The Inventory Shuffle
Covid-era chaos is still creating opportunities and risks among industrials
One of the many things we learned during the pandemic was how vulnerable supply chains are to disruption. Lockdowns led to shuttered factory floors and crippled shipping capacity which laid bare the real risks of employing just-in-time inventory practices while simultaneously sourcing components from the other side of the world. Meanwhile, demand skyrocketed for some products while collapsing for others. Then just when the lockdowns lifted and life started to return to normal, inflation reared its ugly head throwing skyrocketing raw materials prices into the mix. Companies cited multiple challenges in this environment including:
Shortages of key parts limiting the ability to sell other inventory. Companies could not finish production on items that were already largely complete.
Scarce inventory items had lead times of 2-4 months, causing companies to double order to plan for these delays. But the log jam broke and suddenly double orders and the 2-4 month order book all arrived in a matter of weeks.
Strikes and closures suddenly halted demand – automakers dealt with strikes in 3Q23 which caused orders to be delayed.
Customers throughout the product chain all experienced surges of inventory – causing order cancellations or simply less ordering overall as inventories were de-stocked throughout the channel.
De-stocking caused production to be cut – and companies to operate less efficiently.
Inflation surged into inventory with higher material costs, higher sourcing costs, and higher transportation costs – followed by much of that correcting and lowering inventory costs in 2023.
These events caused huge swings in inventory levels and gross margins and had big implications for cash flow and earnings. Many companies have benefited of late as conditions have normalized, but that situation may be close to playing out for some. At the same time, several others are still reporting weak results, but there may be the makings of a turn-around coming. We see this scenario creating both risks and opportunities for those willing to sift through the details to discern in what phase of the recovery each company is in.
We started looking at the industrial sector by examining each company’s inventory days of sales (DSI) and gross margin for the last seven years comparing their current and pre-Covid levels. We found several where inventories remain much higher than normal and margins are impaired. Those could see improvement in both areas and enjoy rising guidance in 2024. Others appear to have already had their recovery and may not have the same catalysts working for them going forward such as customer orders rising after destocking. These companies already had their bump. While some may still beat guidance, higher valuations could limit any appreciation.
Below, we take a closer look at two companies that may have upside in the form of higher guidance as well as two who may have had their day in the sun.
Let’s get Behind the Numbers…