Think Twice Before Investing in Companies with Supply Chain Difficulties

by: Investment U

By Tony D'Altorio

Large industrial companies around the world are reporting increasing strength in demand. And many of them have even adopted hopeful outlooks on global growth.

Better-than-expected profits for the second-quarter allowed many companies to raise their full-year growth forecasts. So far, that includes:

  • Boeing (NYSE:BA)
  • Caterpillar (NYSE:CAT)
  • Honeywell (NYSE:HON)
  • FedEx (NYSE:FDX)

That trend shows the industrial sector leading the recovery in developed economies, thanks in large part to emerging market’s healthy gains.

Yet the very companies that have staked their comebacks on those countries have some major problems on their hands. And worse yet, they caused them in the first place.

Supply Chain Woes

Big manufacturers have had trouble securing vital components from supply chain firms that were weakened by the recession. And that factors heavily into how fast they can increase production to meet increased demand.

Recently, manufacturers have begun to realize the importance of their supply chains. Most of them chose to outsource years ago, thereby shifting the responsibility of ramping up deliveries onto suppliers.

To meet those added expectations, some of those suppliers cut costs sharply early on in the downturn. That decision is really hurting them now that they’re suddenly faced with larger orders to fill again.

In the end, big industrial companies have to accept blame for that. Gautam Dalal, the head of diversified industrials at consultant firm KPMG in London, describes why:

In the downturn, companies were extremely quick to turn off the tap. In some cases this caused suppliers to cut back greatly on capacity and in some cases to go out of business altogether. Now that the big companies want to turn the tap back on again, they are finding it difficult to do this effectively.

According to, an online marketplace for manufacturers, some 51% of US manufacturers experienced “significant supply chain disruptions” in the second quarter. And 42% of small and medium-sized suppliers received inquiries or work from big companies in urgent need of assistance because of supply chain problems.

Supply chain difficulties seem especially acute in the electronic components industry. For one, US semiconductor maker Altera (NASDAQ:ALTR) recently said its lead times have lengthened from a maximum of 16 weeks to 26.

GE (NYSE:GE) CEO Jeff Immelt notes the same:

Anybody in the electronic supply chain has seen the tightness around certain components.

His company saw some $50 million in orders canceled at the end of the quarter because of component shortages.

Japan Has a Better Way

Adding to their woes, many small and medium-sized suppliers still can’t secure loans at reasonable rates.

The Financial Times reported in July that US small business have to pay more to borrow relative to the Federal Reserve’s benchmark rate than at any time in at least 25 years. Those companies, the lifeblood of the US economy, are slowly being starved of the capital they need to survive.

Unsurprisingly then, the US looks the worst in supply chain difficulties. In contrast, Asian manufacturers – especially those in Japan – often work closely with their suppliers.

In many cases, Japanese manufacturers will even extend credit to their suppliers to help them fund production capacity expansion. This has traditionally protected the big guys from cyclical shortages in key components.

Large American manufacturing companies can learn a thing or two from them. They should especially take note that careful stewardship of supply chains is important at all stages of the economic cycle… and that materials don’t appear out of thin air.

Fortunately, Mr. Dalal of KPMG has seen a difference in the sector. He said:

Many of them are starting to realize that they should have paid more attention [in the early stages of the recession] to keep supply lines going at least from their most critical suppliers.

But while they may be getting a clue, investors should still be wary…

If a company is struggling to keep up with demand due to supply chain difficulties, orders will simply go to somebody else. And investors should head that way too.

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