Cut Off? Global Supply Chain Pain Explained – Morningstar


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Supply chains
A year ago few people outside the shipping or manufacturing industries had ever heard the term “supply chain”.
Nowadays, “supply chain issues” are front and centre in most investors’ vocabularies, and when it comes to the outlook for inflation, supply chains are seen as one of the primary factors that will help determine how fast price pressures cool off from 40-year highs.
Global supply chains are the networks between companies and their suppliers needed to turn materials and resources into the products they sell. Massive supply chain shortages emerged in the wake of pandemic lockdowns that shut businesses around the world and kept workers at home.
There were hopes that supply chain issues would start to abate in the first half of 2022 as the effects of the pandemic became contained in more countries. But other events, such as the war in Ukraine, have added new bottlenecks. And with lockdowns in Shanghai and other key cities across China, pandemic-driven snags are hurting supply chains again.
Whether it was Tesla (TSLA) missing key materials for production, asset manager Aberdeen (AABVF) postponing an acquisition due to a lack of paper, or the current baby formula shortage in the United States, supply chain issues have been hurting both consumers and companies as rapidly reopening economies have overwhelmed the system.
Across a wide spectrum of industries, companies have been trying to get a handle on when supply chain logjams will improve, but it’s been a moving target virtually everywhere. 
“No one really knows,” says Morningstar senior equity analyst Michael Field, who covers shipping and logistics. “Nearly every company has supply chain issues. The number of companies doing anything about it is far fewer.”

Field points to a few bright spots. Labour availability has improved in key areas, such as ports, to help move goods across the world. Companies have been signing long-term contracts with shippers to secure transportation. Prior to the pandemic they bought it as and when they needed it.
Some of the industries worst hit by global supply chain shortages include semiconductors, automobiles, industrials, retail, and restaurants. Below, we’ll highlight how issues have progressed for each of those industries.
For all the woes hitting other industries, when it comes to shipping and logistic companies like Maersk (MAERSK B), supply chain issues have been a boon, and led to higher shipping rates.
For customers, it’s a mixed bag, as those rates now come with long-term contracts. “This effectively means the input cost inflation we’ve seen across consumer and industrial products is likely to persist for some time,” Field says.
Although these long-term contracts should help move goods, substantial issues remain, with delays in the first three months of the year averaging seven days, nearly twice as much as in 2019. Ocean schedule reliability hasn’t fared any better, with about 36% of cargo being delivered on time, less than half that of prepandemic levels.

Semiconductors have been at the heart of some hefty global supply chain snarls, affecting a wide spectrum of industries. These include mobile phones, car manufacturing, and even lightbulbs.
Computer and tech companies have been struggling to keep up with roaring demand that started when workers shifted to working from home. Coronavirus factory shutdowns slammed chipmakers’  capacity to produce, leading to a backlog of orders. Morningstar technology strategist Abhinav Davuluri does see a light at the end of the tunnel, though.
“It’s more likely than not that the [semiconductor] industry turns in the other direction,” he says.
However, it’s still a mixed picture.
Firms like Taiwan Semiconductor Manufacturing (TSM) have been prioritising higher-value chips that are more lucrative to their businesses. These are called leading-edge chips, and they use the most advanced manufacturing process (also known as a node) to produce.
Those chips are used for the latest phones, computers, and cloud supercomputing. Companies like Apple (AAPL), Nvidia (NVDA), and Advanced Micro Devices (AMD) have been among those spending billions to contract with Taiwan Semiconductor for their advanced nodes to manufacture chips.
On the other hand, lagging-edge chips, those made with older or less advanced nodes, are typically used in autos, networking hardware, and industrial machinery, which aren’t as lucrative for foundries. Those chips are on the back end of the production line, but that is starting to turn around.
“The PC market is starting to slow down, freeing up capacity at foundries to focus on other semiconductor needs,” Davuluri says.
“Foundries are also trying to improve production capacity, but that takes time to come on-line,” he says. “The industry will improve, but pockets will remain throttled.”
Still, the long-term story looks good, Davuluri says, as the semiconductor industry takes steps to safeguard against shortages.
“Chipmaking is very concentrated in Asia,” he says. Companies are investing to diversify their supply chains to other parts of the world. Taiwan Semiconductor, Samsung, and Intel (INTC) have been working to increase capacity in the US.
Incentives for domestic semiconductor firms to expand production in the US may also be on the way from the government. A bipartisan bill to provide roughly $52 billion in investment to improve semiconductor production in the US is undergoing review. Both the House of Representatives and the Senate have passed their own versions of it, but a compromise has yet to be finalised.

Additionally, the normally lean-running industry has started to hold onto inventory to serve as buffer for customer orders, Davuluri says.
Still, various challenges remain. Russia’s war on Ukraine may disrupt the flow of necessary materials used in manufacturing semiconductors, such as neon and palladium. Davuluri also points out that firms supplying the tools and technology to manufacture chips, such as ASML Holdings (ASML), are struggling to provide them because of the global semiconductor shortage, pushing back the timeline for new capacity.
Cars have been ground zero for semiconductor chip supply chain issues. That has helped trigger a shortage of new cars, and led to a massive spike in used car prices.
European automakers production has been hit as the war in Ukraine – which is a large supplier of important wiring systems for vehicles – stalled production for companies like Volkswagen (VWAPY) and BMW (BMWYY). Volkswagen had to shut down two factories in Germany as a result.
In the US, Ford (F) and General Motors (GM) are still stumbling because of parts shortages in recent months. In late March, a lack of semiconductors forced Ford to halt production at its Flat Rock, Michigan, plant, where it manufactures Mustang vehicles. Likewise, General Motors shut down production at its Lansing Grand River assembly facility due to a “temporary parts shortage,” Reuters reported.
Morningstar sector strategist David Whiston says there’s not much companies can do in the short term but try to negotiate with suppliers. It takes roughly six months to manufacture a chip and get it to the automakers, Whiston says.
“What you can get, you allocate to the most lucrative vehicle models,” he says. “Companies don’t expect major relief or meaningful improvement until the second half of 2022. It’s a gradual process. I think the worst is over, but it’s still bad.”
The situation seems to be stabilising. US light vehicle inventory supply has remained steady at over one million vehicles in the last few months. While shortages continue, Whiston thinks the industry’s inventory supply bottomed out in September 2021, when inventories reached 973,000 vehicles.

In the long term, he sees some automakers taking steps to protect themselves from future supply chain shortages. General Motors is one, he says. The firm has been working to reduce the number of chips used in vehicles by 95% by switching to microcontrollers that can consolidate the functions that individual chips perform, the Detroit Free Press reports.
One sign that conditions are improving is a declining Manheim Used Vehicle Value Index, which measures pricing levels for used vehicles. The index started to decline from its all-time high in January and is down 5.7% for the year. As inventories are replenished and supply better meets demand, used-vehicle prices should also come down from their all-time highs, according to Whiston.

Like many other sectors, industrial companies are hoping supply chain issues abate in the second half of the year, but “no-one really knows,” Morningstar senior equity analyst Joshua Aguilar says.
That uncertainty has forced companies to offer a wider range on earnings this year. During its investor day in March, 3M (MMM) didn’t offer long-term targets, an unusual occurrence, Aguilar says.
Adding another layer to concerns is inflation on goods used for production. As input costs rise, companies will need to raise prices to offset losses due to inflation. This has also been a problem for 3M because it’s locked into long-term contracts, Aguilar says.
Companies faring well in the inflationary environment thus far include those operating in niche markets, such as electromechanical and electronic instrument provider Ametek (AME), or thosewith strong branding power, such as electrical and power component supplier Hubbell (HUBB).
Labour availability is also compounding the issue for various companies and has led to an increase in the backlog for orders.
“Sherwin-Williams (SHW) and PPG Industries (PPG) are missing earnings because they just couldn’t get the materials to sale,” says Brian Bernard, Morningstar’s equity research director for industrials.
For his part, Aguilar says the question for industrials with backlogs is whether those orders will translate to revenue. Customers may end up cancelling them. However, given there is typically a high cost of failure when customers use alternative products, he believes orders should stay, but that cash flows from those sales will be pushed back.
The rising cost of ingredients, labour, and utilities has been pressuring hospitality companies. Supply chain issues are to blame there too.
The cost of common inputs for cooking, such as meat, wheat, and sunflower seeds have skyrocketed as the Russia-Ukraine war exacerbated supply chain disruptions. The price of wheat has risen 70.4% in the past year and more than doubled in the last three years. Corn and soybean price are nearly double what they were three years ago. UK supermarkets have been rationing sunflower oil to prevent customers over-buying.  

This has been a major issue for restaurants, as they often use a broad basket of commodities to operate, and the all-around increase in prices has dramatically increased their costs.
Rising costs for running physical locations such as utilities and labour, are also leading to higher expenses for chains such as Darden Restaurants (DRI), the owner of Olive Garden. Fuel and the tight market for drivers have also posed idiosyncratic risks for those with a large footprint in delivery, such as Domino’s Pizza (DPZ).
Despite inflationary pressures, sales at companies such as McDonald’s (MCD), Starbucks (SBUX), and Chipotle (CMG) have been on the rise. However, that rising revenue is due to companies increasing their own prices.
“Operators have been raising prices, but they’re reluctant to outrun the consumer,” Morningstar equity analyst Sean Dunlop says. “The balance that we’ve seen is that restaurant margin levels margins have started to decline.”

Companies that have a large number of franchisees might be better positioned to resist inflationary pressures. McDonald’s, which owns about 5% of its stores, makes money from royalty sales. As a result, company-level margins may not be affected to the same degree as individual stores.
“Your heavily-franchised operators,” Dunlop says, “like Yum Brands (YUM), Restaurant Brands International (QSR), and McDonalds, are actually quite well positioned to navigate this to the extent that their franchises remain solvent.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person’s sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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