The food thesis

With food in particular, there is an opportunity to write a new chapter in this story, one in which the premium consumers place on safety and quality is heightened. The consolidation angle is also present, although in this case it comes with a ringing government endorsement. To achieve the levels of quality required to win back consumer confidence, domestic enterprises must look to their developed world counterparts. Technological innovation, unimpeachable processes and vertical integration are the goals, and they are only realistic for those with scale. 

Several dairy industry investments made in the wake of the 2008 melamine scandal, when corruptions in the milk supply chain resulted in tainted infant formula claiming the lives of six children and hospitalizing hundreds more, have gone some way to proving the thesis. China Modern Dairy, which KKR and CDH Investments helped turn into a global standard milk producer, is the standout example, but The Carlyle Group also profited from its work with a dairy brand, Yashili.

Investments in the space continue as private equity firms partner with dairy companies to build out farming operations that should in theory allow production to be traced from cow to supermarket shelf. KKR, CDH and Modern Dairy unveiled their greenfield farming operation last year, and this was followed by two other joint ventures: Affinity Equity Partners and Sunlon, and then RRJ Capital and Bright Dairy & Food. A third, involving Yunfeng Capital, CITIC Private Equity and Inner Mongolia Yili Industrial Group was announced last week.

The food thesis is also expanding to other product types. Pork, another victim of safety scandals arising from fragmented supply chains, has become a focal point. First, PE-backed Shuanghui International - China's leading meat processor, which now goes by the name WH Group - acquired US-based Smithfield Foods, an established giant in vertically integrated pork production. And then last week a KKR-led consortium teamed up with COFCO Meats to develop hog farms and processing plants.

It begs the question where does private equity go next. Into chicken? Horizontally into agricultural inputs such as vaccines, nutrients, seeds and fertilizer? Or cross-border. The answer may well be a bit of everything. There is room for participation by multiple parties at almost every point in the supply chain, whether it involves brokering off-take agreements with Australian farmers or plugging the holes in China's logistics network that can render products inedible regardless of the quality of the ingredients.

These solutions have huge economic potential but they don't come easily. While there is undoubtedly increased demand for quality foodstuffs, it is not limitless. It occupies the very top of the demand pyramid and each step down sees a jump in price resistance from wholesalers and distributors.

There are still people who are willing to use those who cut corners if it maintains profit margins. That is why PE investors in farming enterprises of any nature talk about improving efficiency as well as quality; each cow should not only produce better quality milk but more of it than before.

This dynamic doesn't undermine the food investment thesis, rather establish its present parameters and the scale of its growth potential. Relatively speaking, the China consumer story is still in its early chapters.

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• Topics
• Consumer
• Greater China
• Buyouts
• Consumer
• Agriculture
• China
• KKR
• CDH Investments Management
• RRJ Capital
• The Carlyle Group
• buyout