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June 2023 / VIDEO

My Two Biggest Rules for Investing in Industrials

Key Insights

  • There are good times and bad times to own industrial stocks, depending on where the economy and a company’s end markets are in the cycle.
  • The proactive industrial policies pursued by the U.S. and other governments could be a tailwind for the sector.
  • Companies specializing in automation and industrial gases could benefit from efforts to shore up supply chains and decarbonize the economy.

Transcript

Hi, I’m Melanie Rizzo. My job gives me a behind-the-scenes view of the infrastructure that makes modern life possible—and the chance to drive fully loaded tractor trailers.

I cover a range of industries—from agricultural equipment and heavy machinery to factory automation and specialty gases.

There are good times and bad times to own industrials. This reality underpins my two biggest rules for investing in the sector, and my optimism for what I see as a revolution in industrial policy.

Rule Number 1: Respect the business cycle.

The companies I cover exhibit varying degrees of cyclicality. That’s how much their earnings fluctuate with the economy and the supply/demand conditions in their end markets.

Understanding these macro and micro cycles is critical.

Highly cyclical companies usually do well in the early stages of an upswing, but even those with a compelling growth story can get dragged down during periods of weakness.

Industrials with less cyclical business models, on the other hand, tend to fare better in tough times and lag when conditions start to improve.

Valuations, economic uncertainty, and demand risks make me cautious. However, I am excited about the next upcycle, which brings us to my second rule:

Government policy can create winners and losers.

A revolution in industrial policy is underway.

Trade tariffs and disruption stemming from COVID-19 and Russia’s invasion of Ukraine have prompted companies to prioritize supply chain resilience.

Mexico, Vietnam, and India should benefit from the push to diversify production to areas where the labor supply is plentiful.

Meanwhile, the U.S. has embarked on an aggressive industrial policy that aims to develop capacity in critical areas.

The CHIPS and Science Act, for example, offers tax credits and subsidies to build foundries for fabricating advanced semiconductors.

And the Inflation Reduction Act includes significant incentives for projects that would reduce greenhouse gas emissions from transportation and heavy industry.

Other governments are pursuing similar programs to avoid being left behind.

Supportive industrial policy, technological innovation, and the push to decarbonize the economy could set up industrials for a better cycle ahead. I think the amount of spending related to the energy transition could surprise a lot of investors.

Two areas excite me the most.

First, companies specializing in automating physical processes. They’re likely to benefit from investments in reshoring manufacturing. And the productivity from these solutions could be even more compelling after a period of high inflation.

Second, industrial gas companies.

Over the long term, they’re uniquely positioned to reduce greenhouse gas emissions by replacing fossil fuels with clean-burning hydrogen.

Generous subsidies create a large opportunity set, especially on the U.S. Gulf Coast. The geology there is favorable for storing captured carbon underground. And the region is home to a lot of energy-intensive industries.

Bottom Line: I’ll be watching the coming industrial revolution closely while minding the cycle and keeping an eye out for potential disruption.

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