The coronavirus pandemic has caused widespread disruption across the length and breadth of the global economy. Few industries have been immune to its impact, though some have suffered worse than others.
Perhaps unsurprisingly, companies that were already ailing before the outbreak were especially vulnerable, including a multitude of highly leveraged companies that had already found it increasingly difficult to cover their debt payment obligations even with business running normally. I warned about such "zombie companies" in a GuruFocus article early this year, highlighting the potential danger of a corporate debt time bomb going off. As the Covid-19 crisis has dragged on, the dangers have only intensified.
More companies catch the zombie virus
Years of increasing corporate leverage and lower quality debt issuances have put the corporate credit market on increasingly precarious footing. These conditions have only worsened over the course of 2020.
On Nov. 17, Bloomberg published a startling report on the state of US corporate debt. According to Bloomberg, more companies than ever now suffer from the debt zombie virus:
"Almost 200 corporations have joined the ranks of so-called zombie firms since the onset of the pandemic, according to a Bloomberg analysis of financial data from 3,000 of the country's largest publicly-traded companies. In fact, zombies now account for nearly 20% of those firms. Even more stark, they've added almost $1 trillion of debt to their balance sheets in the span, bringing total obligations to $1.36 trillion. That's more than double the roughly $500 billion zombie companies owed at the peak of the financial crisis."
Companies that were already unable to cover their existing liabilities have flooded the corporate bond market with new debt issuances on a truly unprecedented scale. As a result, there has not only been a proliferation of zombie companies, but also intensified investor exposure to their virulent debt.
Companies go from zombie to vampire
Zombie companies are not the only scary things shambling through capital markets. Indeed, there is now a frightening proliferation of companies with negative earnings before interest, taxes, depreciation and amortization, or Ebitda, as Bloomberg reported on Dec. 3:
"In the latest quarter, the number of junk-rated corporations that borrow in U.S. dollars and lost money before paying interest and other required expenses, known as having negative Ebitda, reached an eye-popping 47, according to a Bloomberg Intelligence analysis. That's nearly double the level in the second quarter, out of a universe of about 600 borrowers. These companies are doing worse than many other zombies, or corporations that have losses after covering interest expenses. In this case, the businesses are losing money even before servicing their debt."
Whereas a zombie company is a firm that cannot cover its debt payments through cash flow generated from regular operations, these even more troubled businesses cannot even break even when interest, depreciation and amortization expenses are added back in. Among the ranks of these unfortunate companies include such established names as Carnival Corp. (CCL, Financial) and Delta Airlines Inc. (DAL, Financial)
These companies are reliant on fresh injections of capital to sustain their fundamentally unprofitable operations. This fact led Zero Hedge on Dec. 3 to christen such businesses "vampires."
My verdict
Exactly one year ago today, legendary bond investor Jeffrey Gundlach issued a chilling warning to investors, admonishing them to give corporate debt a wide berth:
"Corporate bond exposure should be at absolute minimum levels right now."
Based on the rampant growth in the number of zombie companies in the marketplace, as well as the emergence of the even more worrying negative-Ebitda vampires, Gundlach's advice seems sounder than ever.
Unfortunately, the desperate hunt for yield in a zero interest rate market environment has pushed a huge amount of investment capital into the bonds of these zombies and vampires. As such, a lot of institutional capital is now exposed to this virulent debt.
In my assessment, investors would be wise to get out of this particular haunted house as soon as possible and avoid further contagion at all costs.
Disclosure: No positions.
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