Industrial Technology: Market Observations

Key Takeaways

  • While many industrial technology management teams are focused on short-term execution, longer-term fundamentals remain positive, particularly within industrial automation.
  • Industrial technology serves a number of end markets currently benefiting from favorable tailwinds, including 5G testing and infrastructure build-out, automation technologies and remote actuation and monitoring, data center and power, logistics and warehouse automation, medical technology, water and wastewater treatment, and others.
  • Buyers are prioritizing assets with innovative, differentiated technologies and growing, sustainable demand arising from the impacts of the COVID-19 crisis.

Challenges and Opportunities Across the Industrial Technology Landscape

As with many industry sectors, industrial technology companies reported challenges during the most recent batch of earnings calls. “The vast majority of earnings calls have included significant warnings regarding Q2 and Q3 performance,” says John Arendale, a managing director in the Harris Williams Industrials Group. “Management teams are pointing to 15%-25% declines in year-over-year sales for the second quarter of 2020, and generally expect to see signs of improvement starting in the third and fourth quarters.”

Arendale adds that a number of industrial technology companies have pulled guidance for the year, issued substantial revisions to capex forecasts, and paused or tempered share buyback programs while prioritizing investments in critical maintenance, safety, and regulatory projects.

bigstock-robotic-vision-sensor-camera-s-277614154.jpgGlobal supply chains are another key focus area according to Jeff Perkins, a managing director in the Industrials Group based in Frankfurt. He says that while industrial tech companies have largely addressed their initial supply chain shocks, certain emerging markets remain challenged: “Companies with sourcing networks in China have seen substantial improvements, while Indian and Mexican suppliers still appear to be at risk, and are being severely impacted by governmental restrictions on returning to work.”

“As a result of these challenges, we are seeing a bigger push to digitize supply chain networks,” notes Andy Leed, a director in the Harris Williams Technology, Media & Telecom Group. “Doing so helps companies collaborate in real time with their suppliers and service providers, increasing visibility and agility. They can react more quickly and intelligently to supply chain disruptions, tariff challenges, and changes in demand.” Overall, says Leed, the underlying theme behind digital supply chains is driving efficiency and transparency at each phase of the supply chain.

Managing Director Giles Tucker says that while raw material and component costs are generally decreasing, those savings are at risk of being offset by unexpected additional logistics costs. “Supply chains are disrupted, modes of transport are dynamic, and we’re seeing more technology-enabled logistics and asset tracking technologies driving supply chain efficiencies and cost reductions,” he explains. “Plus, safety and cleaning standards required for material handling have become more stringent, further increasing costs.”

Likewise, key industrial tech subsectors display a mix of long-term positives and short-term challenges. For instance, in the communication and connectivity space, COVID-19-related supply chain disruptions and work interruptions have caused delays in new building projects. However, in the longer term, large-scale demand for connectivity and power remains strong in sectors such as data center, cloud, and communication infrastructure, driving growth for companies providing innovative hardware and software solutions. See our recent report on the impact of 5G on telecom.

Engineered components suppliers with exposure to oil and gas, hospitality, and brick-and-mortar end-markets may experience some softness in the near term, while those serving the utility and critical infrastructure markets are likely to fare better. There’s a similar theme in the test and measurement space: While providers serving the e-commerce, healthcare, and water and utilities end markets should benefit from stable or increasing demand, others will suffer due to the widespread delay in capital projects across a number of industrial end markets.

Managing Director Eric Logue says that industrial automation and data analytics tools are the brightest spots within industrial technology at the moment. “While the trend to leverage technology to reduce labor and increase visibility in industrial applications has been present for many years, COVID-19 is likely to spur increased investment across supply chains and the shop floors,” he says. “Flexible automation technologies and comprehensive sensor, analytics, and monitoring solutions have become more relevant across industries, potentially helping manufacturers keep up with this level of change while staying efficient and driving visibility throughout their operations.”

“The pandemic has placed a spotlight on automation, from back office operations to handling and manipulating goods on the plant floor,” says Perkins. “While this sector is a clear beneficiary of these trends, the time and resources needed to deploy these solutions make it challenging for companies to commit to programs today. However, the escalation in interest bodes well for a rapid influx of demand as we exit this crisis in the coming quarters.”

That demand will increasingly be for more complex, less structured solutions that require more collaboration with human operators, as well as heightened machine perception and artificial intelligence. “There is a rapidly growing crop of young, innovative companies tackling these application barriers and pursuing the next generation of automation and robotics solutions,” says Logue. “These aren’t just academic experiments anymore—these new solutions are being tested, piloted, and deployed in the world’s largest companies.”

Executive Perspective

“We believe the opportunities for automation will accelerate post-pandemic as businesses see the resilience benefit of a more automated workflow. There will also be…a heavy reliance on warehouse automation and logistics automation. To that end, our investment in new products, distribution, and organizational capability continues at full speed.” – Mark E. Jagiela, President & CEO, Teradyne

Overall, the heightened relevance of industrial automation contributes to company valuations that have demonstrably outpaced the overall industrial technology sector, as well as the broader S&P 500 benchmark (Figure 1).

Figure 1: Industrial Technology Public Company Valuations

hw-industrialtechgraphs-0702_1.pngSource: Capital IQ

Perkins says that warehouse and logistics automation is one area showing particular promise. “In recent years, sustained growth in e-commerce has pushed companies in every sector to improve material processing and handling speed and accuracy at distribution and fulfillment centers,” he says. This, says Perkins, has boosted demand for warehouse and logistics automation solutions over the long term.

More recently, he says, the COVID-19 crisis has heightened the importance of e-commerce across many product categories, bolstering revenue for warehouse and logistics automation suppliers. As shown in Figure 2, leading companies in the space have experienced strong bookings uplift of 12% and 9% in Q4 2019 and Q1 2020, respectively, reflecting the COVID-19-related acceleration of warehouse automation demand.

Executive Perspective

“The surge in e-commerce, as government enacts social distancing requirements, has created more demand for our warehouse automation business and supports continued conversion of our robust Intelligrated backlog. In the second quarter, we will see growth from the major systems projects that we booked last year.” – Darius Adamzcyk, CEO & President, Honeywell

Figure 2: Leading Warehouse and Logistics Automation Firms Showing Resilience

hw-industrialtechgraphs-0702_2.pngSource: Capital IQ

Perkins is quick to point out that while current events are creating opportunities within warehousing and logistics, long-term investors such as private equity groups should continue to diversify the capabilities of their portfolio automation companies: “We see strong potential for ‘land and expand’ strategies that take advantage of automation opportunities across end markets, versus those focused strictly on what’s trending today.”

Conclusion

Despite short-term uncertainty, long-term prospects are good for all industrial technology subsectors, powered by resilient demand for the efficiency, productivity and quality gains industry participants can generate for their customers.

In the nearer term, Harris Williams sees particular promise within industrial automation, especially with regard to warehousing and logistics. Steady growth in e-commerce and direct-to-consumer models paired with supply chain disruptions related to COVID-19 have made automation increasingly relevant and valuable. And while the cost and complexity associated with new automation programs can be a limiting factor in uncertain times, demand should be strong as the global economy ramps back up.

Published July 2020

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