Zombie companies: how to avoid getting caught

You don’t have to be a die-hard fan of horror movies to know that a zombie is not someone you want to get up close and personal with. In this late- to post-pandemic world, there is a lot of talk about zombie companies and the effect they may have on the economy. But what are zombie companies exactly, and how can you tell whether you might be getting too cosy with one?

As Head of Claims & Collections for Allianz Trade’ World Agency – out team dedicated to multinationals, I invest a lot of time in helping our largest, multinational clients to spot red flags in potential business partners and avoid credit risk. Here are my key tips for identifying this particular potential carrier of bad debt.

What is a zombie company?

Soon after the pandemic hit in 2020, governments across the world provided support schemes to help companies through the overnight disruption in trade. At the same time, states lifted obligations to file for insolvency even if a company couldn’t pay its creditors. Viable businesses suffering from temporary problems, such as the closure of non-essential stores, received much-needed funds to see them through until Covid-related restrictions were eased. However, the schemes also provided financial help for companies that would not be able to recover from the pandemic or would otherwise naturally have become insolvent due to changing consumer patterns and other factors. Now that global markets are rebuilding and state support schemes are coming to an end, we may soon see mass insolvencies from so-called “zombie companies”.

A zombie company is a business that generates cash, but is so indebted that it can only pay off its fixed costs and interests, and not the debt itself. In the context of Covid-19, we’re seeing fragile businesses accumulating more and more debt thanks to ongoing low interest rates on loans. Even though these companies are technically still trading, it’s not enough to cover their debt once it has to be paid back and in reality, they’re already insolvent.

Identifying a potential zombie takes expert risk assessment, but there are a few simple warning signs to look out for. Beware if:

• The company can’t cover its interest costs twice over with the last year’s earnings before taxes

• Its one-year and average three-year sales growth is less than 3%

• Its vision relies on outdated products or distribution channels

Bracing for a boom in insolvencies

In a normal capitalist economy, healthy competition results in a steady and predictable flow of bankruptcies. Businesses that sell goods or services that not enough people are willing to spend money on will give way to those with stronger business models. State support schemes temporarily put a stop to this. My office is currently seeing about 50% fewer claims relating to insolvencies compared to the same period in 2019.

In the next couple of months, we’ll see the phasing out of the last remaining state support schemes. Additionally, the same period is set for huge pressure on pricing across the globe. Prices of commodities are being driven up, which creates additional insolvency risk for companies that may not be able to swiftly recalculate the rising prices to their end products. This will create a new stress test, especially for companies that are already in a poor financial state.

We expect that from the beginning of 2022, there will be a correction, with a higher-than-normal level of insolvencies: the regular amount to be expected, as well as those from zombie firms struggling without government support.

Dawn of the unindebted

The difficulty in credit intelligence, especially in today’s context, is to assess which companies are likely to survive and which will fail. The safest way to mitigate credit risk and avoid bad debt is to rely on the limits that your trade credit insurer is providing. At Allianz Trade, we leverage data from our global client base to give the most thorough risk assessments and provide cover based on our unmatched knowledge of global markets.

To find out how we can help you company, find us in your country and contact our local teams.