'Zombie Companies' Unable to Pay Interest Double in Two Years (Comprehensive)

Hankyung Research, Survey of 685 KOSPI-listed Companies: 20% Can't Even Pay Interest Despite Profits
Last Year's Bad Inventory Hits Record High of 100 Trillion Won
"Urgent Government Support Needed to Withstand Crisis"

[Asia Economy Reporter Changhwan Lee] Last year, the business conditions of Korean companies were revealed to be the worst ever. One out of five listed companies was a so-called marginal company that could not even cover interest expenses with operating profit. In particular, the number of zombie companies, which have been marginal companies for three consecutive years, doubled in two years.

Malignant inventory, which refers to products made but not properly sold, also increased to an all-time high. Due to the economic recession caused by the COVID-19 pandemic, the business situation this year is likely to worsen compared to last year.

On the 9th, the Korea Economic Research Institute (KERI) announced that, based on an analysis of the financial statements of 685 KOSPI-listed companies, 143 companies had an interest coverage ratio of less than 1 as of last year.

The interest coverage ratio is the figure obtained by dividing operating profit by interest expenses; a ratio less than 1 means the company is insolvent, unable to cover interest expenses with operating profit. The number of insolvent companies increased annually, with 94 in 2016 and 123 in 2018.

In terms of ratio, one out of five listed companies (20.9%) could not properly pay interest expenses with operating profit. Moreover, the number of zombie companies, which have failed to cover interest expenses with operating profit for three consecutive years, increased from 28 in 2017 to 57 last year, doubling in two years.

KERI analyzed that the reason for the increase in marginal companies is that while sales stagnated, operating profit significantly decreased, reducing profitability.

Last year, the sales of surveyed companies amounted to 1,152 trillion won, a 3.2% decrease from the previous year, and operating profit was 56 trillion won, down 50.1% from the previous year. The operating profit margin, which is the ratio of operating profit to sales, also dropped by about half from 9.4% in 2018 to 4.8% in 2019.

Malignant inventory also increased significantly as companies failed to sell products properly. The average inventory assets held by listed companies last year were about 100 trillion won, the highest ever recorded. KERI pointed out that the increase in inventory assets last year represents 'malignant inventory' accumulated due to unsold products and is a factor that reduces corporate cash holdings along with poor business performance.

The inventory turnover ratio, which indicates the speed at which inventory is converted into sales, was 11.5 times, decreasing for two consecutive years since 14.3 times in 2017, indicating an increased inventory burden on companies. The average number of days inventory assets take to convert into sales increased by about a week over two years, from 25.5 days in 2017 to 31.7 days last year.

Red flags have also appeared in companies' cash reserves. The cash assets of 685 listed companies decreased by about 10 trillion won from 142 trillion won in 2018 to 132 trillion won last year. Numerically, 355 companies (51.8%) saw a reduction in cash assets. The cash asset ratio, which is the proportion of cash holdings relative to total assets, also declined for three consecutive years from 9.3% in 2016 to 7.6% last year.

KERI analyzed that the decrease in cash assets of listed companies is due to a sharp decline in cash flow from operating activities. Cash flow from operating activities was 103 trillion won last year, a 26% decrease compared to 138 trillion won in 2018. Among 313 companies with reduced cash flow from operating activities, 133 recorded losses, accounting for 19.4% of all listed companies.

Due to insufficient cash flow, companies have relied on external financing for investments, increasing net borrowings that must be repaid. Net borrowings, calculated by subtracting cash assets from total borrowings, rose by 38.4% from 171 trillion won to 237 trillion won compared to the previous year. While borrowings increased, cash inflows decreased, intensifying companies' financial burdens.

The problem is that this business situation is likely to worsen this year. Due to COVID-19, South Korea's economic growth rate is expected to fall into negative territory for the first time since the 1998 foreign exchange crisis. There are calls for active government policies such as tax reductions and deregulation to help companies survive.

Choo Kwang-ho, Director of Economic Policy at KERI, said, "With the increase in chronic marginal companies, the number of companies pushed to the brink due to the COVID-19 economic crisis is expected to rise. Financial support is urgently needed to help companies at the crossroads of survival endure the crisis."

This content was produced with the assistance of AI translation services.