Understanding Food and Beverage's Financial Challenges

Whether funding food and beverage innovation, expansion or acquisitions, expert help is essential.

By Chris Nay, GE Capital, Corporate Finance

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The food and beverage industry faces both cyclical and secular headwinds but also enormous opportunities for long-term growth. For CFOs of mid-size companies, this environment demands creative thinking and, ideally, a close working relationship with a lender that understands food and beverage and can help position the company for growth.

Following the recession, consumer demand remained slack while commodity inflation took hold. Given the difficulty passing along commodity price increases to consumers, boosting productivity to lower costs and hedging commodity risk are both necessary to shore up profitability.

At the same time, consumers are paying attention to the food they eat more than ever, creating product opportunities. Specifically, health and sustainability are top of mind, with about a third of consumers receptive to marketing messages such as "fair trade," "gluten-free" and "natural." To participate in this trend, a company should consider funding product innovation and/or make acquisitions.

A recent survey of the food and beverage industry by accounting and business advisory firm Plante Moran and The National Center for the Middle Market (NCMM), a partnership between Ohio State University's Fisher College of Business and GE Capital, put a spotlight on some of these challenges.

In addition to operational and risk management issues, the survey asked industry executives to rank their top financial issues on a scale of 1 (low) to 10 (high). The answers were revealing: commodity hedging (8.3) was closely followed by escalating labor costs (8.1). Inventory levels and fulfillment rates (7.7), capital expenditures including repair and maintenance (7.7), and collection of receivables (6.9) rounded out the top five.

Considering what's at stake, and given the very specific challenges faced by the food and beverage industry, a company is best served by a lender with deep knowledge of the sector, one that can serve as a strategic partner as well as a capital provider. Such lenders can properly value industry-specific assets and are comfortable with the peaks and troughs of the business cycle. They also understand the company's business model, as well as its sustainable competitive advantage within its industry.

Take commodity hedging, for example, which food and beverage executives ranked as their No. 1 financial issue. Commodity hedging is difficult for food and beverage companies because there are rarely enough types of commodity contracts to optimally offset a company's various exposures. There are cattle contracts and pork bellies and frozen concentrated orange juice, but the food market still lacks sufficient scope and breadth in the futures markets to easily hedge all of a company's various exposures.

Constructing an effective hedged position, and making sure it does not morph into a speculative position, takes expertise. For mid-size companies with limited resources, tapping a specialty lender's insight can be an efficient way to access the necessary expertise, ensuring the strategy is effective.

Another financial issue of concern to food and beverage executives is inventory financing, which was ranked third highest in the survey. While inventory in other industries can lose value over time as fashion changes or technologies become obsolete, some inventory at food and beverage companies literally has an expiration date. These companies need lenders with a keen familiarity with the customers of food and beverage companies and turnover rates. Such lenders are more likely to understand and value those assets and provide greater liquidity and flexibility.

Another important area involves capital expenditures, which ranked fourth on the NCMM list. Faced with the headwinds of the current cycle, some food and beverage companies delayed capital expenditures to preserve cash. But repair and replacement costs can only be delayed for so long. Outdated equipment can hurt productivity and, with more valuable commodities, operations need to be as efficient as possible. Here again, a lender that knows the food and beverage industry and understands plant equipment—whether it's a bottling system or packaging equipment—can often extend a bit further on loan-to-value ratios.

For the most part, all these financing issues are focused on mitigating risks, lowering costs and increasing efficiency. But CFOs and their lending partners can also play a big role in helping to develop new revenue streams. Take, for instance, the recent industry trend toward health and environmentally friendly food: There are two main ways that a food and beverage company can capture growth in this area and enhance shareholder value: fund innovation to develop new products and/or make acquisitions.

The same NCMM survey asked about innovation, and food & beverage executives ranked the importance of innovation at 8.5 out of 10, the second highest out of the eight industries surveyed. But no matter how focused a food and beverage company is on innovation, a well-designed acquisition strategy is important to capture growth opportunities. Here a specialty lender can be particularly valuable. The lender can plan and supply flexible financing.

For example, a dedicated food and beverage lender knows the marketplace and the potential pool of acquisition candidates. The lender can also offer flexible "accordion" lines that can expand under certain conditions. If the acquisition target is specific, a lender may pre-commit with a tailored facility, which is useful if bidding is expected and fast action is necessary. And when it comes to M&A, a specialty lender's vast network of professionals with food and beverage industry expertise — accountants, attorneys, investment bankers and private equity professionals — can prove particularly valuable in closing a transaction.

Companies in the food and beverage industry need more than a banker in today's very competitive environment; they need a strategic partner to help on both the cost side and revenue side of the business. A lender's industry expertise will give the company access to know-how, insights and resources. Establishing a relationship with such a lender — one that is ultimately a partner in growing the business over the long term — is well worth while.

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