Sometimes, there is a gleaming gem - in this case, an article entitled: McKinsey on Industrials - A Phoenix Ready to Rise Again (January 2017). The purpose of the report is presented as follows:
This report provides a comprehensive assessment of the sector’s historical performance and outlook. It begins with an analysis of the overall sector’s performance over the past 15 years, including the three distinct economic profit creation cycles that characterize this period.
The analysis then de-averages performance across the different subsectors and companies to shed light on four key levers that leading Industrials companies have employed to outperform their peers. The report closes with the McKinsey perspective on the sector going forward and the strategies Industrials companies can deploy to reignite value creation.
The Executive Summary
Over the past 15 years, the Industrials sector quietly ranked third among all sectors by economic profit creation. During this period, the sector also outperformed the S&P 500 on margin improvement and total return to shareholders (TRS).
The past 15 years were not, however, a single period but were instead characterized by three distinct economic profit creation cycles: Rapid growth (2001–07), slump and recovery (2008–10), and flatlining (2011–15). De-averaging economic profit creation to revenue across subsectors and companies during these cycles revealed significant performance variance within and across cycles. While three subsectors (test and measurement, building technologies, and multi-application components) excelled, every subsector had companies that consistently created economic profit and far outperformed their peers.
Four distinct company profiles emerged based on economic profit creation through time—Leading, Rising, Declining, and Trailing. Leading and Rising companies held or extended their lead based on the management choices they made rather than their starting point. In particular, four factors separated Leading and Rising companies from their Declining and Trailing peers—the quality of revenue growth they sought, their ability to maximize margins, the soundness of the M&A strategies they pursued, and their ability to optimize resource allocation.
As the sector looks to the future, several macroeconomic trends (demographic, geographic, social, regulatory, technology, and end market) will create tailwinds for the sector. However, the willingness to make the bold management choices that differentiated performance in recent cycles and the ability to get the three “Ns” right— new offerings/business models, new capabilities, new operating models—will determine which companies profit from these tailwinds.
For me, the report was useful from a variety of perspectives:
- It shed light on approaches to assess the sustainability of enterprises over extended periods of time including factors which authors felt were most important. Financial metrics, while important, are only indicators of the most important ingredient: the sagacity of management in making choices.
- The report identified subsectors and companies which outperformed their peers within the industrial sector.
- It presented a global view, reflecting the globalized economy as opposed to a more restricted national/continental view.
- The presentation of global trends is very useful in establishing a "view" about strategic investment possibilities.
- The report contained clues about companies able to sustain the profitability of their enterprises (and rewards to share owners) over extended periods.
A few conclusions:
- Many of the companies noted in the report are not listed on North American exchanges and, therefore, are not generally included in reports of American analysts. (This said, many of the companies are listed as ADR's.)
- In visiting the web sites of most of the companies, I was impressed by the international scope of their operations and the economies of scale achieved in the rollout of products and services developed through the companies' R&D activities. This has several other aspects of interest to investors: a) some "insulation" from protectionist measures which appear to be gaining ground in reaction to "globalization" (hard to implement when companies have significant operations in a diversity of areas); geographic diversification which may offset to some extent, differences in regional economic performance.
- The trends to automation, more effective analysis and decision-making (read artificial intelligence) and inter-connectedness through the Internet of things are well-established and represent a fertile "hunting ground" for investors.
- The report confirmed my belief that the quality of management and its decisions are crucial to the long-term performance of a company. These are things which are difficult to assess through the use of standard parametric measures. Since I invest on the basis of the "long view", I place a greater reliance on identifying long-term trends and the associated demand for products and services and then searching for companies which are positioned strategically to meet those needs. Only then will I use parametric metrics to assess the strength of a company, especially its "financial fitness".
The report led me to investigate a few companies in more detail. Included are:
FANUC
DUERR AG
WATERS CORP
KEYENCE CORP
THE MIDDLEBY CORP
KEYENCE CORP
THE MIDDLEBY CORP
Most of them are listed on exchanges outside of North America; however, most of them can be purchased as ADR's with the disadvantage that some of them trade thinly. However, for those willing to take the "long view" this need not be a major disadvantage.
Again: read the article both to appreciate the thinking process and the identification of some possibilities for investment.
Note: You will have to register (free) with McKinsey to access the report which can be downloaded as a PDF. You can also register to receive periodic e-mails which address a variety of topics. Highly recommended.
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