March 17, 2020
As the world faces the COVID-19 pandemic, the broader business community is working to rapidly adjust to its social and economic impacts. Cascadia Capital’s Food, Beverage and Agribusiness team has a unique lens through which to view its impact on the sector. We will continue the dialogue with our clients and industry contacts regularly as the situation unfolds and share new information as it becomes available. Our firm recently also provided perspectives from our Seattle-based headquarters regarding how the Coronavirus is impacting our region and the capital and M&A markets overall.
Despite the significant market correction, the economy year-to-date has enjoyed favorable tailwinds, as evidenced by key economic indicators (e.g., financial earnings growth, low unemployment, resilient consumer demand). The dislocation we are currently experiencing does not appear to represent a fracture in our system, but rather a Black Swan that has impacted near-term confidence given the uncertainty of infection spread and containment, travel and trade disruption, and a flash crash in oil prices.
If China is a proxy for the arc of COVID-19 spread and stabilization, we may see moderation with a new normal in the course of eight to 16 weeks. Should the instability persist for several quarters, we anticipate longer-term effects in the public and private markets driven by negative GDP growth, earnings contraction, and financial defaults. The consumer has been the firewall against a recession. If we experience meaningful Coronavirus-driven job losses, a recession is, in our opinion, inevitable. It is difficult to imagine a scenario other than weak-to-negative Q2 earnings for most sectors (adjusted for pantry stocking for food, beverage and household items) and muted GDP growth, as isolation practices, in the interest of public health, put a damper on the earnings momentum we’ve seen over the past few years.
Capital pools actively seek exposure to food, beverage and agribusiness assets due to the resiliency consumer staples provide across business cycles. In short, “people have to eat”, and their needs cannot be satisfied by self-production. As such, the demand function remains strong and consistent, and if providers are able to successfully navigate a strained supply chain and production environment reliant on human capital, performance can remain stable through this period.
Downstream food and beverage companies should closely monitor shifts in consumer behavior to stay engaged with their customers through digital media, using this unique opportunity to gain share. Upstream providers will need to closely monitor supply chain and distribution dynamics to ensure continuity and performance. We see businesses across the supply chain adapting to the situation well, taking steps to ensure continued product availability and adhering to food safety protocols for the end-consumer, resulting in steady business performance.
By monitoring current client processes and engaging in discussions with industry participants, we have seen buyers’ commitments to deploying capital behind existing investment and acquisition strategies remain; although they are becoming more discerning and diligent around factors that will impact 2020 and future company performance. We expect that transactions may take longer to close, as travel is delayed, diligence is protracted, and strategic buyers are focused on internal priorities. Pandemic considerations will be included in the final drafting of purchase agreements for processes as part of material adverse change clauses. After all, there are new considerations to keep in mind in light of the changing realities. In the interim, the best thing for business owners to do is focus on systematically managing their businesses through this period of uncertainty, as specific company performance will remain the most important factor that dictates interest, price, and terms in a transaction.
While we believe demand remains relatively stable overall, we are seeing some companies benefitting from this environment by taking advantage of a burst in consumer spending for specific products. Other opportunities are emerging that are more long-term in nature. For example, we believe the Chinese market will open for certain agricultural products as Asian consumers shift their preference away from domestic production, instead placing more trust in foreign goods. We are also in discussions with those who are seeing near-term business interruption issues caused by supply and production constraints, a focus on internal food safety concerns, and labor supply issues.
For privately-owned companies, these temporary gains or losses will no doubt have an impact on future valuations and M&A outcomes. However, coming out of this period, we expect to see an abundance of Coronavirus-related EBITDA adjustments to normalize earnings, both positive and negative. At the end of the day, buyers will continue to focus on sustainable, normalized growth and financial performance in assessing the value of an opportunity today and over time.
Consumers are at least temporarily shifting their purchasing away from foodservice and toward grocery and online retailers. Shelf-stable packaged foods and frozen goods are increasing as a percent of consumers’ baskets. CPG brands already selling online are seeing a material uptick in sales. Brands on Amazon and other online outlets should be leaning into that at this time in order to meet those consumers where they are shifting spend, potentially taking advantage of an opportunity to profitably acquire new customers. Those not previously selling on Amazon may choose to leverage this as a springboard in an attempt to gain share. As always, managing profitability throughout all distribution channels should be a priority during this time.
Distribution changes also have impacts on marketing strategy and spend, which should be considered alongside any adjustments made in product availability or distribution.
Businesses should be proactive in talking to customers about what they want and where they want it. Brands able to inspire confidence that they can remain a reliable, trusted partner through this period will see dividends. Varying strategies based on the specific needs of regional markets or metro areas could be appropriate in some cases.
Another question to address is the assessment of inputs, whether domestically or foreign-sourced, and the consideration of where shortfalls are likely to occur. Even domestic supply chains rarely evade a global element. For example, manufacturers must consider items like film, which often comes from China.
Producers should evaluate their ability to build inventory stockpiles of ingredients or finished goods, and then manage shelf-life and expiration dates carefully for minimal financial impact. Redundancy is a protective measure to ensure risk is managed in the event of a compromise at an owned or third-party supplier’s facility.
A brand working with a single co-manufacturer or a single facility production environment should strive to create redundant production capacity, as the compromise of a single facility represents a significant business risk. As the virus has ramped up, we’ve seen investors place a premium on businesses with supply chain redundancies, and an assessment of contingency plans is essential.
FDA officials have stated they are not aware of any reports at this time of human illnesses that suggest Coronavirus can be transmitted by food or food packaging. That said, increased hygiene and containment measures are being implemented at plants and distribution outlets industry-wide in an effort to keep employees and consumers safe and mitigate operational disruptions.
There are many precautions manufacturers can take and questions to ask internally in advance of a potential mass self-quarantine or business disruption. Where employee health is concerned and potential contamination between employees is possible, we’ve seen manufacturers institute working groups or “pods” for those on the manufacturing floor. Creating these silos limits the number of potential employee interactions to a captive group (they are prohibited from interacting with employees outside of their group), and staggering work schedules whenever possible helps to mitigate a facility-wide spread should a positive case appear among the workforce.
As rapidly as these changes must be implemented to be most effective, it is imperative for management teams to model varying scenarios and their financial impacts on their businesses.
We are working with our clients to stress-test financial statements, model downside budget scenarios to show how a slowdown might impact cash needs, and understand how fluctuations in inventory and distribution will impact cash concerns. Companies that have generally untapped revolving credit lines might consider drawdowns to ensure the availability of funds, albeit at a carrying cost. As a first line of risk management, banks do not always honor revolving commitments in times of financial crisis.
Many companies and suppliers operating on thin working-capital margins will require thoughtful solutions to ensure they can adjust inventory levels to protect against future disruptions. These exercises will give management teams the valuable data needed to make decisions that will best serve their businesses in both the short and long term.
Deals are still being completed and financing is still available, albeit on somewhat elongated cycles. The most significant thing for businesses to weigh as part of the decision-making process is their specific business performance in the near-term and throughout 2020, potential counterparty performance during the same period, and the impact of the duration of volatility on markets and lenders.
As you make critical business decisions that may impact your future financing and exit options, please do not hesitate to reach out to our team. We are available as a resource to you should you be interested in discussing these or other components in more detail. Our contact information is below, and we look forward to speaking with you.
Bryan Jaffe // firstname.lastname@example.org or (206) 436-2534
Erik Einwalter // email@example.com or (206) 436-2538
George Sent // firstname.lastname@example.org or (234) 380-3242
Nicole Nugent Fry // email@example.com or (310) 993-4761
Michael Butler // firstname.lastname@example.org or (206) 436-2530