This article originally appeared in Business Insider and TMA Midwest Blog

July 24, 2012

By David Johnson, ACM Partners

Reuters reports that farmers, enjoying both an improved risk management infrastructure and healthy balance sheets, are in a better position to ride out the current drought than they were in 1988.  That is wonderful for them, but what about the food companies?

The market is changing for the companies that sell us all the food that we care to eat, and many of those changes are pushing down profitability.  As usual, those most severely impacted will be the middle market companies far outside of the limelight, but the implications are substantial.

The two primary challenges facing food companies are as follows:

  • Input Cost Challenges: Substantial increases in all major food price indices over the past several years have severely impacted the ability of food companies to maintain gross margins, let alone increase them.
  • Pricing Power: As supermarkets continue to push more aggressively for private label options, many food companies will see their pricing power erode further.  Supermarkets understand that in the wake of several years of uninspiring economic growth many consumers are looking for any opportunity to save money, and brand loyalty for food products appears to be rather weak.

The food industry is not a small one, and many private equity firms and other capital providers have a great deal of capital invested in portfolio companies in this industry.  With those portfolio companies facing the pincer of top-line pressures from a push for private label options combined with the gross-margin pressures from input cost increases, we could easily see increasing distress in food companies in the coming months.