Middle-Market Profitability Has Taken a Dive in 2022. Should Investors Worry?

Rising supply chain costs and labor costs are to blame, but good opportunities for investors in private credit and private equity funds can still be found.

Lawrence E. Golub (SeongJoon Cho/Bloomberg)

Lawrence E. Golub

(SeongJoon Cho/Bloomberg)

Companies in the middle market are trapped in a world of low profitability, and this is posing challenges to the burgeoning number of private credit and private equity funds that have focused on this slice of corporates in recent years. Still, even though performance was down in the first quarter, experts say it’s too early to turn bearish on the sector as companies have time to adapt.

Middle market companies have seen revenue growth outpace earnings growth for the third consecutive quarter, according to the latest quarterly report on the performance of underlying companies in the portfolios of Golub Capital, a $45 billion direct lender and credit manager. In the first two months of 2022, the median year-over-year revenue growth of these companies was 18.2 percent, while earnings grew only 9.4 percent, according to the report. In part, that means rising costs are taking a bigger bite out of revenues.

“The boom part of 2021 ‘boomflation’ has started to decelerate in the first quarter of 2022,” Lawrence Golub, CEO of Golub Capital, told II. He added that the 18 percent growth in revenue is “good,” but not great. What’s worse, the 9 percent increase in earnings is almost negligible when the current 8 percent rise in consumer prices is taken into account, he said.

The CEO’s conclusions are based on the firm’s Golub Capital Altman Index, which measures the revenue and earnings growth of more than 150 private companies in the manager’s loan portfolio. These are companies with $5 million to $75 million in earnings before interest, taxes, depreciation, and amortization, according to the firm’s definition.

Golub said that middle-market companies “are extremely reflective of what’s going on in the overall U.S. economy.” The declining profitability of such companies is largely due to supply chain disruptions and rising labor costs that they’ve faced over the last few quarters, he said, and both factors are unlikely to be resolved in the near term. For one, the world’s largest exporter — China — is still sticking to a zero-Covid policy that has led to large-scale lockdowns in metropolitan areas such as Shanghai and Shenzhen. As a result, importers in the U.S. have suffered from supply chain uncertainties, but they have yet to pass the costs on to consumers.


Nitin Gupta, partner at the middle-market-focused private equity firm Flexstone, said that supply chain challenges are “definitely putting a bit of strain on the cost side” for middle-market companies. But Gupta doesn’t think the margin pressure should make investors pessimistic. It usually takes manufacturers a quarter or two to raise prices, and some companies have been doing that since late 2021, according to Gupta. He added that there are also abundant merger-and-acquisition opportunities in the middle market, which could provide companies with better cost structures. “[In the middle market], there are more levers that you can pull on the growth side, whether that’s organic growth or acquisition-driven growth,” he said. But he added that for larger companies, “the number of different avenues for growth might be more limited.”

Golub agreed that there are still good opportunities in the middle market despite slowing profitability growth. Companies that can improve productivity and meet the demand of affluent consumers will continue to be big winners, he said. In addition, “healthcare businesses that can control costs, industrial companies with large backlogs, and industries where overcapacity is not so big of a concern” also have the potential to outperform.