Commercial and Industrial Inventory - Produce

Produce

Industry Insight

TARIFF ALERT

Date January 2019

Projected Values - Produce

Current Trends

  • Tariffs cut 2018 exports of cherries to China by half of 2017 levels
  • Recalls affecting romaine lettuce sparked a new voluntary leafy greens labeling program
  • Produce suppliers hold a first priority security interest, which prevails over a preexisting, perfected security interest for any personal property
  • Demand for organic produce is on the rise
  • The Consumer Price Index for the year ending December 2018 rose 1.8 percent for fresh fruits and vegetables, driven by increased pricing for vegetables
 

approximate net recovery on cost

Synopsis

Quality issues impact industry: Two major quality issues related to romaine lettuce in April and November of 2018 caused the Food and Drug Administration (FDA) to announce a new voluntary leafy greens industry labeling program in order to aid market recalls and traceability, as well as help consumers avoid contaminated products. The FDA has been in discussions with leafy greens growers and other agricultural industry participants to come up with solutions to both avoid and minimize the impacts of future outbreaks in leafy greens produce. On November 26, 2018, the FDA announced that major growers in the romaine lettuce industry have now agreed to label all romaine lettuce going forward with both the date of harvest and harvest growing region.  While these labeling practices will not prevent future outbreaks, they will assist in sourcing problems and identifying products not fit for consumption following an outbreak. Growers are not solely affected by quality concerns, as fruit and vegetable processing facilities have also been affected by issues such as listeria, causing a complete shut down and recall of all products processed in a contaminated facility. While appraisals typically do not consider the sale of inventory under extraneous conditions, such as recalls, lenders need to remain aware of the catastrophic effect such an event can have on value. The risks of food-borne illnesses such as Salmonella, E-coli, and Listeria remain very real issues and can have a devastating effect on health, reputation, and value. In rarer instances, just the perceived risk of contamination can be enough to dampen demand for products.
 

Increasing organics: Organic food sales, the rise of which has posed a significant competitive challenge to many industry businesses over the past five years, show no signs of slowing.  A 2016 poll from the Pew Research Center found that 55 percent of Americans believe that organic food is healthier than conventional, particularly organically grown fruits and vegetables. According to natural foods research firm Spins LLC, about half of organic food revenue is generated from only one-fifth of U.S. consumers. The organic food trend has been driven largely by a relatively small group of consumers that are highly unlikely to return to the processed, non-organic food products that have historically been staples for this industry. Organic food has moved steadily into the mainstream in recent years; in 2017 organic sales were up 6.4 percent year-over-year, which was significantly higher than the 1.1 percent growth in the overall food market. For the same year, organic food comprised 5.5 percent of over $822 billion in total sales, according to information from the Organic Trade Association. Growing acceptance of organic products will likely continue to push more consumers away from the industry’s canned varieties.
 

Rising prices: By 2022, the price of fruits and vegetables is expected to grow at annualized rates of 2.6 percent and 1.6 percent, respectively. Although over the long term manufacturers can pass these cost increases on to consumers, over the shorter term price increases will likely erode profit margins. Increased prices for fresh fruits and vegetables have the potential to drive consumers to lower-cost canned varieties; however, stronger disposable income growth over the coming years may mute the cost benefit of industry products relative to the prior period. 
 

Tariff impact: The produce industry has been affected by a 15 percent tariff imposed by China on a variety of fruits including, but not limited to, apples, pears, cherries, peaches, plums, strawberries, raspberries, kiwi, blackberries, watermelon, cantaloupe, grapes, lemons, limes, grapefruit, and oranges. The Seattle Times reported that  Washington farmers and exporters saw foreign sales cut by 20 percent to 28 percent from last year.  Frank Davis, an executive with Washington Fruit and Produce Co. noted that Washington cherry sales to China dropped from 3.2 million cartons in 2017 to 1.6 million cartons in 2018, with tariffs costing growers around $60 million to $80 million. Davis said it is early to see the impact of tariffs on the apple industry, but Washington growers could lose between $120 million and $130 million.  Farmers hurt by the tariffs are getting some relief from a one-time $12 billion aid package through which the U.S. Department of Agriculture will send payments to producers of certain crops and will also purchase surpluses of commodities such as fruits and distribute them to food banks and other nutrition programs. 
 

Additionally, producers expect that rising costs will lead to increased prices for all canned products, food, and beverages. The ultimate impact on gross margins and how much of that can be passed along will be a major monitoring point for asset-based lenders. Additionally, the increased cost of new equipment will have an inflationary effect on used equipment prices. New agriculture equipment prices are also rising as a result of steel tariffs. As tariffs increase prices on imported steel, manufacturers and distributors may be reluctant to buy new processing equipment and instead will buy used.
 

Private label consideration: Many frozen and canned products are manufactured under a private label. Lenders should beware that manufacturers may not be permitted to sell private label product unless it is repackaged. While in certain instances repackaging may be possible, it will incur extra time and expense in a liquidation.   

Perishability factor: Due to the perishability of fresh, canned, or frozen fruits and vegetables, product age and integrity are critical to recovery value. Most customers seek delivery of fresh products to stores or distribution centers within days of packaging, maximizing salability. The short shelf life of fresh produce necessitates rapid turnover in finished inventory levels. It is common for crops to be sold before the harvest.  Products that are not sold fresh are also typically frozen or canned quickly. This short fulfillment cycle has a positive impact on recovery values in an orderly liquidation sale. Proper storage is key to maintaining freshness and value, which is why many processors contract with third-party cold storage facilities to manage inventory.  However, lenders should beware of liens these third parties may have on inventory stored at their facilities, and should consider whether inventory held at these locations should be excluded from the borrowing base to minimize risk.  
 

Regulatory issues: In 1984, the Perishable Agricultural Commodities Act was amended to impose a statutory trust in favor of any unpaid supplier of produce to a seller. Under this revision, any seller must hold the produce and anything derived from the produce such as food products, receivables, and other proceeds in trust until the produce supplier has been paid.  This provides the produce supplier with a first priority security interest in the assets, which prevails over other creditors including those holding a preexisting, perfected security interest in any personal property also included in the trust assets. A secured party should consider reserving for any outstanding payable amounts owed to these parties in order to secure the possession of the inventory in a liquidation.