Will supply-chain snarls force capital spending?

One way to gauge just how transitory the current supply-chain challenges are is to look at the degree to which companies are spending to add more capacity.
The third-quarter industrial earnings season kicks off next week with factory-floor distributor Fastenal Co. The theme will undoubtedly be logistical logjams and parts shortages, which have become materially worse since the last time manufacturers reported results en masse over the summer. Data-center equipment maker Vertiv Holdings Co, electrical giant Eaton Corp and lock manufacturer Allegion Plc are among those that have already warned Wall Street that their sales will be weaker than previously expected because of insufficient supplies. Paint-maker Sherwin-Williams Co cut its guidance not once but twice in the span of only a few weeks as it gave up hope for an improvement in logistics markets and raw-material costs this year. “The sheer amount of money we’re spending on flying parts around the world isn’t great,” Tesla Inc Chief Executive Officer Elon Musk said at the electric carmaker’s annual meeting.
CEOs insist revenue hasn’t been forfeited but rather delayed until 2022 or 2023. Whether that’s truly the case depends on how long these supply-chain snarls last. There’s no guarantee of an absolute level of demand for any given economic cycle, and there isn’t “a ‘lost and found’ department for industrial revenues,” Barclays Plc analyst Julian Mitchell wrote in a report. There are myriad reasons for the current gridlock but two main solutions: buy less stuff or build more factories and container ships. The world’s transportation and supply-chain infrastructure was designed to support a certain pace of economic growth; when demand is three times that level, the system simply can’t keep up. One end or the other has to give.
If manufacturing CEOs are right that customers won’t slow purchases anytime soon, then it’s a bit weird that there hasn’t been more in the way of capital spending increases. Few, if any, major multi-industrial companies increased their spending plans in the second quarter, even as many indicated their current capacity is booked up for the next several years. In an August note, Melius Research analyst Scott Davis attributed this discrepancy to the difficulty companies are having finding materials and labour: They want and need to expand, but they can’t, or it’s too expensive.
Indeed, 3M Co Chief Financial Officer Monish Patolawala said in September that the Post-it maker’s capital expenditures would most likely be on the low end of its forecast for $1.8 billion to $2 billion this year because of a lack of materials. “We won’t hesitate to invest where we see the growth opportunities, and we do see growth opportunities,” Patolawala said. “You’ll hear more from us as we go into 2022 on that front.”
It’s a bit of a catch-22: If companies don’t add capacity to ease the supply-chain crunch, they risk missing out on demand. But they can’t add more capacity because of the supply-chain crunch. And because it can take months or even years to set up new manufacturing capabilities, companies risk building factories for a market that no longer needs them.
The supply-chain headaches may be reaching the point where companies have no choice. There have been more than a dozen high-profile spending announcements for semiconductor and electric vehicle plants from the likes of Ford Motor Co, Intel Corp and Samsung Electronics Co Sherwin-Williams, meanwhile, is aiming to set up 50 million additional gallons of architectural paint production capacity in the next two quarters. The company also announced late last month that it’s buying Specialty Polymers Inc — a maker of coatings ingredients — to help diversify its supply-chain away from the hurricane-prone Gulf region in North America.
Specialty Polymers generated $112 million in revenue last year and has production facilities in Oregon and South Carolina. In mid-September, plastic-container maker Berry Global Group Inc announced a more than $110 million investment to expand its food-service manufacturing capabilities in North America.
Perhaps the official start of the third-quarter earnings season will bring more announcements of capital outlays. But there’s also a bigger question of whether industrial companies are truly interested in investing in fresh hardware manufacturing capabilities.
The largest manufacturing behemoths have primarily been spending their money on software takeovers. Such deals have accounted for almost 10% of all M&A volume by US industrial acquirers so far this year, an allocation that’s second only to 2020, according to data compiled by Bloomberg. And that’s before accounting for the latest news that Emerson Electric Co is in talks to merge its software assets with Aspen Technology Inc.
Either way, the continued supply-chain bottlenecks and niggling questions about the strength of underlying demand make capital expenditures a key watch item.

—Bloomberg

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She
previously wrote an M&A column for Bloomberg News