narrow definition’ added a third requirement that the company had its Tobin’s Q lower than the median for the sector, pointing to relatively low growth expectations.]
Yael Selfin, Chief Economist at KPMG in the UK, said: “The threat that zombie companies pose to the wider economy is very real, regardless of what the post-Brexit environment looks like. Many unproductive businesses have been able to stumble on in recent times, generating just enough profits to continue trading but without the innovation, dynamism or investment necessary to sustain bottom-line growth. This has, and will continue to, create a drag on UK productivity, which continues to lag our peers in the G7 and much of Europe.
“If interest rates rise further, highly-leveraged businesses may soon find that borrowing will become more difficult to repay, and if the economy continues to stutter, these businesses will be left especially vulnerable to adverse market forces or a tightening of liquidity – as will the lenders they rely on.”
Of the circa 21,000 private companies that KPMG analysed, 60% display one or more of the symptoms associated with zombies, while just 8% display three or more. The worst affected industries are travel and leisure (12%), real estate (11%), financial services (10%) and professional services (10%).
A number of wider-economic factors are causing this; travel and leisure businesses are being hit by reduced discretionary consumer spending appetite; retail landlords are finding income and asset value pressure due to the demise of high-street names; financial and professional services companies are being impacted by on-going economic uncertainty.
Blair Nimmo, Head of Restructuring at KPMG in the UK, commented: “For the past decade, zombies have been allowed to sleep walk largely undisturbed, thanks to an extraordinary monetary and political environment, coupled with lenders exhibiting greater creditor forbearance to struggling companies in their portfolios.
“The uncomfortable truth, however, is this environment is unlikely to persist indefinitely. In the event of a liquidity squeeze, many of these underperforming businesses would fail – and if this happens, the potential for contagion is very real, creating broader challenges for an economy already struggling to deal with a plethora of issues."
“The good news is that prognosis doesn’t have to be terminal – but, as with many things in life, acting sooner rather than later provides more options and can improve the chances of recovery. Urgent dialogue is required between regulators, banks and businesses in order to minimise the ongoing drag that these companies have on the economy, and to mitigate against potential risks in the event of an economic downturn.”