Why capex is key to solving the supply chain issues hampering the economy
Capex levels have slumped in recent years, which has led to supply-side problems from steel to semiconductors and even a shortage of bicycles as well as HGV drivers.
There are many incentives for capital expenditure (capex). Companies may invest in new technologies that help boost productivity and allow them to become more efficient. Or there may be inflationary pressures that companies want to offset with less waste, or through new equipment that will allow them to become more productive but will also help with the use of raw materials.
So, there is always an incentive for capex, but in recent years capex levels have not kept pace with depreciation, particularly from about 2017. There was also a significant deterioration in 2020, during the Covid-19 pandemic. As a result, a material underinvestment in capex has built up in recent years.
Some industries, such as coal and oil, have also consciously underinvested due to environmental, social and governance (ESG) pressures from investors.
Underinvestment is leading to supply shortages
We are seeing numerous examples of supply shortage; from steel to semiconductors, as well as haulage drivers in the UK and shipping containers in China.
Consequently, there is a huge tailwind of pressure to respond with supply side initiatives which we think basically boils down to capex.
On top of the need for higher spending by corporates, governments around the world are set to accelerate their spending after the Covid-19 crisis. The EU’s recovery package, which will begin to be spent in 2022, will be tilted towards green initiatives. This could be for new infrastructure to charge electric vehicles (EVs) or for the more efficient transmission of electricity and or super fast broadband. And then in the US we have President Biden’s infrastructure programme, which will be focused on spending on capital equipment covering renewables, airports and mass transportation.
Perfect storm of inflation pressure and underinvestment
So, there is an underinvestment backdrop, combined with inflation pressure which is encouraging companies to invest to improve sooner rather than later. With a high backlog of orders and supply shortages, we currently have a perfect storm to encourage capex.
Our forecasts see capex growing by about 12% this year and then by 8% in 2022, which has only recently been upgraded by 5%. And this is a conservative estimate; we’ve already seen revisions to this figure and expect further upgrades. We are now about to hit peak capex, compared to levels seen in the past. However, if these figures are adjusted for inflation, we are still at much lower levels than we should be.
So, while capex is lower than it should be on an inflation-adjusted basis, it is also well below where it should be on a capex to depreciation basis (i.e. a company's total capex versus the rate at which its fixed assets decline in value).
And then you’ve also got government spending programmes that are coming through.
What does this mean for investors?
This presents a two- to five-year opportunity for investors. To benefit from it, investors are likely to switch away from companies focused just on industrial production. Instead, they will move towards providers of capital equipment – covering robotics, process and discrete automation products, supporting software, energy efficiency products, providers of electrification and storage.
The likes of Siemens, Schneider and Daikin as well as Caterpillar or John Deere in the US could be among the beneficiaries.
This article is issued by Cazenove Capital which is part of the Schroders Group and a trading name of Schroder & Co. Limited, 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
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