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Small caps to benefit from global supply chain disruption

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By Bernard Chua
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4 minute read

Businesses are building up their logistics operations in response to widespread supply chain rising tensions with China, which could lead to favourable outcomes for small cap investors.

US businesses, in particular, are shifting their logistics operations to within their borders, as well as nearby, lower-cost locations in Mexico and South America. Similarly, European companies are moving production to “friendlier” and lower-cost areas such as the Czech Republic, Hungary, Romania, and Poland.

Such shifts offer the advantage of operating in the same or adjacent time zones as suppliers and partners. As a result, simplified scheduling helps reduce costs and improves collaboration and communication. Conducting business in these markets may also offer access to English-speaking workforces, which is the language of global trade.

IT companies, especially those in IT services, logistics software, and semiconductor supply chains, appear to be forerunners of onshoring and nearshoring, whereby company operations are moved to neighbouring countries.

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In industrials, manufacturers need dependable sources of raw materials and components. Moving operations closer to home may help tighten the supply chain, although upfront capital investment expenditures and labour costs may be higher.

Government and corporate preferences are also aligning to avoid a repeat of recent disruptions. This includes the US government’s moves to support “strategic” industries, which should help the makers of semiconductors, electric vehicle components, and health care supplies and tools.

Closely watched supply chains, such as those for new smartphone launches, sit at the forefront of this trend. Apple reportedly intends to rely less on suppliers in China and Southeast Asia in favour of closer, easier-to-manage options.

China and other Asian trading partners may bear initial losses

Investors remember the profound impact of China’s zero-COVID policies shutting down transportation hubs. Factories and ports idled throughout Southeast Asia as ships sat offshore the mainland, Taiwan, Los Angeles, and other ports. These shipping backups crippled supply chains across multiple industries.

Global firms have no appetite for re-enacting that scenario, so they are casting their nets in other waters.

How small caps benefit from shift to deglobalisation

Reasons for this rational include the following:

  • Onshoring implies increased capital expenditure as companies build new facilities at or near home. According to a Bank of America research, small cap revenue growth has historically shown a high correlation with capex spending.
  • New production facilities require vast support networks. For example, spurred by the availability of federal subsidies through the CHIPS Act of 2022 – legislation designed to boost US competitiveness, innovation, and national security – the Taiwan Semiconductor Manufacturing Company (TSMC) will invest $40 billion to open two chip plants in North Phoenix, Arizona. TSMC Arizona and its workforce will need new infrastructure, housing, restaurants, retailers, medical facilities and more. The new jobs in TSMC’s supporting industries will likely be skewed towards small cap companies.
  • Small caps tend to derive more revenue generation and earnings growth from local operations than their large cap peers, given the greater domestic focus.
The global business landscape is undergoing a significant transformation as companies take proactive measures to secure their supply chains and mitigate future disruptions.

Onshoring, nearshoring, and friendshoring initiatives are gaining momentum, with Mexico, South America, and Europe emerging as potential beneficiaries at the expense of China and other emerging markets.

Companies in the IT and industrial sectors may be well-positioned in this environment, but companies across all sectors of the global economy should be assessing the efficiency of their respective supply chain.

Bernard Chua, senior client portfolio manager, American Century Investments

Small caps to benefit from global supply chain disruption

Businesses are building up their logistics operations in response to widespread supply chain rising tensions with China, which could lead to favourable outcomes for small cap investors.

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