John Lin, Portfolio Manager of China Equities: Chinese companies were already starting to move their own products offshore well before the current trade war with the US, to reduce labor costs. When we visited an Adidas supplier in the coastal city of Ningbo five years ago, the company told us that the shift of production to Vietnam was already well under way. Last year, when our analysts visited the Vietnamese factories for Chinese garment and electronic manufacturers, they found that Vietnam labor costs were about 40% lower than their equivalents in China. During these visits, we also discovered that companies have learned important lessons about modern slavery. We’ve engaged with managers in Vietnam who seem very attuned to global scrutiny of working conditions and understand that employers must be sensitive to cultural sensitivities for outsourced operations to succeed. Investors should pay close attention to these ESG issues as supply chains are reconfigured.
The trade war accelerated the offshoring trend for many Chinese companies. Many textile companies sped up timetables for setting up factories in Vietnam, Cambodia and Indonesia. Interestingly, many US retail brands continue to partner with long-established suppliers, even though the factory locations have now changed, partially to sidestep US tariffs. So for investors to access these cash-flow streams, they’re largely buying the same set of Chinese and Taiwanese companies.
Samantha Lau: In the smaller-cap universe where we invest, the semiconductor industry has had an agile supply chain for some time. Even before COVID-19, many suppliers for the post-fabrication process—cutting, bonding and packaging—were already based in Vietnam, Thailand and Mexico. This trend has continued because all component manufacturers are trying to make sure that manufacturing isn’t dominated by one country, so that the origin of the product can be more ambiguous to avoid scrutiny. For example, Monolithic Power Systems uses some fabs in the US, but enough steps are done in these other countries so the components can be labeled “Made in Vietnam.” Southeast Asia and Mexico will continue to be beneficiaries of this trend.
3. What financial stresses has the economic crisis revealed regarding supply chain risks for companies, and how can investors assess the risks?
Frank Caruso: In some cases, supply chains were revealed to be vulnerable. For example, Arista Networks, a network equipment manufacturer, saw both extended lead times (by two to four weeks) as well as constrained product shipments as a result of COVID-19. In response, the company said it would increase its inventory levels through the end of the year in order to improve lead times and help buffer against future pandemic-related supply chain disruptions.
Companies better positioned were able to mitigate supply chains risks with greater ease. ASML, the semiconductor equipment maker, has been able to pass through higher costs of doing business in this environment to its customers, reflecting pricing power and an oligopolistic industry structure. Texas Instruments has benefited from its large scale, the long shelf life of its products, internal manufacturing and a pristine balance sheet. In mid-2020, the company was able to maintain high utilization in its factories, building “buffer” inventory while its peers cut capacity. As a result, Texas Instruments was able to service better-than-expected orders and picked up market share.
Product flow is definitely a risk. Companies that have relied on steady goods flow (ships, trucks, warehouses) have stumbled. Ironically, fast-turning companies were hit harder in the very short term versus slow-turning companies. There are acute working capital effects resulting from payables and inventories. So during the first couple months of the crisis, they hemorrhaged cash, and as soon as they cut orders, the cash flow partially reversed.
Tawhid Ali: During the early days of the pandemic, investors became particularly sensitive to leverage, worrying about the vulnerability of companies to a revenue slowdown. In order to really assess this risk, we used data science to look at not just our holdings’ leverage, but also leverage along the supply chain that could disrupt operations. It provided a quick way to highlight potential risks that might not be obvious.
4. What types of companies and countries are likely to benefit from the changing global supply chain landscape?
Dan Roarty: We see tremendous opportunity for companies that facilitate the localization, diversification and automation of supply chains. For example, providers of factory automation systems and equipment help manufacturers improve productivity, asset utilization, product quality, resource efficiency, waste production and even employee safety. These are many of the most important issues companies will need to consider as they reconfigure supply chains and face potentially increased costs.
