Amid ongoing economic uncertainty, many investors are taking a disciplined, wait-and-see approach with various sectors. The same cannot be said for industrials, which has quickly become one of the sectors in focus, especially in the public markets. But private markets have been slower to buy in.
A common misconception is that the industrials sector is cyclical. History has shown, however, that the space is a high performer in many different market cycles. There are numerous reasons for this; one is that the sector serves a broad range of end markets and beneficiaries, providing it a natural immunity of sorts to volatility. Industrials play a vital role in everything from electronics to packaging to building products to agriculture.
Continual market growth over the last two decades has led to attractive investment returns in the sector. During this time, industrials have represented a stable and large portion of U.S. gross domestic product (GDP), averaging 20 percent from 2001 through 2021. In fact, from 2017 to 2021, the industrials sector grew an average of 4.5 percent annually. Further, while the sector has generally grown in line with the U.S. economy, it has notably rebounded more strongly than other spaces in post-recessionary periods.
Exciting Time for Industrials
Industrials is not the sleepy sector many perceive it to be. The number of manufacturing companies has grown almost 14 percent from 2012 to 2022, and while U.S. GDP outlook for 2023 is 1.3 percent growth, manufacturing is projected to grow 2.5 percent.
From an investment perspective, industrials have provided steady performance across cycles, delivering the most consistent returns of any sector. Industrials comprised 20 percent of global buyout deals completed from 2005-2022; yet, while the sector has grown, the influx of North American private equity capital into the space has not kept pace. Thus, for the foreseeable future, the combination of relatively less demand for industrials deals and near-term tailwinds fueling opportunity in the space make the sector attractive from an investment standpoint.
Tailwinds Driven by Macro Trends
Several tailwinds are currently at play in the sector, creating opportunities for U.S.-based industrial companies, including a heightened focus on sustainability, and the revival of domestic production, namely reshoring and nearshoring.
The past few years have highlighted certain vulnerabilities in the sector, with rising trade and geopolitical tensions, and pandemic-related supply problems causing unprecedented disruption for manufacturers.
Yet the bright side to this cloudy picture is that both U.S. companies and the federal government are actively seeking to bolster domestic manufacturing. New laws offer tax incentives and funding for certain industries.
The supply chain issues experienced during the pandemic, paired with the current geopolitical uncertainty, convinced businesses to lessen import dependence on certain countries. At the same time, the U.S. government is focused on reviving the U.S. industrial base.
The CHIPS Act, for example, provides important funding to fuel growth in the semiconductor space. It has already spurred over 50 new semiconductor ecosystem projects and 44,000 new jobs across 20 states.
The Inflation Reduction Act is expected to drive significant volumes of electric vehicle manufacturing onshore with content from North American suppliers. This is leading to opportunities in laser welding, battery recycling, transportation, and logistics.
Pockets of Opportunity
Water Ecosystem
Rising population growth and growing per capita water consumption are fueling water demand, which in turn stimulates higher purity demands and standards, and increased regulation around wastewater.
The water industry is roughly an $800 billion global market with structural factors driving several long-term secular trends, including:
Scarcity: Global demand for water in just the first half of this century is expected to increase by 400 percent due to increasing manufacturing
Quality: More than 80 percent of the world’s wastewater flows back into the environment without being treated or reused, and industrial consumption accounts for 30 percent of global water use, increasing industrial wastewater discharge
Aging infrastructure: Favorable legislation will serve as a catalyst for significant investments in U.S. infrastructure and is expected to produce long-term macroeconomic tailwinds for the water and wastewater market
For the foreseeable future, investment opportunities in the global water ecosystem abound, notably in the areas of water sustainability and related equipment, engineering and design services, and chemicals – all of which are necessary to help protect the global water supply.
Agriculture
Global population growth and rising incomes around the world are spurring an increase in protein consumption. Additionally, demand has historically been less cyclical in this area as food is not a discretionary purchase. Agriculture equipment, while durable, is used in harsh environments, creating a strong demand for aftermarket parts and replacements. The increased focus on crop productivity means that crop protection and micronutrients are paramount to protect yields from extreme weather events and geopolitical events challenging global crop supply. There is also an increasing global regulatory focus on sustainable crop production and soil management.
While a U.S. or global recession would certainly slow the progress of these sector trends, it would unlikely derail them completely, especially in a sector where a long-term perspective has time and again proven advantageous. There is no doubt that there will be attractive investment opportunities in the industrials sector over the next decade and that the hands-on approach of private equity is well-suited to support the growth of companies in the sector.
