Three Attractive Business Models
Within the sector, we see three business models that can provide durable sources of long-term growth potential.
Services and spare parts providers. For some firms, selling the initial industrial tool or machine is often just the gateway to a stream of longer-term cash flows. Industrial workhorses require a regular supply of spare parts and services to keep them humming without interruption. Spare parts and services are typically not discretionary items; they generate recurring purchases and often must be bought from the original equipment manufacturer, which means they command high margins.
Look for clues in revenues. We distinguish between revenues driven by capital expenditures (capex) and operating expenditures (opex). Capex orders are big onetime purchases, such as a massive mining machine, and are more sensitive to macroeconomic cycles. In contrast, opex represents recurring spending, like the spare parts or servicing for mining equipment, which tends to be much less exposed to the business cycle.
The Weir Group, based in Scotland, manufactures mining equipment such as slurry pumps, which transport waste from mining operations. The company generates about 80% of its revenue from the aftermarket, as these machines require spare parts several times per year during their 15-year product lifecycle. Given that the Weir Group’s market share is much larger than its nearest rival, the company’s business model offers resilient growth potential through macrocycles. And since the slurry pump is essential to keep the mine running, customers are willing to pay a premium to buy original Weir parts rather than cheaper competitors’ products.
Serial acquirers and consolidators. In fragmented market segments, some companies can augment a competitive edge with strategic acquisitions. That might involve buying small local competitors and then stepping up purchases of regional and even global businesses.
Beijer Ref is a serial acquirer. The Swedish company sells heating, ventilation and air-conditioning systems and generates most of its revenue from recurring maintenance and spare parts. Its organic growth has benefited from demand for energy efficiency and environmentally friendly refrigeration systems. Meanwhile, Beijer Ref has acquired more than 50 companies since 2004, providing the company with more scale, which it can use to secure better pricing from suppliers and deepen its competitive moat. When executed successfully, bolt-on acquisitions can be valuable drivers of additional growth along with organic development of the business.
Digital transformers. The line between technology and industrials is blurring. Many industrial products are being adapted for the digital age with connectivity devices, data-capture sensors and software capabilities. Europe might not have AI leaders like the ones in the US. But European industrial businesses are enabling AI, such as manufacturers of electrical cables, switchgears, circuit breakers and transformers used in data centers and the wider electrical grid. These companies provide advantages for investors: you don’t need to bet on a specific AI technology leader, since these industrials benefit from the broader AI growth trend.
France’s Schneider Electric is one of Europe’s biggest beneficiaries of the surge in demand for AI and data centers. The company supplies many of the electrical products and much of the software that keep data centers working. Data centers now represent 23% of Schneider Electric’s order backlog, and its customers are outlining spending plans for the next five years. Software has become a bigger component of Schneider Electric’s increasingly digital business, which has helped improve margins and provide a clearer view of future revenue growth.
Visibility Supports Consistent Return Potential
These types of growth drivers aren’t mutually exclusive. Serial acquirers like Beijer Ref can also benefit from recurring revenue from spare parts. Digital transformers like Schneider Electric have also made strategic acquisitions. Industrial companies with one or more of these business model features offer attractive investment opportunities, in our view.
Mapping out the right parameters can unearth exciting industrial firms that bear little resemblance to the capital-intensive smokestacks of the past. And by applying a consistent fundamental research framework, selective equity investors can discover industrial businesses with much clearer visibility of their paths to future growth—and long-term returns.
