Experts estimate the number of zombie companies in Russia for the first time

NKR and Rescore experts estimate the number of Russian companies, almost all of whose profits go to debt service Experts of the NKR rating agency, together with Rescore, for the first time calculated how many zombie companies in RUSSIA are businesses that barely have enough profit to service their debts. it turned out,

At the end of the pandemic 2020, 7.7% of Russian companies operated in zombie mode, according to experts from the National Credit Ratings agency (NKR, part of the RBC group) and the Rescore counterparty scoring system. This is much more than in 2016-2019, when the share of such companies was about 3%, follows from the study.

The study sample included almost 77,000 enterprises reporting under Russian accounting standards (RAS) for 2016–2020. To be included in the sample, the company's revenue had to be at least 100 million rubles. for 2020 and be non-zero every year since 2015. Earlier, RBC wrote that more than a quarter of legal entities from the base of the Federal Tax Service reported zero revenue - for the most part, these are companies that are no longer functioning or not yet functioning.

The total revenue of zombie companies in 2020 amounted to 6.7 trillion rubles, the authors of the study calculated.

Who are zombie companies

The concept of a “zombie company” has long been used by Western economists: initially, in the era of the “lost decade” in Japan in the 1990s, this was the name given to local corporations that generated cash that was only enough to service debts. American economists estimated that until 1993 the share of zombie companies in Japan ranged from 5 to 15%, and then jumped to 25% and above. Each new crisis, including the global financial and economic crisis of 2008 and the pandemic recession that has not yet ended, brought back the urgency of the problem of zombie companies.

In the U.S. in 2019, approximately 7% of public companies and 4.5% of private companies were classified as "zombies," according to a Federal Reserve (Fed) survey last year. According to her, the share of zombie companies is closely correlated with business cycles in the economy and the dynamics of individual sectors (for example, the decline in the US oil and gas sector, which began in 2014).

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As part of the study by NCR and Rescore, Russian companies were classified as “zombies”, which for at least two years in a row show an interest coverage ratio of no more than one. In other words, their annual earnings before interest and taxes (EBIT) are less than or equal to the interest expense on debt. Accordingly, companies formally recognized as zombies at the end of 2020 showed such a ratio of EBIT and debt service costs at least in 2019-2020. This approach is consistent with the BIS methodology (.pdf), although BIS also adds a second criterion: the Tobin ratio (the ratio of a company's market value to the sum of the costs required to acquire all of its assets at current prices) must be below the sector median - also two years in a row.

How the number of zombies increased during the pandemic

The number of zombie companies in the sample almost tripled in five years, from 2,110 in 2016 to 5,920 in 2020. A significant increase in the share of such companies - from 2.9% in 2019 to 7.7% in 2020 - is primarily due to the impact of the covid-19 pandemic , comments Vladimir Buev, DIRECTOR General of the National Institute for Systemic Research on Entrepreneurial Issues. “In 2020, businesses, especially small ones, did not look to the future and used a survival strategy, that is, in the face of shrinking demand and declining profits, they took out loans to replenish working capital and pay salaries in order to continue working,” he explains. But for the most part it was impossible to close such companies, because they provide at least some opportunities for life.

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According to the NKR, small businesses with revenues of 100-300 million rubles. make up the bulk of zombie companies: in 2020, their share reached a record 64% of the total number of zombie companies (the minimum was recorded in 2018 at 43%). Small companies in Russia tend to be less profitable, and besides, lending rates for them are usually higher than for large companies, the authors of the study explain.

In the regional context, there are no significant differences in the share of zombie companies, it follows from the data of the NKR and Rescore. But very significant differences are observed in the sectoral context. Thus, the largest number of zombie companies at the end of 2020 is in the field of trade (42%). In construction and real estate management, 8 and 7% of legal entities, respectively, are classified as zombies. This is natural, says Pavel Mitrofanov, CEO of Expert Business Solutions. “Trading is an area that lives “from wheels”, directing all liquidity into turnover, rent and wages. It is characterized by low margins and a situation where there is only enough money to make ends meet,” explains Mitrofanov.

Which companies fall into the number of zombies for formal reasons

In an ideal world, if a zombie company is isolated (not part of a group of companies), with an interest coverage ratio below one unit, its operating income is not enough to cover debt costs, and the deficit has to be replenished through external injections - refinancing with new loans, contributions owners, government support. In particular, the functioning of zombie companies depends on the possibility of obtaining cheap loans, and the growth of the key rate of the Central Bank, which affects the cost of attracting loans, threatens the existence of zombies. There are banks that, in pursuit of maintaining the volume of the loan portfolio and their own interest income, can endlessly refinance the debts of any borrowers, ignoring signs of deterioration in their financial condition, the authors of the study argue.

A methodological shortcoming (not dependent on NKR and Rescore) is that the study was conducted on the basis of unconsolidated financial statements under RAS, that is, some companies may be part of a corporate group (holding) and be formally classified as zombies, but this does not indicate their problems, but is simply a consequence of the internal structure and distribution of financial flows. For example, one company may be a center for attracting borrowed funds, while the main profit of the holding may be concentrated in other enterprises. In some cases, this may hide an illegal tax evasion scheme, when one of the enterprises is used as a "loss center", generating bad debts.

It is impossible to assess, without special analysis, whether a company is an isolated company or part of a group, according to RAS. According to NCR estimates, only about 200 companies in Russia prepare consolidated financial statements in accordance with IFRS, which is not a representative sample for this study. The authors proceeded from the assumption that the share of zombie companies, which are such simply due to the financial structure of the group, should not fluctuate much, respectively, the presented dynamics should be quite reliable.

“Since the error from the influence of holdings is large, you must first clean out all parts of the groups of large holdings from the analysis, and after all, the main part of the economy is huge holdings with consolidated reporting, with their own profit and loss centers and relatively free flow of liquidity,” Mitrofanov emphasizes. Inside the holdings, they do not closely monitor the reliability of Russian reporting in terms of long-term goals and conclusions, where the result for taxation is more important. “Companies, especially trading companies, can manage the effective level of their taxation, so a marginal result with a small plus may even be beneficial for them,” he adds.

Larisa Loznova, HEAD of International Non-Financial Companies Ratings Practice at ACRA, agrees that companies tend to manipulate margins and this is difficult to track correctly in non-consolidated financial statements. “For example, in construction (the second largest share of zombie companies in the industry in the study. -) each project represents a separate legal entity, so many companies were included in the sample. At the same time, developers tend to manipulate margins between individual projects and concentrate profits on the parent company, leaving only funds to cover costs on the legal entity-developer. Hence the large number of so-called zombies, ”she argues.

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Perspectives for future research

NCR and Rescore will conduct an additional assessment of the change in the number of zombie companies after receiving company reports for 2021, however, they do not expect a significant improvement in the situation due to a rather short recovery period in 2021. The increased share of zombie companies by the beginning of 2022 “will become an additional negative factor for the Russian economy” in addition to sanctions pressure, the authors argue.

The cost of credit resources in the Russian economy as a whole increased with the current level of the key rate of 17% per annum. The Ministry of Finance and the Ministry of Economic Development predict that the decline in real GDP in 2022 will be about 10%. Economists surveyed by the Bank of Russia expect, on average, that unemployment will rise to 6.9% by the end of 2022, while exports of goods and services will fall by 12%. Some companies from the current sample may remove their statements from public access due to sanctions risks (this is allowed by the March government decree).