New Opportunities Arise From Supply-Chain Disruptions
Emergent tech and industrial companies offering advanced solutions
A new earnings season is here. And with it a global supply-chain crisis looms large.
On the most recent earnings calls at S&P 500 companies, some 70 percent warned that supply chain issues either had a negative impact on earnings or revenues in Q3, or is expected to in future quarters. Added to the mix: labor shortages, COVID, and higher transportation and freight costs.
While this narrative reached new heights last week and will continue to be heard in earnings calls in upcoming weeks, the US stock market is taking it in stride, at least for now.
Among the leading sectors, Energy and Financials stand out as the top performers over the last 12 months, and most other sectors are up between 20 to 30 percent during the same period and also trading at or near their highest levels.
One explanation is that the supply-chain disruptions have already been factored into prices and that investors are looking ahead six months and more into the future when such concerns, they believe, will be past.
Still, caution is warranted because the problems appear to be deeper than just a transitory event. Economist Tyler Cowen writes:
“The bad news is that the world’s supply chain problems are more persistent and more severe than previously realized. The worse news is that there is no single reason why, and therefore no straightforward fix. And the even worse news is that no one really knows when the situation will improve.”
Transportation, energy and high-end semiconductor chips all are experiencing big problems at the same time. Shipping rates spike then collapse due to a lack of containers and truckers at ports, while car makers struggle to meet demand due to chip shortages. The reasons are distinct yet broadly related.
Part of the problem, according to the Wall Street Journal, is a global economy that is out of sync on the pandemic, restrictions and recovery.
“Factories and retailers in Western economies that have largely emerged from lockdowns are eager for finished products, raw materials and components from longtime suppliers in Asia and elsewhere. But many countries in Asia are still in the throes of lockdowns and other coronavirus-related restrictions, constricting their ability to meet demand.”
If supply chain disruptions and inflationary pressures are deemed to be more than transitory, central banks could be forced to tighten monetary policy sooner. Such decisions for the Fed may become more complicated in the weeks ahead as they wrestle with increasing supply-side constraints that push up inflation while threatening to undermine the recovery.
While the supply side of the equation is garnering most of the attention, American consumers have saved enormous amounts of money during 2020 and early 2021 and are now spending it. Several rounds of government stimulus have left households sitting on roughly $1.6 trillion in savings, representing 9.4% of their disposable income, well above pre-pandemic levels, according to the Commerce Department.
So, it’s not all exogenous shocks. Consumers have money and they are spending it. The huge surge in demand for goods is a big reason for the stress on supply-chains.
This combination of tighter supplies and soaring demand has fueled price inflation. Supply cannot keep up with demand. Cowen points out that it’s not just one problem that has an easy, direct fix, but rather a series of interlocking paths of economic chaos and delay.
“These problems with the supply chain will eventually straighten themselves out, even if no one can say exactly when. In the meantime, suppliers and distributers — as well as consumers — can perhaps take some small consolation that they are navigating, and hopefully persevering, through a complex mess that has no close parallel in recent history.”
Investors are generally in tune with his thinking. Besides, they still consider stocks the best alternative around.
Impact on Smaller Companies
According to the National Federation of Independent Businesses (NFIB) monthly small business survey, over two-thirds of owners reported a significant or moderate impact from the supply chain disruptions. Only 10% report no impact from recent supply chain disruptions. The NFIB notes that optimism has been flagging given soaring inflation and widespread worker shortages.
Smaller tech firms – typically with modest sales and dependent on intangibles rather than infrastructure and equipment – are definitely not invulnerable to supply chain issues. Just as a single missing semiconductor chip disrupts the auto supply, a company with, say, 150 employees and annual sales of $50 million can suffer consequences from similar interruptions.
Though early in the earnings season, we searched for signs within the quarterly conference calls for small and microcap companies. We uncovered three situations – SMART Global Holdings, VOXX International and Arcimoto – whose businesses cover a sampling of industries linked to integral supply chains. The shares of the latter two have been weak performers for most of the year.
SMART Global Holdings (SGH)
SMART designs and manufactures electronics for computing, memory and specialty LED solutions. It specializes in application-specific product development and support for customers in enterprise, government, OEM and other channels. Market cap: $1.3 billion; Revenues LTM: $1.3 billion, Net Income LTM: $8.2 million.
Two-thirds of inventory growth in SGH’s memory solutions group was related to its supply-chain business. The company expects inventory balance to come down as it moves from Q4 to Q1.
When asked about supply constraints today versus three months ago, SGH management responded: “…in general we are still seeing constraints around specific parts of our overall solution sales, so there are still constraints. And I think like other players within the electronic supply chain, if we had more parts, we would be able to do more revenue…. yes, there are constraints, but we’re managing through it. And that is incorporated into our overall guidance.”
VOXX International (VOXX)
As a manufacturer and distributor, VOXX has three operating segments – automotive electronics, consumer electronics and biometrics. Within the automotive segment it has relationships with many of the world's largest OEM's. VOXX has solid market positions across many consumer electronics’ categories. Its majority-owned subsidiary EyeLock provides iris-based authentication solutions. Market cap: $239 million; Revenues LTM: $643 million, Net Income LTM: $30.7 million.
CEO led off its conference call saying that “the VOXX team has done a good job navigating through what we believe was the worst of the supply chain short falls.”
The initial price increases VOXX instituted have taken effect and due to the rapid increase in Q2 of container prices, the company instituted a second wave of price increases in September. It has the inventory on hand to deliver in all-important Q3. In addition, it has added new or alternative suppliers to increase component availability.
Based on what CEO’s been told by OE customers, automotive production is anticipated to increase and the capacity constraints should begin not only to stabilize, but improve over the coming quarters.
Arcimoto (FUV)
Arcimoto, which designs, develops, manufactures, sells, and rents three-wheeled electric vehicles in the U.S., is struggling to gain traction for its products. Arcimoto products are the Fun Utility Vehicle, for daily driving, ride share and rental; the Deliverator, for last-mile delivery of food and goods, the Rapid Responder for emergency services and security, the Flatbed, for general fleet utility, and the Roadster for fun. During the six months ended June 30, 2021, Arcimoto sold 64 customer vehicles and produced 78 vehicles during Q3. Market cap: $393 million; Revenues LTM: $3.4 million, Loss LTM: $23.8 million.
The company reports that 11 more vehicles were nearly completed, but missing one or two parts due to supply chain challenges.
CEO said that supply chain issues would remain for at least the near-term foreseeable future.
To complete its goal of developing replicable mass production for its vehicles, Arcimoto acquired a new 200,000 sq ft factory space and implemented company-wide process standardization. Construction at the new factory is expected to begin at the start of Q4 and the company is targeting a maximum output of 50,000 units a year.
Three companies represent a tiny sampling, yet they begin to help us gauge how smaller firms are managing the disruptions. Investors should be alert during the current earnings season to see how these issues are handled in calls, and use them as a benchmark for next quarter to assess progress.
New Opportunities Arise in Tech and Industrials
The worldwide chip shortage has plagued companies large and small since early 2020, but it’s doing wonders for semiconductor startups.
In 2021 so far, 85 global deals in the sector have raised a total of $3.7 billion, according to Crunchbase. US semiconductor startups are responsible for 43% of that. In dollar amounts, US semiconductor deals through nine months of 2021 are up one-third from last year and 133% from 2019.
Notably, the bulk of this year’s semi startup investments are focused on “new and better-designed chips that can cut down on the amount of chips needed and the power they use,” Crunchbase reports. It’s unlikely these companies will scale manufacturing capacity to any large degree; rather their focus is R&D.
Emerging Tech Brew points out Qualcomm’s 2021 acquisition of Nuvia, a California-based semiconductor startup founded by former Apple chip designers. At $1.4 billion, it’s the biggest semiconductor deal this year, so far. Nuvia has been working on a chip lineup with higher performance and lower power consumption, which Qualcomm plans to incorporate into everything from smartphones to cars to XR devices.
With accelerated digitization likely to continue in the post-Covid-19 world, semiconductor companies will benefit from burgeoning investments in self-driving cars, the Internet of Things, and artificial intelligence, along with the coming shift to the 5G connectivity standard. All opportunities for further growth and specialization.
Covid-era supply chain disruptions are also pushing venture capitalists to invest in industrial tech start-ups offering innovative solutions. A record $45 billion has been raised by industrial start-ups so far this year, compared with the $34 billion raised in all of 2020, according to data from PitchBook.
Supply chain issues used to be a functional problem that only people directly involved in the supply chain knew and cared about. Post-pandemic they became broad issues and actually started to affect consumers. Now, as CNBC reports, industrial-oriented tech firms are gaining appeal and attracting early-stage funding:
“Lacking a sexy story and consumer-facing products, industrial companies have long struggled to attract venture capital interest. But the recent surge in supply chain bottlenecks, logistical issues and factory shutdowns during the Covid pandemic has pushed Lux Capital, GGV Capital and General Catalyst, among other reputable VCs, to invest in cutting-edge start-ups that specialize in predictive technology, software and artificial intelligence.”
Lux Capital has allocated $150 million to $200 million in industrial companies such as Veo Robotics and Nozomi Networks this year, according to CNBC. Nozomi, which specializes in cybersecurity for the industrial sector, just raised $100 million in a Series D round from a group of investors including GGV Capital and Honeywell.
Furthermore, a growing number of industrial businesses that aim to solve supply chain issues with robotics, 3D printing and artificial intelligence have gone public this year.
Representative of this group is Xometry (XMTR), a provider of an AI-enabled marketplace for on-demand manufacturing. Its technology is used create a marketplace that enables buyers to efficiently source on-demand parts and assemblies.
Xometry opened at $68 in June, 54% above the IPO price of $44, above the estimated range of $38-$42. The company delivered 45 percent year-over-year revenue growth in Q2, 66 percent year-over-year active buyer growth and sequentially improved gross margin. After rising to $97 in its first session, the share price has dropped to $59.88 but it is still 46 percent above the IPO price. XMTR’s market cap stands at $2.7 billion.
For startup and small-cap firms with tech and industrial solutions addressing knotty issues in supply chains, the current momentum could lead to a new push next year. The pending U.S. infrastructure bill would be a catalyst for industries that seek more capital investment from the public and private sector.
See you next week, and thank you for your support.
Josh
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