Zombie Companies Littering Europe May Tie the ECB's Hands for YearsBy
BofA says 9% of European firms have subpar interest coverage
ECB policy normalization constrained by corporate debt fears
Watch out for the zombies.
The plethora of companies propped up by the European Central Bank will limit policy makers’ ability to withdraw monetary stimulus that’s been supporting the continent’s bond market since the financial crisis, according to strategists at Bank of America Corp. About 9 percent of Europe’s biggest companies could be classified as the walking dead, companies that risk collapse if the support dries up, according to the analysts.
After the crash of Lehman Brothers sent global markets into a tailspin, a decade of easy-money policies gave breathing room for nations to get their balance sheets in check and allowed for a spirited revival in corporate profits. But as central bankers look to pull back stimulus for fear of overheating, the potentially grim outlook for vulnerable companies may give them pause, according to Bank of America.
“Monetary support in Europe over the last five years has allowed companies with weak profitability to continue to refinance their debt and stave off defaults,” analysts led by Barnaby Martin wrote in a note Monday. “This supports the point that our economists have been making: that the ECB will likely be very slow and patient in removing their extraordinary stimulus over the next year and a half.”
The strategists classify zombies as non-financial companies in the Euro Stoxx 600 with interest-coverage ratios -- earnings relative to interest expenses -- at 1 or less. The thinking goes that companies in this category are particularly vulnerable to rising interest rates.
About 6 percent of European companies had a coverage ratio of less than 1 on the eve of Lehman’s downfall, a percentage that fell to as low as 5 percent in 2013 when the euro-area sovereign debt crisis cooled. Zombies shot up to as high as 11 percent in June 2016 before easing in recent months.
Energy companies, thanks to weak oil prices, and those based in southern Europe -- particularly smaller firms faced with weak profit generation amid feeble growth -- make up a disproportionate share of the zombie world, according to Bank of America.
To be sure, different metrics tell different stories about the health of corporate leverage, with some investors citing growth projections and yardsticks like net debt to earnings as reasons bond buyers can be more sanguine. But the coverage ratio is particularly useful in projecting how companies can cover debt costs from their earnings as interest costs rise.
Companies with coverage ratios of less than 1 include the Italian broadcaster Mediaset SpA, the Swedish energy company Lundin Petroleum AB, French advertising firm Publicis Groupe SA and Netherlands-based media group Altice NV, according to data compiled by Bloomberg.
The ECB’s dovish tone last week -- pushing back the timing for a decision on the future of its bond-buying program until possibly October -- confirms it will embark on a gradual pace of tightening in order to juice the economic recovery, according to Bank of America. It reckons the ECB’s taper will start in January 2018, with the first increase to the deposit rate projected in the spring of 2019, compared with consensus expectations for a hike in October 2018, according to overnight index swap contracts compiled by Bloomberg.
Similar studies confirm zombie firms litter the landscape across developed markets, and place the blame squarely on loose monetary policy. Last month, the Bank for International Settlements calculated businesses more than 10 years old whose earnings don’t cover interest expenses represent almost 10.5 percent of publicly listed companies across 13 advanced economies, compared with less than 6 percent pre-crisis.
The Organization for Economic Cooperation and Development warns that zombie firms drive down productivity as capital and labor are misallocated across the economy.
Still, the ECB risks a big backlash if it were to tighten policy prematurely. Allowing a “credit tantrum to take hold would only pressure corporate interest costs again, and risk a rise of the zombie,” Bank of America strategists conclude.