Industrial CEOs are still in the mood to spend

Inflation is running hot and supply chains are still snarled, but CEOs are ready to spend. 

This week brought a deluge of earnings updates from industrial heavyweights including General Electric Co., 3M Co., Rockwell Automation Inc. and Caterpillar Inc., giving investors a fresh opportunity to hear executives' thoughts on the operating environment. There are some signs of progress: Resin availability was severely curtailed because of storms early last year that shuttered Gulf Coast factories in the U.S., but that has since improved, Rockwell Automation Chief Executive Officer Blake Moret said in an interview. 3M said the pace of inflation slowed in December compared with that of earlier months, though time will tell whether that trend holds. Dover Corp. can buy raw materials such as steel at cheaper prices now than what it paid to build existing inventory, CEO Richard Tobin said on a call with analysts. "It's not as bad as it was, and it's getting better," Tobin said of the supply chain. 

But in general, industrial leaders seemed frustrated that there hasn't yet been more material relief on shortages, out-of-sync-production pileups and high logistics costs. Sales in GE's health-care business would have been about 7 to 8 points higher in the fourth quarter if the company had been able to fill all customer orders. Caterpillar's operating margins were weaker than expected at the end of 2021 because the company kept factories open even when it lacked supplies and paid up for premium freight options to meet as much customer demand as it could. Most CEOs are coalescing around the second half of this year as the turning point for supply chains to finally start to normalize and for price increases to overpower inflationary input pressures. But all anyone seems to know for sure is that semiconductor shortages will take the longest to resolve. "It's a combination of constraints that are directly pandemic-related but also constraints that were probably brewing even before the pandemic," Moret of Rockwell said. "Vehicles are requiring more chips than ever before. Everything is becoming smarter. New capacity will improve the situation, but it's not going to come online for a while."

The concern among investors is that rising costs and long wait times will destroy demand before broad supply relief comes — or that a lack of parts and people will constrain companies' ability to spend on new capacity to ease supply crunches, creating a self-fulfilling cycle. 

But while inflation appears to be weighing on consumer spending, there remains little evidence that the buying appetite among industrial customers is fading — outside of arguably idiosyncratic factors in the China construction markets. Asia-Pacific sales in Caterpillar's construction segment fell 12% in the fourth quarter, and the company warned China demand may decline in 2022. But the growth potential is strong "everywhere else," Caterpillar Chief Financial Officer Andrew Bonfield said. More broadly, sales and order rates will start to moderate in the back half of this year as companies lap the early stages of the Covid recovery. But at the current pace, that is a healthy phenomenon and reflects a stabilization of demand at levels much higher than before the pandemic. Dover, for example, has a backlog of $3.2 billion, up 84% from the year earlier, and some of its businesses that typically have short sales cycles are taking orders for well into the third quarter. "Look, bookings are going to slow," Tobin said. "It's just inexplicable to me that there's even any need for our customers to go beyond there at this point." It's a good sign if the order backlog declines, though, because that will mean production performance is getting better as labor availability and supply chains improve, he said. 

In a testament to how strong industrial companies think the underlying demand environment truly is, just about every major manufacturer that has reported earnings so far has announced a step-up in capital investment plans for 2022. Dover plans to spend as much as $220 million on capital expenditures this year, up from $171 million in 2021 and the most on an annual basis since 2012. Projects include adding more capacity to support higher production of biopharmaceutical pumps, heat exchangers and beverage packaging machinery. Consumer-goods companies are pivoting to more environmentally friendly aluminum options, driving demand for metal-based can and bottle systems from Dover's Belvac unit. 3M recently announced a $500 million investment to expand its manufacturing operations for Command hanging products and Filtrete air filters in Clinton, Tennessee. Even GE, whose ability to spend has been constrained in recent years by its debt woes, is targeting higher expenditures next year. The company will give more details when it hosts an investor event on March 10.

Some companies — including 3M, long-haul trucker J.B. Hunt Transport Services Inc. and grocer Albertsons Cos. — have said they had to curtail their spending plans in 2021 because they couldn't find enough supplies. But they're hopeful they can make that up this year. Rockwell CEO Moret sees these delays as simply elongating the capital spending cycle rather than reducing the potential opportunities. "Everyone is coming out of this historic time looking to add new products, new agility and more flexibility than they've had before," he said. "I look at our own investments —  no way are we just going to not do it." 

Rockwell had previously flagged a $200 million increase in spending this year, and that goal remains on track, CFO Nick Gangestad said on a call with analysts. The company is investing in visualization tools, cloud-native software development and new hardware functionality for its control system offerings, among other things. 

"The fact of the matter is — and I don't want to get cheeky about ESG-driven nomenclature here — is that the fastest-growing portions of that segment are in sustainability technologies." — Dover Corp. CEO Richard Tobin

Tobin was commenting on Dover's fourth-quarter earnings call about the company's decision to change the name of its fueling solutions unit to "'clean energy and fueling" and to shift the name of its refrigeration and food equipment division to "climate and sustainability technologies." The renaming was prompted by a shake-up of Dover's businesses: In December, the company completed the divestiture of its Unified Brands cooking equipment operations and announced the acquisition of a pair of clean energy flow control companies for a total of more than $900 million. It doesn't make sense to have a food equipment division if you no longer sell food equipment. But narrative is increasingly important for manufacturing companies. Much of the industrial stock outperformance last year was driven by thematics, with companies that fit neatly into buckets like "automation," "climate" or "electrification" benefiting from higher valuations than those with more complicated stories. The point is that if a company has a clean energy business, it should advertise that fact. It can't hurt. To industrial companies' credit, they mostly haven't embraced NFTs, random crypto forays and other such nonsense in the way more consumer-facing businesses have. There's still time, though. 

Trouble in Dealmaking? 

Lockheed Martin Corp.'s $4.4 billion takeover of rocket-booster maker Aerojet Rocketdyne Holdings Inc. is on thin ice after the Federal Trade Commission sued to block the deal. The FTC argued the transaction would give Lockheed the ability to cut off other military contractors' access to essential components for making missiles. That reduced competitive pressure would allow the company to "jack up the price the U.S. government has to pay, while delivering lower quality and less innovation," Holly Vedova, director of the agency's bureau of competition, said in a statement. The FTC also appeared to give credence to concerns reportedly raised by Raytheon Technologies Corp. that its intellectual property could be at risk if one of its key suppliers is acquired by a direct rival.

The merger agreement gives Lockheed and Aerojet 30 days to decide whether to terminate the transaction or fight the FTC in court, but shareholders are already acting as if the deal is dead. Aerojet plunged more than 18% on the news and closed at a lower price than it traded at before the Lockheed deal was announced. This reaction may partly reflect its less-than-robust standalone public company infrastructure; Aerojet doesn't host quarterly conference calls, for example, and it doesn't regularly engage with Wall Street analysts, according to Truist Securities' Michael Ciarmoli. Lockheed, on the other hand, rallied amid speculation that the money earmarked for the Aerojet deal could be diverted to share buybacks and dividends that may ultimately prove more beneficial for investors. 

The broader takeaways from this deal's likely demise are more limited. Defense mergers are always tricky. The FTC's decision to block the merger rather than sort out remedies with Lockheed does signal a tougher stance on antitrust than the past, but this isn't exactly a surprise. Large, high-profile deals in industries that are already extremely consolidated look vulnerable. On the other hand, the Department of Justice last year cleared a merger of the two largest aircraft lessors, and AerCap Holdings NV has since merged with GE's leasing arm. The sheer volume of transactions awaiting approval will limit the number of transactions that regulators can effectively challenge. As far as vertical integration goes, Lockheed's bid to buy one of its suppliers may have failed, but the trend remains alive and well. General Dynamics Corp. said this week that it's expanding in-house wing production capabilities to help boost output of Gulfstream jets and keep up with booming demand.

Deals, Activists and Corporate Governance

Boeing Co. is expanding its stake in air-taxi startup Wisk with a fresh $450 million investment. The planemaker will also provide engineering expertise to help build an electric four-seater jet that Wisk aims to eventually certify with U.S. regulators. It's interesting that Boeing chose to prioritize this investment, especially amid an increasingly crowded landscape for electric air taxis. The company hasn't exactly been rolling in cash lately; it burned through more than $31 billion over 10 quarters as it grappled with the 737 Max crisis and the global pandemic before finally eking out a positive number in the fourth quarter. Boeing announced a spinoff of its venture capital arm, dissolved an internal investing operation, walked away from a much larger deal with Embraer SA and sold off real estate, among other things, to help cut costs and raise funds. 

CACI International Inc. paid $225 million to acquire ID Technologies, a software services and network modernization provider with National Security Agency-compliant protocols for handling classified information. The technology allows for secure remote access by defense and intelligence customers. 

Schneider Electric SE is considering a sale of several industrial automation and control assets, people familiar with the matter told Bloomberg News. Schneider's Telemecanique business could be valued at about $1 billion in an auction process that's likely to attract both strategic and private equity suitors, the people said. The company is also reportedly considering parting with a business that makes uninterruptible power supplies for rugged environments and its Eurotherm unit, which provides products for temperature and power control and data measurement. 

Salmon M&A! This isn't industrial exactly but it's fun. Apparently, there's a mini deal frenzy in the salmon world.

NTS ASA built a majority stake in Norway Royal Salmon ASA last year and struck a deal earlier this month to merge its SalmoNor unit with that business to create the world's sixth-largest salmon farmer. Shareholders of NTS tried to buy out the company. But now Mowi ASA, the world's largest producer of Atlantic salmon, has made a counteroffer that values NTS at 13.8 billion kroner ($1.55 billion). The offer is half stock and half cash. Should the deal proceed, the acquisition would add an additional 84,000 metric tons to Mowi's existing harvest of 466,000 tons of Atlantic salmon a year. That is a lot of fish. 

Brooke Sutherland is a Bloomberg Opinion columnist covering deals and industrial companies. She previously wrote an M&A column for Bloomberg News.

Disclaimer: This article first appeared on Bloomberg, and is published by special syndication arrangement.