PM Perspectives: Rising Demand, Capacity Constraints Create Opportunity For Industrials

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by: Janus Henderson Investors

By George Maris

Co-Head of Equities - Americas and Portfolio Manager George Maris says suppliers of commodity goods are in a position to exert pricing power after stripping out capacity and excess costs in the decade since the Great Financial Crisis.

Key Takeaways:

  • Aggregate demand globally is strong, creating a tailwind for suppliers of base industrial and raw materials.

  • A decade spent focusing on reducing costs and removing excess capacity has created an environment where producers of industrial base materials can exert greater pricing pressure.

  • Miners, semiconductor wafer makers and industrial plant manufacturers are among those that may benefit as demand picks up globally.

Transcript

If you look at the economic growth of the United States for the last 10 years, and it applies globally, real GDP over the last 10 years has never grown at a lower pace, i.e., we grew at 1.27% for the last 10 years. Even in the period of the Great Depression, we grew at 1.36%. So what has happened is the business models have constrained, they have really battened down the hatches, because you need to survive in a period where you are not getting a lot of demand, you can't get any pricing. What that has done is created an investor marketplace that has really truncated and focused on every single data point or tweet or what have you that is out there. When you focus on every data point or every tweet, you can get a misleading picture of what is happening on an aggregate basis.

Why that's important, when you have got a low capex to sales ratio, it means people haven't been investing in their businesses for growth. You saved cost, you didn't spend on the new factory or the new advertising initiative or what have you; you really focused on keeping costs constrained. Business models were really tight. But there has been a synchronized expansion in global economic activity that we are seeing throughout the companies we look at and throughout the economies we monitor.

That to me leads to a really interesting opportunity in investing, particularly in a sector or sectors that have been overlooked by investors for pretty much most of the past decade, and that is in the more commodity and capital goods-oriented aspects of the market. Now that you are getting aggregate demand back, people are investing for growth again. And why this is particularly engaging is that these commodity companies, which have really truncated all their expansion and shut expansion and capacity for the last several years, are now seeing demand come in, come in aggressively and what you have seen as a response is prices skyrocket and will do so sustainably as a consequence of an inability to go ahead and add capacity back in any reasonable period of time.

So, companies that are positioned to benefit from this theme are companies like Shin-Etsu, which is a Japanese corporate that one of its primary businesses is making semiconductor wafers. Semiconductor wafers are a commodity and because that business has been, because semiconductor business has been in oversupply for a long period of time, no one has added new capacity to this space for literally a decade. As a consequence, with more industrial activity happening and with the advent of increased need for technology, whether it is autonomous cars or cloud servers, etc., there is an extraordinary demand for semiconductor chips, and semiconductor wafers are how you get those chips.

Rio Tinto, which is a global mining company, will also benefit. They are diversified in terms of iron ore and copper and other elements. But they dramatically cut all their capex costs over the last several years to really focus just on maintaining the mines that they had and trying to keep costs as low as they could to preserve cash flows and eke out any bit of profitability they could and continue dividend payments. And the industry did the same. As a consequence, Rio Tinto is now set up in a position where as commodity costs rise and the entire industry can't really add capacity in any of these key commodities, they will be benefiting dramatically from the increase in revenues on the same cost basis that they have had previously.

What I am not suggesting is that there isn't sort of innovation and disruption that is happening, that is providing extraordinary levels of growth for certain companies, certain sectors of the economy at all, right? Those growth avenues are apparent and they are tremendous and they seem to be set for a very long-term period of rapid expansion. But there are other parts of the market and the economy that look very interesting and are going to be benefiting from these developments that I think the market has just not focused on. They are not anywhere near as cool as some of the shiny metal objects that are out there, and yet still benefit tremendously. I think a lot of these commodity companies and industrial companies that have been essentially forgotten in this whole euphoria behind all the innovation that is happening, and justified euphoria, that has created a real opportunity that has been ignored and yet they are creating tremendous value and that value is likely to persist for many years.

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