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Zombie companies and other horror stories for the economy

Using some very forgettable movies as illustrations, this analyst shows just how deeply the current financial crisis has cut into the economy.

If you’re looking for a way to illustrate the problems in the economy and the markets, movies are a great place to start. That’s the word we get from a man who’s an expert on the markets, and an unrepentant film buff.

Mr. Raymond DeVoe, a market strategist for a securities firm in New York, brings us his rather unique perspective in the DeVoe Report.

Ranging from movies to markets, this analyst arrives at some very telling observations on just how the problems spreading through the economy are coming home to roost.

He starts with two movies that will be better remembered for their colourful titles than for their artistic merit.

Snakes and strippers

If you did not see “Snakes on a Plane,” you didn’t miss much, says Mr. DeVoe. The title may have been better than the film, “but the plot reminded me of the ‘subprime’ problem,” he adds. “Once the snakes got loose in the cargo bay, it was impossible to ‘contain’ them there.”

A New York Post review recently stated that the best title since that forgettable film came out is “Zombie Strippers.” Mr. DeVoe was less interested in the movie itself than in the news that its star “actress,” director and producer is the first recorded multibillionaire among pornographic filmmakers.

This edifying news came on the same day the New York Times had these headlines: “Workers Get Fewer Hours, Deepening the Downturn,” and “Across Globe, Empty Bellies Bring Rising Anger.”

That may give us a broad perspective (pun not really intended) on the disparities in the world, but the word “zombie” leads the analyst to a more specific problem — “undead” companies.

Zombies or vampires?

Mr. DeVoe objects to the Japanese term “Zombie Companies,” which refers to “companies that are essentially dead, but kept alive by regular infusions of capital by banks who do not want to acknowledge their losses and write off the loans,” he explains. “I contend that they should be better known as ‘Vampire Companies,’ requiring transfusions of blood regularly.”

One of these was featured in the Times’ “Workers Get Fewer Hours” article. The Ludowici Roof Tile Company in eastern Ohio has been eliminating overtime and cutting back on the hours worked by employees in order to keep its workers on the job.

“One worker is cited whose weekly take-home pay has fallen from $600 to $450 recently,” says the analyst. This has a ripple affect on the local economy, as less is spent on all but the necessities.

The stealth force

These factory workers are suffering from rising financial distress, reports Mr. DeVoe, as real average earnings slipped for six consecutive months. Their access to credit is increasingly limited as lending standards tighten up and the equity in their homes can no longer serve as “an automatic teller machine.”

Add the spectre of inflation, “which in my opinion is running at substantially higher levels than the Consumer Price Index and the dimensions of the squeeze on declining paychecks becomes more visible.”

Mr. DeVoe then quotes the Times directly. “The gradual erosion of the paycheck has been a stealth force driving the American economic downturn. Most of the attention has been focused on the loss of jobs and the risk of layoffs. But the less noticeable shrinking of hours and pay for millions of workers around the country appear to be a bigger contributor to the decline.”

This development is scarcely confined to eastern Ohio, or to the United States. If Ontario, for example, is to become a “have-not” province in the next two years, as one well-known report has claimed, the same “stealthy” erosion is liable to take place. The one difference is that more equity remains in Canadian homes than in American ones. So far.

But there is one more “stealth” factor that the analyst feels is often overlooked.

The red flag

One last point in the Times article caught Mr. DeVoe’s eye. Ludowici’s unsold inventory was beginning to soar. As hours were cut back and sales fell, the company kept producing, building up stocks of tiles it hoped to be able to sell eventually.

As the plant manager commented, “the philosophy around here is we remain hopeful that things are going to get better.”

Mr. DeVoe replies: “As I have said in relation to the stock market — hope and prayer are two of the poorest investment strategies, and that applies to business decisions as well.”

As a security analyst, he adds, he has always looked for signs of companies starting to run into difficulty. “A sharp buildup in inventories is always a red flag, followed by rapidly rising accounts payable, debt and interest expenses.” In good times it’s a warning sign, and in bad times it can spell disaster.

“The cost of carrying the unsold products would be the first strain on a company’s financial condition,” states Mr. DeVoe. “The next would come when the inventories are dumped on the market, frequently at reduced prices, resulting in lower realizations or even losses on the products.”

(You may recall that when push came to shove, Nortel was stuck with warehouses full of unsold stuff — although it rather imprudently decided to declare its idle inventory as revenue.)

Hope that things will get better can soon turn to grim reality if economic conditions do not improve rapidly, says Mr. DeVoe. “Production is lowered closer to levels matching incoming orders, or frequently further than that, and employment is cut to match current production.” Less money is spent, the economy constricts further and a vicious circle is set in motion.

The message is clear — the stock market alone does not tell the story. Investors should keep an eye on the growing economic squeeze in the U.S. The snakes on that particular plane are still on the loose, and they could be headed our way.