Morningstar - Q4 2021 - 48

Strategies
Supply Chains Break Under Pressure
But affected areas still offer opportunities.
SUPPLY CHAIN
Michael Field and David Whiston
Global shipping moves in cycles. As the economy
expands, demand increases, stretching capacity
and causing freight rates to rise. Carriers, salivating
at the sight of lofty rates, move to increase
capacity by placing large orders for vessels, which
generally arrive en masse two to three years later,
often as the global economy is slowing down.
Faced with overcapacity, freight rates tumble, and
carriers find themselves back at square one.
Today, after a period of tight capacity, the industry
is raising freight rates once again. This follows
a lean five-year low-rate period, during which the
major carriers were more active than usual,
spurred on by the bankruptcy of industry giant
Hanjin in 2017. Essentially, they got organized and
introduced a level of long-term thinking
not seen in the industry for decades. They forged
alliances, improved capacity, and reduced
the number of " blank sailings, " or cancellations.
The most important repercussion from this new,
more conservative approach was that of ordering
vessels. New orders as a percentage of the
existing fleet has fallen off markedly since 2015,
declining roughly 50% from the first half of the
past decade. This base of tight capacity kindled
the fire we're now feeling, with demand far
outstripping supply and freight rates skyrocketing.
The match that started the fire, however, was
the COVID-19 pandemic, coming hot on the heels
of the already-disruptive U.S./China trade war.
Pandemic Breaks the Supply Chain
The disruption to global trade happened in
phases. First, the pandemic hit China, leading the
government to shut down a large part of the
country in January 2020. This action led to goods
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Morningstar Q4 2021
being delayed leaving the country, or not leaving
at all. For Western companies, particularly
those in the industrial and consumer segments,
the shutdown caused havoc. Supply chains that
usually operated with lead times of just a week or
two experienced delays of months or more.
By April 2020, just as China began to open much of
its economy again, Europe and North America
encountered their first waves of the pandemic,
and swaths of countries closed in an effort to stem
the spread of the virus.
The second phase began as supermarket shelves
were emptied and demand for personal protective
equipment soared. The scramble for goods
from China and other regions was on. The urgent
demand for PPE goods necessitated a shift from
sea to air freight. This demand, combined with
lower supply due to the closure of many passenger
air routes, which also transport cargo, resulted
in a spike in air freight rates. For sea freight,
the disruption caused by the closure of ports, first
in China, then in Europe and the U.S., had
already affected sailing times. Added demand from
businesses attempting to stockpile goods and
from quarantining consumers ordering items
such as gym and office equipment was enough to
overwhelm the diminished shipping capacity,
causing sea freight rates to spike also.
Delays in shipping and the increase in freight rates
have affected almost all markets. Some
industries have been hit harder than others, and
some have even benefited from the disruption.
To explore this dynamic, we will delve into the
four sectors we believe have been the most heavily
affected by the supply chain crisis.
Semiconductors: Intel an Attractive Opportunity
The shortage in semiconductors started with
tight supply caused mainly by the U.S./China trade
war. Although 70% to 80% of the world's
high-end chips are produced in Asia, almost 50%
of the total is produced by U.S.-listed firms,
using U.S. intellectual property. When the U.S.
government announced that it would prevent
the use of U.S.-manufactured chips by the Chinese
military, affected companies such as Huawei
began stockpiling chips. This led to a domino
effect: Competitors followed suit to avoid shortages
in the event of a squeeze. Then, the pandemic
hit. Demand for electronics rose rapidly as people
rushed to set up home offices and ordered
monitors, computers, and other items; stuck at
home, people also upgraded their TVs and gaming
consoles. Combined, consumer electronics and
computers use more than 40% of the world's
semiconductor production. Any unexpected spikes
in demand can quickly disrupt the market,
particularly when supply was tight to begin with.
Although higher demand is the largest reason for
the current chip shortage, supply-side issues
also contributed. In 2020 and 2021, producers closed
foundries as the U.S. and other semiconductorproducing
countries took measures to prevent the
spread of COVID-19. Additionally, several one-time
events occurred-including storms in Texas that
knocked out the state's power grid last winter and
a fire at a factory owned by manufacturer Renesas
Electronics 6723:JP in the spring-that contributed
to constraining supply and increasing prices.
U.S. nationalistic policies may have a lasting effect
on the supply/demand imbalance in the
semiconductor market, at least until China, the
largest consumer of chips, can source alternative
supplies or produce enough chips itself. But
the pandemic-related disruption to the market
should be a shorter-term challenge. As demand for
computers and electronic consumer goods
slows down and supply catches up, we should
return to a more balanced state in the coming year.
Rising prices and high demand have led to
sharp increases in the share prices of the largest
semiconductor stocks over the past two
years. We believe wide-moat Intel INTC now offers
the most attractive opportunity in the segment.
Intel is the leader in the integrated design and
manufacturing of microprocessors found in
PCs and servers, two areas in which we expect
material growth in the future.
https://www.morningstar.com/authors/1995/michael-field https://www.morningstar.com/authors/766/david-whiston https://www.morningstar.com/stocks/pinx/rnecy/quote https://www.morningstar.com/stocks/pinx/rnecy/quote https://www.morningstar.com/stocks/xnas/intc/quote
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