The Zombie Companies have been living for some time. They were meant to be dead by now, troubled by a volatile pricing and growth environment with interest rates the potential final dagger. But none of this has proven to be enough to take them down. In fact, the number of Zombies has slowly declined from the Covid induced peak. That is – until recently. Now, there appears to a shift in the trend sideways to slightly higher. The question is whether this is a harbinger of an emerging sinister change in trajectory or something benign.
That is a difficult one to parse. Zombies have survived higher rates the past several years without much of a threat to broader markets. Their ability to survive higher rates comes as a bit of a shocker. After all, interest expense is something investors tend to “look through” or completely ignore in large cap investing (at least until the hyperscalers started hyperscaling their debt loads). For smaller companies, interest expenses are an increasing burden to income statements. This should be a significant stress to their viability. But the companies have adjusted and continue to survive.
And not simply surviving – thriving. The Zombies have outperformed their healthy counterparts for the year by a wide margin. That should be taken as a signal for investors. Yes, they the Zombies are risky. But when markets are in rally mode, they provide a significant source of upside and potential outperformance. Notably, they have dramatically outperformed the larger companies on a return basis as well.
So, what does this mean for the future of the Zombies? If elevated interest rates and a volatile inflation picture (from inputs to labor costs) could not break them, it is difficult to see what the kill shot will be. In fact, there is a case to be made that further advances in efficiency stemming from AI could be more beneficial for some of the Zombies than other companies. That will take time to materialize, but that is a narrative that should not be set aside. The Zombies are always searching for a antidote. Maybe they have found one.