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Commentary

Supply chain opportunities

May 19, 2022

Warehouse worker wearing face mask and protective workwear checking products using digital tablet.

China accounts for about 12% of global trade. Covid restrictions have idled many factories and warehouses, and it could prove to have a great impact on local and global businesses. United States (U.S.) and European ports are already swamped from the present supply crisis, leaving them vulnerable to additional shocks.

China’s top exports are broadcasting equipment ($223 billion), computers ($156 billion) and integrated circuits ($120 billion). Top imports include crude petroleum ($150 billion), integrated circuits ($144 billion), and iron ore ($99 billion).

In the short run, the pile-ups will mean more costly headaches for the $22 trillion global merchandise trade. In the mid-term, investments in China will slow as cross-border travel will remain difficult. To give a sense of implications, there are more than 70,000 foreign-invested companies in Shanghai alone.

Chinese Covid restrictions will only accelerate the need to onshore, a theme that has been developing in the last couple of years. For a company, the risk factor of buying key components from foreign countries has become an important consideration among managers on a daily basis. The availability of goods has become critical in competitive landscapes. And, as the saying goes, the downfall of some will be the fortunes of others.

As investors, we certainly look to profit from these disruptions and seek to identify the companies who will gain market share from supply chain disruption or abrupt changes in market conditions, such as changes in tariff regulations.

Lesson learned, in 2017, Global Alpha invested in Solaredge Technologies, a small, sub $1 billion market cap technology firm providing high-quality inverters to the solar industry. At the time, Huawei was to enter the US market and compete heavily on price. The story unfolded where Huawei could not compete technically, and, deterred to enter the U.S. by international trade tariffs, Solaredge has a $12 billion market cap today. We have since exited the position.

Global Alpha believes that the China lockdown and the accelerated onshoring could provide more Solaredge-type opportunities.

Caesarstone (CSTE:US)

Caesarstone is a concept and lifestyle-driven company with a customer-centred approach to designing, developing, and producing high-end engineered surfaces used in residential and commercial buildings globally. The company has two main manufacturing facilities: one in Israel and the other in the U.S.

The company provides high-quality countertops for the professional network of architects and home designers. With time, it has expanded its offering to big box outlets, such as Home Depot, Lowes and IKEA. Its markets are global, with concentrated sales in the U.S., Canada, Australia and Israel.

In the last few years, competition from Chinese countertop manufacturers has put pressure on company margins, as well as demonstrated a deeper need to innovate from quartz to ceramics materials.

Recently, Caesarstone has shown revenue growth, both from the rebound of U.S. construction, as well as a strong focus on its product mix, both in the professional and big-box segments. With a strong presence in the southeastern United States, Caesarstone is also in a good position to benefit from a fast-growing market.

The supply shortages occurring in China could affect Ceasarstone’s competition as Chinese countertops lack availability. We would expect the company to take full advantage of this situation. Long term, non-Asian distributors could increase their relationships with Caesarstone as they implement deeper onshoring strategies.

De’Longhi (DLG:IM)

De’Longhi is an Italian manufacturer and distributor of small domestic appliances worldwide, with operations in the espresso coffee makers, food preparation, comfort and home care segments. The group’s brand portfolio comprises De’Longhi, Kenwood, Braun and Ariete.

The company competes against French company Group SEB and Australian company Breville in many home-destined consumer products. The competition in the high-end coffee maker segment has been notable with Hollywood-level advertising and De’Longhi using Brad Pitt to fend off George Clooney’s success with Nespresso.

With a strong manufacturing base in Treviso, Italy, the company may be able to navigate the Chinese supply issues with some ease. Its competitor Groupe SEB is four times the size of De’Longhi, but mostly because it has global dominance in cookware. As Groupe SEB ferociously competed with the Chinese in cookware, they moved most of their production to China. Today, De’Longhi is in a position to take the market share because of its favoured local production. 

The onshoring theme is providing many strong tailwinds in certain industries. As an example, Taiwan chip manufacturer TSMC is investing heavily in Japan in an effort to diversify from China. In fact, Japan could become a major beneficiary of moving production out of China from its industrial technology leadership, proximity to Asian markets and developed market status.

Kurita Water (6370 JP)

Global Alpha recently purchased Kurita Water in Japan. Founded in 1949, Kurita Water manufactures and sells water treatment equipment and chemicals. Revenue mix by region is Japan at 60%, Asia 18%, and the rest of the world at 22%. Water treatment equipment represents 61%, while chemical sales are 39%, a strong recurring revenue source. The main industry focus of Kurita is the electronics industry, at 63% of revenues.

Water treatment in electronic manufacturing is of high technical standard supporting Kurita’s expertise and leadership in water treatment.

Kurita Water has always been on our watch list for the quality of its products and long history. During the last eight years, it participated in a highly competitive Chinese market. The diversification decision by its clients, such as TSMC to develop chip manufacturing in Japan, should support company growth over several periods.