A rising number of underperforming “zombie firms” are creating a major drag on the UK economy and threaten to exacerbate a future downturn, says a new analysis by KPMG.
As many as one in seven UK firms are potentially “under sustained financial strain” and had been able to “stagger on” partly thanks to low interest rates, the accountancy firm warned. These struggling firms are crowding out healthy rivals, when under more normal economic circumstances they would probably have ceased trading.
In a report issued on Monday, KPMG warned that “the rise of zombie firms in the UK could spell trouble ahead”.
The authors said there were differing views as to what constituted such a firm, but that in their view it was a company where turnover was static or falling, profitability was persistently low, margins were being squeezed, cash and working capital reserves were limited, leverage levels were high, and there was a limited ability to invest for the future.
The authors looked at 21,000 UK companies, using information from their last three sets of annual accounts, and found that 8% of UK firms were displaying “zombie-like symptoms”. However, they added that based on the latest figures and other economic data, the proportion of such companies across the UK could be as high as 14%.
The highest concentrations of zombie firms were in the energy, automotive and utilities sectors.
In the energy sector, many firms will have been hit by the 2018 oil price slump, while carmakers and utility firms were facing fierce competition from start-ups and technological developments.
KPMG argued that in previous recessions, businesses that were not productive enough would have ceased trading, thereby eventually making way for “new dynamic companies” and ensuring capital was invested in high-growth businesses.
Construction group Carillion is a high-profile example of a UK firm that is said to have been in financial difficulty for several years prior to its collapse in January 2018, but which had managed to limp on, taking on contracts that could have gone to its financially healthier competitors during those years.
On 2 May, Bank of England governor Mark Carney warned that a modest recovery over the next three years would warrant higher interest rates than financial markets were currently anticipating.
KPMG said if interest rates were to rise further, some of these businesses might soon find their loans more difficult to repay, and if the economy continued to stutter, they would be left especially vulnerable to adverse market forces or a tightening of liquidity.
Yael Selfin, KPMG’s chief economist, said: “The threat that zombie companies pose to the wider economy is very real, regardless of what the post-Brexit environment looks like. Many unproductive businesses have been able to stumble on in recent times, generating just enough profits to continue trading but without the innovation, dynamism or investment necessary to sustain bottom-line growth. This has [created], and will continue to create, a drag on UK productivity.”
Britain’s productivity has been persistently poor since the financial crisis, and is about 16% below the average for advanced G7 economies. Business investment has been falling for the past year, according to the Bank of England, which predicts muted productivity growth in the near term.
Of the 21,000 private companies analysed by KPMG, 60% were said to display one or more of the symptoms associated with such underperforming firms, while 8% displayed three or more.
Blair Nimmo, head of restructuring at the firm, said that in the event of a liquidity squeeze, many of these businesses would fail. If that happened, “the potential for contagion is very real, creating broader challenges for an economy already struggling to deal with a plethora of issues”.
Others define a zombie firm as one that has been around for several years but is unable to cover its debt-servicing costs with its profits – a definition that, looking at well-known companies, could arguably be applied to firms such as Tesla, which recently announced it had lost $702m (£534m) in the first three months of the year and ended the quarter with about $10bn in debts.