How to Recognize the Growing Ranks of Zombie Companies – Barron’s

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With Halloween near, investors need to keep an eye out for zombies. The pandemic has boosted the number of zombie companiesunprofitable, cash-poor firms that rely on financial markets to cover their costsreports money manager Principal Global Investors. In the first quarter, Principal found 18% of companies in the Bloomberg Total Return Index couldnt cover interest costs with the previous years pretax earnings, up from a little more than 10% a year ago.

The zombie label first emerged in Japans Lost Decade from the early 1990s to early 2000s, when Japanese banks were pressured to extend loans to firms at low interest rates to keep them in business. The outbreak has since spread. A Bank for International Settlements study earlier this month said that global publicly traded zombie companies had risen from 4% in the late 1980s to 15% in 2017.

How do you identify a zombie firm? Principal Global offers a guide: companies that cant cover interest costs twice with the previous years pretax earnings; whose spread between return on equity and cost of equity is less than four percentage points; whose one-year and average three-year sales growth is less than 3%; and whose Altman Z-Scorea measure of liquidity, solvency, and profitability sometimes used to predict bankruptcyis below 1.8.

The risks arent easy to quantify. Only 25% of companies classified as zombies exited the market between 1980 and 2017, notes the BIS. Some were liquidated, others were acquired. In 2017, says the BIS, a recovered zombie faced a roughly 17% chance it would relapse in the next two-year period, compared to a 3% chance for firms that have never been among the living dead. Scary.

Alibaba Group Holding hosts a virtual Investor Day that continues through Wednesday. Speakers will include CEO Daniel Zhang.

The Federal Reserve Bank of Dallas releases its Texas Manufacturing Outlook survey for September. The consensus estimate is for an 8.3 reading, roughly even with the August figure.

IHS Markit, McCormick, and Micron Technology report earnings.

The first of three presidential debates between president Donald Trump and former vice president Joe Biden takes place at Case Western Reserve University in Cleveland.

The Conference Board releases its Consumer Confidence Index for September. Economists forecast a 90 reading, higher than Augusts 84.8. The postpandemic high for the index was 91.7 in July.

ADP releases its National Employment Report for September. The economy is expected to add 625,000 private-sector jobs, up from 428,000 in August. Since shedding almost 20 million jobs in March and April, 43% of that total, or 8.5 million jobs, have been regained, according to ADP.

The Bureau of Economic Analysis reports its final estimate for second-quarter gross domestic product. The economy is forecast to have shrunk at an annual rate 31.7%, which would be unchanged from the BEAs second estimate released in late August.

The National Association of Realtors releases its Pending Home Sales Index for August. Consensus estimate is for a 2.3% rise, a deceleration from Julys 5.9%. Home sales are in the midst of a V-shape recovery, with sellers seeing their homes going under contract in record time, according to Lawrence Yun, the NARs chief economist.

The Institute for Supply Management releases its Chicago Purchasing Managers Index for September. Economists forecast a 52.1 reading, slightly higher than Augusts 51.2.

Conagra Brands, Constellation Brands, and PepsiCo report quarterly results.

The BEA reports personal income and spending for August. Income is expected to decline 2.8% month over month, while consumption is seen rising 0.9%. This compares with gains of 0.4% and 1.9%, respectively, in July.

The Bureau of Labor Statistics releases the jobs report for September. Nonfarm payroll employment is expected to rise by 932,500, after Augusts 1.37 million gain. The headline unemployment rate is seen edging down to 8.2% from 8.4%.

Noble Energy holds a special shareholder meeting seeking approval for its proposed merger with Chevron, which would acquire all outstanding shares of Noble. The all-stock transaction, with an enterprise value of $13 billion, was first announced in late July.

Write to Alexandra Scaggs at alexandra.scaggs@barrons.com

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How to Recognize the Growing Ranks of Zombie Companies - Barron's

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