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Markets are facing waves of turbulence as inflation concerns push interest rates higher. Much of that was caused by global supply chain strains. Juliana Faircloth, Industrial Analyst with TD Asset Management, tells Greg Bonnell those strains are helping to push manufacturing back to North America.
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- Global supply chains came under enormous strain during the pandemic, spurring a push toward bringing production back to North America. But what impact will onshoring have on industrial stocks and the cost of goods for consumers? Joining us now with more, Juliana Faircloth, Industrials Analyst with TD Asset Management. Julia, welcome to the program. So great to have you here.
- Thank you. Thanks so much for having me, Greg.
- Let's start with what onshoring is. I mean, it's pretty hard to have escaped any headlines about how snarled the supply chains became globally during the pandemic. What does it mean for an economy to onshore?
- Sure. So when we talk about onshoring, or you might hear reshoring, near shoring, a bunch of terms to capture the same phenomenon, which is re-establishing supply chains domestically or geographically closer to the end customer, so mostly in North America. We can think about it as the opposite of globalization, where many companies outsource production to low-cost jurisdictions, China, Vietnam, those were common destinations. So a reversal of that is what we think about as onshoring.
- We've heard the term thrown around during the pandemic in terms of how great of an idea it was to have these key components of so many things we need made overseas. Is there an actual momentum toward onshoring? Are we seeing this as a real thing that's developing in the market right now?
- Yeah. So there's a few drivers, I think, at play going into this onshoring theme that make it quite topical. The first one, of course, was the pandemic, as you mentioned, whether it was automakers unable to find supplies or infant formula shortages that we had throughout the spring, all the noise about congestion at ports. All of that was an indication of strain in the global supply chain and some challenges there. Onshoring, I think, would be one way to manage through some of that and build a bit more resilience into supply chains.
The second driver is really geopolitical. As we know, there's rising tensions in Europe. There's rising tensions between China and the US. And companies are now realizing that overreliance on certain jurisdictions can perhaps be detrimental to their business.
And then the third reason that I think it's important for investors to consider this theme is that companies are telling us they're thinking about it. The number of times that management teams have used the phrase supply chain, onshoring, reshoring in their quarterly conference calls over the last couple of quarters has really skyrocketed. So it's top of mind for management teams and should be considered by investors as well.
- Now this obviously would be a big shift as to what we got used to in terms of how supply chains would work. Clearly, it will mean change, and change can mean good and can mean bad. So let's sort of break down the benefits and the drawbacks.
So if onshoring really takes hold, it stays a thing, what are some of the benefits for the North American ecosystem?
- Yeah. So there's three benefits that I would point to with onshoring. The first one is, of course, supply chain resilience. If your supply chain is more domestically or regionally located, perhaps you are more insulated from external shocks like changes in international trade policy, geopolitical flareups. You are somewhat sheltered from some of those challenges.
The second benefit, and I think why there's often political support for onshoring, is there's a potential benefit to local economies. There's a bit of a multiplier effect with onshoring. It helps to create jobs. It improves the tax base, perhaps drives better innovation as research and development functions are more localized and centralized.
And the last benefit would be lower transportation costs. This was very topical a few months ago when ocean freight rates had really spiked dramatically. They have normalized somewhat since then, so less of a transportation arbitrage with the onshoring theme. But to the extent that companies are more and more concerned about emissions throughout their entire supply chain, traveling lower distances certainly helps from an emission perspective as well.
- I hadn't thought about that end of it, too, when people have their ESG goals sort of laid out at the corporate level.
JULIANA FAIRCLOTH: Exactly.
- So those would be the benefits of onshoring. Would there be drawbacks to onshoring?
- Of course. There's naturally drawbacks as well. The first one to point to would be, perhaps, a lack of labor availability may make it difficult to implement an onshore strategy. We know the US labor market is very tight. So finding skilled workers to work manufacturing jobs could be a bit of a challenge.
Secondly, it's an expensive undertaking. Onshoring will require capital investment. It's probably a higher operating cost undertaking, given you're moving now from a lower-cost jurisdiction to a higher-cost jurisdiction. And then related to that is this has the potential to be another driver of inflation over the medium to long term. If supply chains become more regionalized onshore and production costs are higher, some of that gets passed on to the consumer through higher prices. So certainly doesn't go in the favor of policy makers trying to battle inflation today.
- Yeah, I've often thought about it-- and it's probably a very simple way of thinking about it-- but if you didn't have that sort of-- the global supply chain phenomenon that we saw of the past several decades, you probably wouldn't have three or four TVs in your house because if you produce those TVs in North America, they're probably going to get more expensive. And as you say, that expense usually a company won't bear. A company will pass it through to the end user, us.
- Exactly.
- What ways do you play that as an investor, then, in terms of different industries? Are you sort of looking forward to where people will be onshoring? Obviously we're talking industrials today. Would they be the largest beneficiary, I guess?
- So certainly the industrial space would be a beneficiary of this type of trend. If we really boil it down to what is going to be the impact of onshoring, it's going to mean higher capital expenditures, higher investment in industrial production and industrial infrastructure. And that is supportive for industrial companies' organic sales growth.
So there's a few pockets worth highlighting within industrials that could stand to benefit from this trend. The first would be machinery. As manufacturing facilities are built and constructed, companies with exposure to construction spending should benefit, a company like Caterpillar, for example.
Then moving on to multi-industrials, this is a broad group of companies and they span many different end markets, many of which stand to benefit from an onshore trend. So if I think, for example, about electrical equipment companies, a company like Eaton in the US is well-positioned. They provide electrical equipment for manufacturing facilities. Company like Honeywell has an industrial software business that stands to benefit. And then there's automation players like Rockwell Automation or Schneider in Europe that are exposed to the theme of industrial automation. They sell automation software. They sell robots to factories. So particularly if wages remain elevated, that could be an area that stands to benefit.
And the last area, which is less direct but probably stands to benefit as well, would be the rails, the North American rails. If a greater amount of industrial production is brought back to North America, that's positive for rail volumes, as they transport raw materials. They transport finished goods. So generally a tailwind there for the rails.
I would say this will be a slow-moving train. Companies are not totally--
- I was going to ask you about duration. This sounds like another kind of play where an investor has to look at the trend, the longer term, and be patient as we work our way toward the trend.
- Exactly. So companies today are not upending their whole supply chain and reconfiguring it in the next six months. That's not really what's expected to happen. But the incremental investment in capacity, or as companies decide to, perhaps, bring more resilience into their supply chain, we may see some of those funds flow onshore, which will be a nice tailwind for the industrial space over the medium term.
[THEME MUSIC]
- Global supply chains came under enormous strain during the pandemic, spurring a push toward bringing production back to North America. But what impact will onshoring have on industrial stocks and the cost of goods for consumers? Joining us now with more, Juliana Faircloth, Industrials Analyst with TD Asset Management. Julia, welcome to the program. So great to have you here.
- Thank you. Thanks so much for having me, Greg.
- Let's start with what onshoring is. I mean, it's pretty hard to have escaped any headlines about how snarled the supply chains became globally during the pandemic. What does it mean for an economy to onshore?
- Sure. So when we talk about onshoring, or you might hear reshoring, near shoring, a bunch of terms to capture the same phenomenon, which is re-establishing supply chains domestically or geographically closer to the end customer, so mostly in North America. We can think about it as the opposite of globalization, where many companies outsource production to low-cost jurisdictions, China, Vietnam, those were common destinations. So a reversal of that is what we think about as onshoring.
- We've heard the term thrown around during the pandemic in terms of how great of an idea it was to have these key components of so many things we need made overseas. Is there an actual momentum toward onshoring? Are we seeing this as a real thing that's developing in the market right now?
- Yeah. So there's a few drivers, I think, at play going into this onshoring theme that make it quite topical. The first one, of course, was the pandemic, as you mentioned, whether it was automakers unable to find supplies or infant formula shortages that we had throughout the spring, all the noise about congestion at ports. All of that was an indication of strain in the global supply chain and some challenges there. Onshoring, I think, would be one way to manage through some of that and build a bit more resilience into supply chains.
The second driver is really geopolitical. As we know, there's rising tensions in Europe. There's rising tensions between China and the US. And companies are now realizing that overreliance on certain jurisdictions can perhaps be detrimental to their business.
And then the third reason that I think it's important for investors to consider this theme is that companies are telling us they're thinking about it. The number of times that management teams have used the phrase supply chain, onshoring, reshoring in their quarterly conference calls over the last couple of quarters has really skyrocketed. So it's top of mind for management teams and should be considered by investors as well.
- Now this obviously would be a big shift as to what we got used to in terms of how supply chains would work. Clearly, it will mean change, and change can mean good and can mean bad. So let's sort of break down the benefits and the drawbacks.
So if onshoring really takes hold, it stays a thing, what are some of the benefits for the North American ecosystem?
- Yeah. So there's three benefits that I would point to with onshoring. The first one is, of course, supply chain resilience. If your supply chain is more domestically or regionally located, perhaps you are more insulated from external shocks like changes in international trade policy, geopolitical flareups. You are somewhat sheltered from some of those challenges.
The second benefit, and I think why there's often political support for onshoring, is there's a potential benefit to local economies. There's a bit of a multiplier effect with onshoring. It helps to create jobs. It improves the tax base, perhaps drives better innovation as research and development functions are more localized and centralized.
And the last benefit would be lower transportation costs. This was very topical a few months ago when ocean freight rates had really spiked dramatically. They have normalized somewhat since then, so less of a transportation arbitrage with the onshoring theme. But to the extent that companies are more and more concerned about emissions throughout their entire supply chain, traveling lower distances certainly helps from an emission perspective as well.
- I hadn't thought about that end of it, too, when people have their ESG goals sort of laid out at the corporate level.
JULIANA FAIRCLOTH: Exactly.
- So those would be the benefits of onshoring. Would there be drawbacks to onshoring?
- Of course. There's naturally drawbacks as well. The first one to point to would be, perhaps, a lack of labor availability may make it difficult to implement an onshore strategy. We know the US labor market is very tight. So finding skilled workers to work manufacturing jobs could be a bit of a challenge.
Secondly, it's an expensive undertaking. Onshoring will require capital investment. It's probably a higher operating cost undertaking, given you're moving now from a lower-cost jurisdiction to a higher-cost jurisdiction. And then related to that is this has the potential to be another driver of inflation over the medium to long term. If supply chains become more regionalized onshore and production costs are higher, some of that gets passed on to the consumer through higher prices. So certainly doesn't go in the favor of policy makers trying to battle inflation today.
- Yeah, I've often thought about it-- and it's probably a very simple way of thinking about it-- but if you didn't have that sort of-- the global supply chain phenomenon that we saw of the past several decades, you probably wouldn't have three or four TVs in your house because if you produce those TVs in North America, they're probably going to get more expensive. And as you say, that expense usually a company won't bear. A company will pass it through to the end user, us.
- Exactly.
- What ways do you play that as an investor, then, in terms of different industries? Are you sort of looking forward to where people will be onshoring? Obviously we're talking industrials today. Would they be the largest beneficiary, I guess?
- So certainly the industrial space would be a beneficiary of this type of trend. If we really boil it down to what is going to be the impact of onshoring, it's going to mean higher capital expenditures, higher investment in industrial production and industrial infrastructure. And that is supportive for industrial companies' organic sales growth.
So there's a few pockets worth highlighting within industrials that could stand to benefit from this trend. The first would be machinery. As manufacturing facilities are built and constructed, companies with exposure to construction spending should benefit, a company like Caterpillar, for example.
Then moving on to multi-industrials, this is a broad group of companies and they span many different end markets, many of which stand to benefit from an onshore trend. So if I think, for example, about electrical equipment companies, a company like Eaton in the US is well-positioned. They provide electrical equipment for manufacturing facilities. Company like Honeywell has an industrial software business that stands to benefit. And then there's automation players like Rockwell Automation or Schneider in Europe that are exposed to the theme of industrial automation. They sell automation software. They sell robots to factories. So particularly if wages remain elevated, that could be an area that stands to benefit.
And the last area, which is less direct but probably stands to benefit as well, would be the rails, the North American rails. If a greater amount of industrial production is brought back to North America, that's positive for rail volumes, as they transport raw materials. They transport finished goods. So generally a tailwind there for the rails.
I would say this will be a slow-moving train. Companies are not totally--
- I was going to ask you about duration. This sounds like another kind of play where an investor has to look at the trend, the longer term, and be patient as we work our way toward the trend.
- Exactly. So companies today are not upending their whole supply chain and reconfiguring it in the next six months. That's not really what's expected to happen. But the incremental investment in capacity, or as companies decide to, perhaps, bring more resilience into their supply chain, we may see some of those funds flow onshore, which will be a nice tailwind for the industrial space over the medium term.
[THEME MUSIC]
