As the conflict in Ukraine continues and COVID escalates in some parts of the world, it seems all eyes are on supply chain dynamics and labor shortages, which could, in theory, bode ill for industrialists – but a recent research trip abroad only reinforced our view that these stocks are well positioned for growth (and deserve their overweight in our broader global equity portfolios). Here are 10 observations on industrialists.
1: Labor shortages are structural
We hear a lot about labor shortages, and it’s not just unskilled labor that has disappeared: engineers, electricians, welders and plumbers are also in short supply.
Several structural reasons explain the shortages. Many people retired during the pandemic, for example. As a society, we have also failed to grow the talent pool fast enough to meet demand. These situations cannot be corrected by raising wages, so labor shortages are unlikely to disappear anytime soon.
Labor shortages will undoubtedly hamper the ability of some companies to meet end market demand for a number of products. But as with many things, the situation is multifaceted. Labor shortages are good for automation, for example, so that’s a key theme we’ll be watching.
2: Supply chain issues continue
We had hoped to see some normalization of supply chain constraints in 2022 with the resolution of COVID-19, but that may not happen any time soon.
There are two reasons: the conflict in Ukraine has limited the availability of raw materials (such as rare earth elements) and created logistical challenges, and COVID-19 is escalating again in China.
Both situations are disturbing. Supply chains are complex. Hundreds of thousands of products are produced and shipped around the world every day, and it only takes one blockage to choke the entire pipeline.
In the short term, I therefore expect continued disruptions, which could lead to volatility in the markets. That said, we are seeing some policy changes that could mitigate the disruption caused by COVID. Chinese policymakers are more liberal this time around, working with companies to keep production going, and I think other countries will likely follow.
We’re also keeping an eye out for the longer-term implications. People are seeing the fragility of supply chains, leading to a policy shift towards regionalization, and this could create new winners and losers among industrialists. We believe that active management will be essential.
3: The request is OK
It seems everyone is focused on demand. They fear that following the conflict in Ukraine, demand will fall off a cliff as it did during the Lehman Brothers crisis or during the pandemic. But the industrial companies we spoke to on our recent research trip – about 25 of them – simply don’t see this.
Companies with sales in Ukraine and the surrounding region were affected, but otherwise business was pretty much business as usual for the companies we spoke to. In general, they benefit from large order books due to strong demand and component shortages that hampered deliveries last year.
That said, everyone observes the secondary impacts of the conflict in Ukraine. For example, what will rising energy costs have on disposable income and, ultimately, consumer confidence? Will there be an impact on demand later?
4: Focus on efficiency benefits manufacturers
We have seen an increased focus on energy efficiency and labor efficiency around the world. At the same time, supply chains are becoming more local, moving to regions and countries.
In our view, these changes are creating an increased need for automation and digitization, and industrial companies are at the center of these trends, providing solutions to help meet the demand. Any solution that helps decarbonize the world, for example, is likely to come from an industrial company.
Efficiency, in many ways, is core to the value proposition of industrial companies, and we believe this should keep them relevant as the world evolves.
5: Deep-rooted businesses reduce disruption
Industrial companies don’t just make substitutable widgets; they are deeply rooted in their customer bases, manufacturing critical components. This makes the cost of switching suppliers high. Add a layer of turbulence as we have seen lately, and it seems to me that industrial businesses are not going to be disrupted any time soon.
6: The growth path for manufacturers is long
Few people have a true appreciation of the length of the growth trail within industrials. Sustainability and digitization, for example, are generational changes. Companies at the forefront of these trends today will likely be 10, 20 or 30 years from now.
7: Industrial companies are resilient
We are looking at a more pronounced global economic slowdown than we expected just a few months ago, and there is potential for a recession. And conventional wisdom holds that industrial businesses, which are cyclical, will suffer in such a scenario. But I think we are too sensitive to the cyclicality of manufacturers.
Indeed, many industrial companies have learned the lessons of the global financial crisis. They have better records. Their portfolios have been cleaned up to diversify away from industries that could be hit hard by cyclical shifts, such as construction, and they’ve added more aftermarket software and services to the mix.
The management teams of the savviest industrial companies are monitoring the situation closely. They understand that rising energy prices will have a significant impact on their business. They recognize that this will cause a kind of slowdown. But they are not in crisis mode, as they are better positioned to weather a major downturn than they were 20 years ago.
8: Pricing power should single out winners
Separating the performance of top companies will likely be the ability to use pricing to offset higher input costs. Everyone faces the same challenges, but there’s a big difference between companies that have pricing power and those that don’t. Again, we believe this makes active management essential.
9: Large industrial companies are always excellent
The verdict: As much as the world has changed over the past two years, so much hasn’t changed. In my view, large industrial companies are still well positioned to meet current (and future) challenges. The current environment has given high-quality manufacturers with pricing power, excellent management and a strong value proposition the opportunity to show their strengths.
10: We think being overweight is justified
Our broader global and international portfolios have a significant overweight in industries, which is a differentiator against some peers. But we think it’s warranted, as we believe the market tends to overreact to economic cycles that influence best-run industrial companies, creating potential opportunities for active managers.
Editor’s note: The summary bullet points for this article were added by the editors of Seeking Alpha.