Building security and redundancy in supply chains
The global supply chain has been under unprecedented stress, from the U.S.-China trade war to the COVID-19 pandemic to the war in Ukraine. If any industry has felt the brunt of the supply chain snarls, it’s been the auto business.
General Motors, Ford, Stellantis and other global automakers have faced steep production cuts, resulting in a scarcity of vehicles on dealer lots and a sharp increase in the prices of new and used cars. This is leading to structural changes within the auto industry, which has had to entirely rethink its supply chains.
One outcome has been a move away from receiving “just-in-time” inventory to holding “just-in-case” inventory when it comes to semiconductors.
Building redundancies in supply chains will come with opportunities and challenges. Certain industries will be beneficiaries, ranging from those supplying semiconductor equipment and industrial components to automation tools and physical metals.
“I anticipate reshoring to be a major growth driver for select industrial companies over the next five to 10 years,” says Capital Group equity investment analyst Gigi Pardasani. “Many U.S. industrials are investing at levels we have not seen since the early 2000s to better position themselves to meet this demand.”
In the near term, there will be financial costs and potential ramifications of supply chain shifts, such as:
Greater levels of corporate spending and higher operating costs. For Western companies moving production back to their home markets, or for Asian companies expanding their footprint into the West, the costs will be higher than running factories solely in China or other Asian countries. Companies are likely to either pay for more expensive automation equipment or higher wages for workers.
Higher costs for consumers. Inflation is already running at a 40-year high in the U.S. as higher prices ripple through global supply chains. Higher costs for companies to build more inventories or reshore manufacturing are likely to translate into higher prices for consumers. Companies will absorb some, but not all, of the costs, which could weigh on consumer demand for their products.
Higher working capital needs and operating margin pressure due to costs associated with building redundancy and flexibility in supply chains. These factors could weigh on future margins and valuations for companies. Lower returns on invested capital may be here to stay as a result of a change in the geopolitical landscape and central banks’ rate policies.
“Companies and businesses with pricing power or economies of scale may benefit from this environment, but those without these advantages may face profit margin and earnings pressure and potentially lower valuation multiples,” says Kent Chan, an equity investment director at Capital Group.
However, he adds, there’s the possibility that “those companies that are able to diversify sourcing and build greater security and resilience in their supply chain may be rewarded with a higher valuation longer term, in spite of the costs.”