An Investor’s Guide to Evolving Supply Chains

04 May 2022

5 min read

Erik Turenchalk, CFA| Portfolio Manager—US Small and Mid Cap Value Equities

James MacGregor, CFA| Chief Investment Officer—US Small and Mid Cap Value Equities; Head—US Value Equities

Many companies are rethinking supply chains amid disruptions from the war in Ukraine and the pandemic. Equity investors must decipher which companies can adapt their processes to compete in a less globalized world.

Solving the supply chain problem is one of the biggest operational challenges facing companies after decades of globalization. Beyond the geopolitical risks, the business benefits of offshoring are coming into question. Offshore wages are rising (Display, left), while increasing automation is reducing the higher cost of domestic labor needed to manufacture closer to home. Shipping costs have skyrocketed (Display, right). And for US companies, domestic energy costs are much cheaper than abroad, while tariffs stemming from US-China trade disputes have added another layer of costs.

Does Offshoring Still Make Sense?

Bar chart on left shows the sharp increase in Chinese manufacturing wages from 2005 to 2020. Line chart on the right shows a jump in China-US shipping rates in the last two years

Past performance and current analysis do not guarantee future results.
Left chart as of December 31, 2020. Right chart as of April 29, 2022.
*Based on nominal CNY to USD exchange rate, averaged monthly.
Source: Bloomberg, National Bureau of Statistics of China, Trading Economics, UBS and AllianceBernstein (AB)

These trends are eroding the economic rationale for offshoring. Offshoring generally makes sense if a company can produce a good for at least 20% less than in its home country. As companies and investors reassess the trade-offs, they may also demand a greater offshore discount to compensate for escalating supply chain risks. Here are some of the key issues equity investors should watch to find companies that are ahead of the reshoring curve.

Capex clues: How a company invests for the future can indicate whether it’s shifting production toward new regions to avert future disruption. In some industries, we’re seeing huge capital expenditures in manufacturing facilities to improve regional alignment with customers and revenue.

The semiconductor industry is among the leaders. Intel recently announced €29 billion of investments in new semiconductor manufacturing facilities in Germany and Ireland. It’s also spending $40 billion on new plants in Ohio and Arizona. Taiwan Semiconductor Manufacturing is investing $19 billion in Japan and Arizona, with further investments expected in Germany. Spending by multinationals on this scale will fuel earnings in other areas, such as steel and construction equipment, creating opportunities for investors who spot the beneficiaries early.

Diversifying suppliers: Some companies are facing dramatic supply problems because of the war in Ukraine. For example, Boeing and Airbus are scrambling for new sources of finished titanium, used for airplane structures and engines, because a Russian company is a dominant global supplier. Western titanium suppliers are well positioned to benefit from this shift. Investors in aerospace companies should closely monitor these efforts to diversify supply, which are indicative of broader changes in the industry’s supply chain. Sourcing new supply quickly and at a reasonable cost could be a decisive factor in their ability to meet delivery deadlines and earnings expectations.

Balance-sheet shifts: Some companies plan to use cash flow to increase working capital and/or to build more inventory on balance sheets. This could create short-term headwinds to cash flow for manufacturers. On the other hand, we believe companies that facilitate the distribution of components and are integrated in supply chains will become more valuable. This trend is already visible. Some distributors across different industries have exceeded expectations in recent earnings reports, suggesting they are beginning to benefit from supply chain changes.

Management quality: Reconfiguring supply chains is a strategic challenge that requires initiative, innovation and the ability to balance increased short- and medium-term costs with long-term benefits. Management quality is essential for success, especially given that intangible factors could make a difference. Since labor costs are a big part of the puzzle, managers who build healthy corporate cultures will be advantaged in retaining highly valued staff.

Gauging companies on these issues requires an active investment approach, in our view. Equity investors must ask the right questions rather than simply relying on a company’s public statements. By engaging with management, investors can gain insight into a company’s strategic vision and influence decision-making. And in a market driven by short-term anxieties, investors with a long-term view can identify companies that are more likely to efficiently restructure supply chains and deliver superior return potential over time.

Luke Pryor, Brian Holland and Ryan Thorpe, Senior Analysts—Value Equities, contributed to this blog.

The views expressed herein do not constitute research, investment advice or trade recommendations, and do not necessarily represent the views of all AB portfolio-management teams and are subject to change over time.

About the Authors

Erik Turenchalk, CFA

Erik Turenchalk was appointed Portfolio Manager for US Small and Mid Cap Value Equities in January 2020. From 2012 to 2019, he was a senior research analyst on the Small and Mid Cap Value team, responsible for covering industrial companies. Turenchalk was also the global industrials sector leader from 2017 to 2019. He joined the firm in 1999, and was promoted to research analyst in 2005. From 1999 to 2007, Turenchalk worked on the Advanced Value hedge-fund team, primarily researching short-position ideas with an emphasis on the consumer-cyclicals sector. In 2007, he relocated to London to support the firm’s international hedge-fund offerings. In 2010, Turenchalk returned to New York to oversee the research of short positions for the domestic hedge-fund portfolios. In 2012, he joined the Small and Mid Cap Value team. Prior to joining the firm, Turenchalk was a business analyst at Pratt & Whitney, a United Technologies company. He holds a BS in business administration with a concentration in finance from the University of Connecticut, and is a CFA charterholder. Location: New York

James MacGregor, CFA

James MacGregor was appointed Chief Investment Officer of US Small and Mid Cap Value Equities in 2009. In this role, he acts as the lead portfolio manager for AB’s US Small and Mid Cap Value strategies. MacGregor was appointed Head of US Value Equities in 2019, responsible for all US Value portfolios in the areas of business management and talent development. From 2009 to 2012, he also served as CIO of Canadian Value Equities. From 2004 to 2009, MacGregor was director of research for Small and Mid Cap Value Equities, overseeing coverage of companies for the Small Cap and Small/Mid Cap Value services. He started as a research analyst covering a wide number of sectors for those same services. Prior to joining the firm in 1998, MacGregor was a sell-side research analyst at Morgan Stanley, where he covered US packaging and Canadian paper stocks. He also serves as a board member and volunteer for Xavier Mission, a charitable organization that provides basic services and opportunities for empowerment and self-sufficiency to New Yorkers in need. MacGregor holds a BA in economics from McGill University, an MSc in economics from the London School of Economics and an MBA from the University of Chicago. He is a CFA charterholder. Location: New York

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An Investor’s Guide to Evolving Supply Chains

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