Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 174

Smart automation provides competitive edge

A relatively slower capital expenditure cycle is often cited as one factor behind the current tepid economic expansion in many developed markets. However, we believe this top-down view obscures a healthy albeit different sort of capex cycle, one that is more technology-driven and focused on efficiency.

Profits for companies that execute automation well

Rather than driving volume via heavy spending on traditional fixed equipment, companies globally seem focused on gaining more lasting competitive advantages by reducing labour costs while increasing throughput and innovating faster via software-driven automation. This trend is durable and could accelerate profits for companies that execute well. Automation has long been commonplace in manufacturing, logistics and other areas, but we are now seeing a differentiating factor with the rise of ‘smart’ automation and instrumentation.

Underpinning this drive for industrial process innovation and accelerated profit are several things we believe should continue for some time.

Outsourcing, often to emerging markets, has been one common way for companies to lower labour costs. While there are concerns now of moderating emerging markets’ growth, the prior decade or so resulted in high and persistent wage inflation (see table below). In China and other parts of the developing world, these inflation pressures remain largely unchanged despite expectations of more modest top-line economic growth. Rising wages compress the payback period for automation, creating incentives for investments in equipment rather than labour.

Fifteen years of global wage inflation

Source: Economics and Statistics Administration analysis of data from US Bureau of Labor Statistics, International Labor Comparisons program and National Bureau of Statistics of China.

Cost containment and operational flexibility

Automation gives companies greater flexibility to manage a range of costs since operations need not necessarily be close to a large, manufacturing-based labour pool. Other factors, including local taxes and regulations, existing infrastructure and the political environment, may further increase demand for automation equipment globally. Shipping costs are another key factor.

Despite the recent fall in commodities prices, North America’s ongoing energy renaissance has resulted in all-time high US natural gas and crude production, possibly prompting some companies to locate next-generation automation facilities closer to their large North American customer bases.

These factors are behind the recent trend of manufacturing ‘near-shoring’ to Mexico, which is poised to overtake Canada and Japan as the number-one source of US car imports. As of the end of 2015, Mexico is now producing nearly one of every nine light vehicles bought by US consumers. Global automakers have been building state-of-the-art manufacturing centres in Mexico, attracted in part by cheaper wages than in the US and Canada as well as proximity to America’s massive car market.

Consumers and governments are also demanding improved quality and safety profiles on goods, especially in emerging markets, where growing wealth correlates with demand for higher quality. Across industries, product failure and/or tampering can cause an immediate and lasting, even terminal, backlash. Additionally, many governments are making quality a legal requirement via more rigorous safety regulations and product specifications, a trend we expect to continue.

Investing in industrial innovation, including robots to improve precision, vision systems to manage quality control, and automated packaging and fulfillment systems to mitigate contamination or tampering, can help manage these costs.

Government-directed initiatives

As the world’s largest command economy, China can wield tremendous power in influencing certain sectors. As part of its 12th five-year plan, announced in 2011, the government emphasised seven key sectors, including next-generation information technology and advanced equipment manufacturing for attention. In 2015, it announced its ‘Made in China 2025’ initiative, designed to transform the country into a global manufacturing power not only in terms of volume, but also in efficiency and sophistication.

While China has not traditionally been transparent about the progress of its five-year plans, the intensive focus on these areas, combined with any spending the government commits now or in the future, should add materially to demand for next-generation automation systems, instruments and components.

How can investors benefit?

Benefits from increased industrial process innovation are fairly broad-based, potentially touching any industry employing automation or sophisticated instrumentation. From an investing standpoint, we believe there are several interesting opportunities.

Traditional industrial equipment manufacturers that have shifted to become hardware/software fused offer good opportunities, as do companies producing industrial robots or machine tools overlaid with next-generation instrumentation and smart automation.

There are also opportunities among components designers and manufacturers such as companies designing infrared componentry, advanced sensors or advanced location devices. Investing in components providers allows us to invest in the broader trend of more sophisticated instruments without trying to select which software platform will ultimately win.

Managing risks

We are mindful of inherent risks that could derail the profit-acceleration potential from this trend, such as competition from lower-cost start-ups, particularly from emerging markets. Profit growth could also be tempered by a slower pace in artificial intelligence take-up, which could limit industrial robots’ dexterity.

We look for companies with a large and powerful installed base of hardware with existing clients. Dominant market share can result in an effectively locked-in audience, aiding in future profits from product-replacement cycles, upgrades and cross-selling.

We also prefer those willing to invest heavily in research and development now. Such investments do impact margins; however, investing strategically is one way to fend off lower-cost upstarts and amplify scale advantages.

Companies with scientific research-driven backgrounds have good prospects. They often develop products or software for extreme situations and can alter them for more common applications, giving them a technological head start over competitors or a low-cost advantage.

 

James D Hamel, CFA, is a Managing Director at Artisan Partners and a portfolio manager on the Growth team. Michael A Schneider, CFA, is an analyst on the Artisan Partners Growth Team, where he conducts fundamental research. This material is for informational purposes only and should not be considered as investment advice or a recommendation of any investment service, product or individual security. Any forecasts contained herein should not to be relied upon as advice or interpreted as a recommendation.

 


 

Leave a Comment:


banner

Most viewed in recent weeks

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

The nuts and bolts of family trusts

There are well over 800,000 family trusts in Australia, controlling more than $3 trillion of assets. Here's a guide on whether a family trust may have a place in your individual investment strategy.

Welcome to Firstlinks Edition 583 with weekend update

Investing guru Howard Marks says he had two epiphanies while visiting Australia recently: the two major asset classes aren’t what you think they are, and one key decision matters above all else when building portfolios.

  • 24 October 2024

Warren Buffett is preparing for a bear market. Should you?

Berkshire Hathaway’s third quarter earnings update reveals Buffett is selling stocks and building record cash reserves. Here’s a look at his track record in calling market tops and whether you should follow his lead and dial down risk.

Preserving wealth through generations is hard

How have so many wealthy families through history managed to squander their fortunes? This looks at the lessons from these families and offers several solutions to making and keeping money over the long-term.

A big win for bank customers against scammers

A recent ruling from The Australian Financial Complaints Authority may herald a new era for financial scams. For the first time, a bank is being forced to reimburse a customer for the amount they were scammed.

Latest Updates

Shares

Looking beyond banks for dividend income

The Big Four banks have had an extraordinary run and it’s left income investors with a conundrum: to stick with them even though they now offer relatively low dividend yields and limited growth prospects or to look elsewhere.

Exchange traded products

AFIC on its record discount, passive investing and pricey stocks

A triple headwind has seen Australia's biggest LIC swing to a 10% discount and scuppered its relative performance. Management was bullish in an interview with Firstlinks, but is the discount ever likely to close?

Superannuation

Hidden fees are a super problem

Most Australians don’t realise they are being charged up to six different types of fees on their superannuation. These fees can be opaque and hard to compare across different funds and investment options.

Shares

ASX large cap outlook for 2025

Economic growth in Australia looks to have bottomed, which means it makes sense to selectively add to cyclical exposures on the ASX in addition to key thematics like decarbonisation and technological change.

Property

Taking advantage of the property cycle

Understanding the property cycle can be a useful tool to make informed decisions and stay focused on long-term goals. This looks at where we are in the commercial property cycle and the potential opportunities for investors.

Investment strategies

Is this bedrock of financial theory a mirage?

The concept of an 'equity risk premium' has driven asset allocation decisions for decades. A revamped study suggests it was a relatively short-lived phenomenon rather than the mainstay many thought.

Vale Graham Hand

It’s with heavy hearts that we announce Firstlinks’ co-founder and former Managing Editor, Graham Hand, has died aged 66. Graham was a legendary figure in the finance industry and here are three tributes to him.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.