Food-related businesses are under stress. Why is this happening to industries that serve such a basic need? Juanita Schwartzkopf explores the causes of this trend, such as changes in consumer preferences, and says lenders and borrowers must remember that cash is king when it comes to today’s food chain.
Over the past year, our clients have discovered that a variety of food related businesses — processors, growers, cooperatives and distributors — have financial problems. This trend affects every food sector — seafood, meat, poultry, fruits, vegetables, nuts, row crops, eggs and dairy — as well as every size and type of business, from private family-owned small businesses to large public companies or cooperatives.
Why are so many businesses in the food chain experiencing problems? We all must eat, so why are the people growing, producing and processing our food suffering financially?
The problems these companies are experiencing are significant and affect their ability to survive to the next crop cycle or season. While nontraditional lenders are often able to show more patience with their borrowers, even these lenders are concerned about their borrowers’ survival possibilities.
Of course, internal debt structure and operations management could drive performance problems, and certainly better structure and management provides additional viability options. But, in many cases, external issues are seriously contributing
As lenders and as borrowers, both sides of the borrowing relationship must assess the risk and anticipate cash flow for the next year. Let’s consider the problems that have recently emerged and assess portfolios and operations accordingly. We have identified the following drivers as especially problematic.
Changing Consumer Preferences
As consumer tastes have evolved, businesses along the previous and current processing chains have been impacted. Consider the changes consumers have made as a result of simple decisions:
- Purchasing fresh food rather than processed
- Selecting organic food options (who hasn’t seen the nonGMO or organic tags on food?)
- Meal delivery service expansion (internet-based and now store-based options for ready-to-prepare meals)
- Take-out meals (grocery stores are evolving into fast casual restaurants).
In one situation, consumers switched their preference to honeycrisp apples, and farmers were able to make more money transitioning to new trees supplying that variety of apple to the fresh market rather than delivering their apples to a processor. Meanwhile, the company that processed apples into consumer products could not continue to receive a steady supply of raw product for its manufacturing process. And so, pricing competition for processed consumer products intensified because demand slowed, resulting in a decreasing ability to increase prices.
In another industry, consumer preferences moved to non-animal-based milk products, which affected traditional dairy farms and the processors who served them. The promulgation of non-dairy alternatives now includes every nut and grain option in a carton, which looks like the traditional milk carton and is found in refrigerator cases. Supply and demand has certainly impacted dairy, but as substitutes fall in and out of favor, the replacement products, such as nuts, are also experiencing large price swings.
Changing Supply & Demand
Even as demand for products grows, in many situations, the farmers or producers are changing their crops faster than supply is growing. Even with a fruit or nut tree taking two to three years to produce, if many farmers change their trees at the same time, supply quickly exceeds demand. This puts additional pressure on the prices paid for alternative crops.
The decreased demand for traditional dairy milk and the transition to non-dairy alternatives caused problems in the supply and demand equation for milk. In California, many dairy farmers converted from dairy operations to nut farming to take advantage of higher nut prices. Then supply exceeded demand, and the value of the nuts decreased.
Milk prices began to drop in 2011. Almond prices were increasing, causing many farmers to convert acreage from dairy farming to nut farming. Almonds hit a high in 2015, but supply also increased, pushing prices back down.
U.S. and global almond supply and demand from 2014 to 2020 was the time period when prices peaked and then dropped almost in half in the U.S.
In terms of walnuts, there was a difference between U.S. supply and demand, while worldwide supply and demand were closer together. The pressure on U.S. walnut producers has been significant.
Changing Regulatory Requirements
As state or federal regulators change requirements, businesses may incur significant costs to meet new rules.
For example, when California changed cage size requirements for chickens, it caused ripple effects through the entire U.S. egg industry. Not only did egg farmers move out of California, but farmers throughout the U.S. spent millions to meet the requirements and allow their eggs to be used in any products to be sold in California. This also created opportunities for new egg operations located in Arizona to serve the California market and take advantage of a more business friendly climate in Arizona.
The seafood industry has recently experienced the impact of trade wars. China is a large processor of fish from the U.S., which is imported and resold back into the U.S. market. As leaders discussed, implemented, negotiated and changed tariffs, uncertainty in the market caused pricing and performance disruption.
Food Safety Issues
In two recent situations, a company was dealing with consumer changes and making progress toward improving its performance when an unexpected food safety issue occurred, which necessitated the destruction of inventory. This reduced collateral and created over advance situations which could not be immediately cured.
In one situation, the problem was a USDA inspection-related issue. But in the other, a processing plant changed its supplier of materials, and the new product did not perform well. The company did not manufacturer product and leave it on the shelf through a normal shelf life cycle. As a result, the problem was uncovered when the product was being shipped to stores. This caused significant additional cost to destroy product and risked the availability of product to fulfill orders.
In both cases, insurance proceeds helped solve the cash flow problems, but not in the short term. The lenders had to provide additional over advance facilities to allow their borrowers to work through the problems.
What Does This Mean for Borrowers & Lenders?
The level of uncertainty in the food sector means performance stresses occur based on consumer demand, company performance and the regulatory environment. Companies survive if they have liquidity, and they are nimble in adjusting to outside forces. We have always stressed liquidity in the agricultural and food processing sector, and the issues identified show how important liquidity is for survival.
Forecasting tools must include sensitivity analysis, which adjusts performance based on variations in unit sales prices, taxes and tariffs, volume and other factors. Company performance must be stress tested.
Weekly cash flow management tools are critical, with weekly performance of budget to actual, a key part of that cash flow management and an early indicator of changes.
Daily, weekly and monthly key performance indicator reports are critical to monitoring performance and anticipating expected changes in labor, raw materials, production, consumer demand and overall expenses.
The food growing and processing sector is certainly one where the adage, cash is king, should be the guiding principal.