Supply Chains Snap Under Pressure

When looking at the current shipping crisis, it’s important to know the background. Since 2015, new vessel orders in freight shipping had fallen markedly, dropping by roughly half from the first half of the last decade. This tight capacity kindled the fire we are now witnessing, with shipping demand far outstripping supply and freight rates rocketing. The match that started the fire, however, was the coronavirus pandemic, coming hot on the heels of the already disruptive U.S.-China trade war.

Semiconductor manufacturers are now running at full capacity and padding their order books for 2022, focusing only on the highest-value clients. Auto manufacturers are depleting their inventories as they wait for the requisite semiconductors to complete their production cycles. Fashion companies are still coming to grips with delayed delivery times and an increased focus on online shopping. And global shipping and logistic companies are taking full advantage of the tight capacity in freight to draw in high-value clients and beefy margins.

The market consensus forecasts normal ocean freight rates in 2022, falling almost 20% from this year’s elevated levels, with the end of 2021 commonly identified as an inflection point. While we agree with the premise here, we believe the risk is to the downside, with the likely impact of these fixes not necessarily having the desired effect until early or mid-2022; this means elevated freight rates could persist for a while longer.

The stock market as a whole has rallied hard over the last 18 months, and a quick comparison between the valuations of those stocks that were worst affected by supply chain issues and those that were not suggests the market believes the worst of the shipping crisis is over and freight rates--as well as many of the supply chain issues--should ease soon. The market is half-right.

The picture is looking brighter because delays at ports are being reduced, schedule reliability is improving, and the successful rollout of vaccination programs across the United States and Europe will soon mean further removals of pandemic-related restrictions. A pause by carriers on scrapping vessels and the addition of 5.40 million new shipping containers this year alone should also help abate elevated freight rates and ultimately get goods moving more quickly and reliably through the supply chain. However, we believe a year-end target for this is probably too optimistic. It could be sometime in the first or second quarter of 2022 before we see meaningful improvement.

This does not solve all the supply chain issues that have surfaced during the pandemic, many of which are more structural in nature. However, the pandemic should be a catalyst for change, with companies already working with shipping and logistic partners to diversify their supply chains in order to bolster against future disruptions. It may also encourage a longer-term outlook, with companies now transitioning to long-term agreements with carriers to lock in capacity and rates, all of which should help avoid a repeat of the mass disruption caused by the pandemic.

In some of the sectors we have analyzed, we see little value. This is particularly true for the shipping and logistics segment, with companies like DSV (DSDVF) and Kuehne + Nagle (KNIN) firmly in overvalued territory. In other areas, many of our picks are focused on stocks with pre-existing overhangs, like Hanesbrands (HBI) in fashion or Intel (INTC) in semiconductors, where we see a mismatch in the strength of the underlying business and lackluster market expectations for both stocks. In the auto segment, we see more stock ideas, with Ford (F) and General Motors (GM) in the U.S. and Volkswagen (VWAGY) and BMW (BMWYY) in Europe. As semiconductor supply issues abate, we believe smart market positioning in the electric vehicle segment will underpin these carmakers’ ability to succeed.

Key Takeaways

• We believe the market is too bullish in expecting ocean freight rates to fall by the end of the year or even early next year; we see mid-2022 as more realistic. Shipping delays and schedule reliability will take even longer to fix, given the confluence of issues causing the current crisis.
• Disruption in the semiconductor segment should even out somewhat in the coming year, with a new supply/demand equilibrium as hybrid work models are maintained, driving longer-term demand for technology to facilitate this. Intel is our top pick in the semiconductor segment, with many of the other names now overvalued.
• Semiconductor supply issues in the auto segment will most likely persist well into 2022. They are already beginning to affect auto sales, with inventories dropping to record levels. In the longer term, we are positive on the auto segment and see a number of attractive stock opportunities. We believe recent supply issues will drive more robust sourcing practices of crucial parts. Ford and GM in the U.S. are our favored ways to play the segment, along with BMW and Volkswagen in Europe.
• In fashion, we believe the global pandemic has caused a split between the most and least capable global brands, with the omnichannel approach now favored by many of the largest companies. Hanesbrands in the U.S. and Swatch (SWGAY) in Europe are our most attractive names in the fashion segment, both trading at significant discounts to our fair value estimates.
• In shipping, giants like Maersk (MAERSK B) have capitalized massively on the capacity constraints caused largely by the pandemic, with higher freight rates generating outsize returns for these companies. However, valuations are less attractive now. Third-party logistics companies have also capitalized on capacity issues to attract new clients and upsell additional services amid increased border restrictions during the pandemic. Structural opportunities remain in this segment, but we believe valuations are now materially elevated.