If you thought ghastly ghouls only came out at night, think again. Hordes of "zombies" are being bought and sold on the Australian Securities Exchange in broad daylight. I'm, of course, talking about ASX zombie companies.
What defines a 'zombie company' varies from person to person. Generally, a business that fits into this deteriorated state can barely pay the interest on its debts as they fall due. They might appear alive, but financially, it could already be turning.
A recent report from accounting firm KPMG points to a rapid increase in ASX shares showing zombie symptoms.
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How many undead companies are there now?
Just in time for the spooky season, analysts at KPMG have delivered a frightening report. Applying its solvency ranking system to ASX shares, the big four accounting firm uncovered 127 listed companies that meet the conditions of a zombie.
Based on KPMG's analysis, the number of ASX zombie companies making the financially ill list has grown 51% compared to six months ago. During this time, the interest rate set by the Reserve Bank of Australia has ticked up from 3.85% to 4.1%.
The swift uptick in zombified companies indicates higher interest rates are biting despite the cash rate plateauing over the past four months.
This could be due to more corporate debts beginning to roll over to higher rates, reduced market appetite for capital raisings, and inflation-fuelled pay increases chomping into the bottom line. In short, it's getting harder for an ASX zombie company to stay afloat.
Already walking a tightrope of existence, some of these companies could be facing a lethal blow next week when the RBA meets. Michele Bullock's hand may be forced next Tuesday as the RBA governor decides on whether to raise rates amid a series of unwelcomed economic data points.
All four of the big Aussie banks are in alignment, forecasting the cash rate to rise another 0.25% to 4.35% at the November meeting.
Protecting a portfolio from ASX zombie companies
Most investors will want to avoid a zombie in their portfolio if they can help it. After all, these companies can barely meet the bills, let alone reinvest for growth. That could mean sapping the life right out of your long-term returns.
Keeping zombies at arm's length doesn't need to be complicated. It's simply a function of profits and debt. If the company can generate profits that cover the interest on its debt with money to spare, then it's likely not a zombie.
A couple of quick-and-dirty checks include:
- Interest coverage ratio (earnings before interest and tax divided by interest expense): If this value is below 1, the company is not earning enough money to cover its debt obligations sustainably.
- Working capital (short-term assets minus short-term liabilities): If a company frequently has negative working capital, the business may not be viable.
Checking the balance sheet of an ASX company, zombie or not, is always a worthwhile endeavour.
