ABGSC on the Capital Goods sector: strong demand recovery, but supply chain shortages set to persist

ABGSC’s Olof Cederholm shares his thoughts on the tumult within the sector + a preview of our upcoming Capital Goods Seminar

“I’ve been doing this job for a long time, and I can’t remember a time in which a whole industry – like the automotive industry – has had to stop production for a significant period of time, just to catch up on the supply of components.”

So says Olof Cederholm, Equity Analyst at ABGSC, of the challenges currently facing many companies within the capital goods sector.
Coming off of the Covid-19 recovery, demand for capital goods is strong – the only problem is that demand is currently higher than what companies can actually produce.
“We have a clear supply chain issue,” explains Cederholm. “When Covid hit, many companies simply pulled back on production and wanted to have as little inventory as possible. Then demand came back quicker than expected. The result was that – across the value chain – there were many areas with too little inventory, particularly in semiconductor components, where there is an overall lack of production capacity.” All of those shortages compounded, resulting in what Cederholm describes as “a complete mess.”
The supply chain issues include a shortage of semiconductors, plus higher prices and shortages of materials (particularly plastics and certain grades of steel).
Companies are also facing logistics challenges, often resorting to expensive airfreight delivery, in response to container shipping back-logs. Since many companies operate on a just-in-time delivery model, these disruptions are resulting in uneven production levels, which in turn hurts capacity utilisation and drives up unit costs.
 
How did we get here?
These issues have been mounting since the beginning of the year. As Cederholm explains: “In the beginning, companies had fairly decent inventories of electronics components, but they used up as much as they could in order to meet customer demand in the short-term.”
Inventory levels are now depleted, which means that for some companies, the squeeze is only going to become more and more apparent. “It’s going to be a very interesting second half of the year,” predicts Cederholm.
So, when will things calm down? It’s difficult to say.
“For many sectors, Q3 will be slightly better than Q2, but for others it’s going to be the other way around.” We may see an improvement by Q4, Cederholm says, but he cautions: “I wouldn’t bet too much on it.”
While logistics challenges are common during periods of high demand, what’s new this time around is the lack of inventory at most levels, across supply chains – plus the semiconductor shortage, “Which is clearly new,” Cederholm notes.
“Of course, this will be resolved. When it comes to investments going into the semiconductor industry, CapEx plans are up 30 percent this year, compared to last. There will be continued growth on those kinds of investments going into 2022, and at some point, we’re probably going to have too many semiconductor components!”
 
The winners and losers
Up until now, most companies – outside of the automotive industry, that is – have been faring well, despite the challenges.
Some have done better than others, though. Cederholm points to Atlas Copco as one such example: “They’re just incredibly good at operations, they have a strong culture of constant improvement, and they always have back-up plans. They’re also exposed to the semi-conductor CapEx cycle, which means that they are receiving a significant boost from the semiconductor shortage. They will come out of this really well.”
Over the next six months, he’ll be watching to see how hard companies are hit by cost inflations. Most should weather the storm fairly well, he believes.
Of course, the biggest losers so far have been in the automotive industry, where component shortages have been the most severe. They’ll continue to face challenges for some time, Cederholm believes.
Nevertheless, Cederholm is positive about their prospects, long term: “The good thing is that demand is still good. We see very low inventory of cars in the US, for example. They are at historical lows, because you sell everything that you have basically.”
“At some point, when this situation resolves, we’re probably going to see a strong recovery in production rates for the car manufacturers, then they’re going to be the companies to own for a period. It’s probably too early to start buying automotive-related companies now, but maybe over the next six months that could be the next big trade.”
 
ABGSC’s Capital Goods Seminar
Against this backdrop, the discussions that will take place during ABGSC’s upcoming Capital Goods Seminar (happening on 15 September) should be very interesting, Cederholm says.
The annual event, now in its second year, will feature a series of “Fireside-chats,” in which Cederholm and fellow analysts Anders Idborg and Karl Bokvist will interview CEOs/CFOs/IR officials from several companies in the capital goods sector.
Companies participating include Volvo, ABB, Atlas Copco, SKF, Wärtsilä and others.
ABGSC clients are invited to join for the event – which will be conducted digitally – for insight into the challenges and opportunities facing companies over the next few years.
Discussions will include: what companies are doing to grow, their long-term strategies, improving profitability, their competitive situation, day-to-day performance, and their ESG strategies – with particular reference to sustainability.
 
ABGSC clients can access more information about the Capital Goods Seminar here.
*Please note, the seminar is accessible to clients only.