Weekly Wisdom – September 7, 2022

By Gina Stahl on September 7, 2022

Focusing on the Enterprise Demand Amid Cyclical Headwinds

The consumer represents 70% of the U.S. economy. The Fed’s tightening policy is meant to slow consumer demand to a pace where supply chains can recover and reach a more sustainable
supply/demand level that ensures greater price stability.

Higher interest rates tend to not favor long duration, cyclical growth assets. In addition to the Fed’s policy actions, higher inflation is creating pain for consumers balancing higher expenses broadly.

The consumer is clearly facing headwinds and will continue to face these headwinds in the months ahead. We’ve already seen shifting consumer demand trends that include favoring experiences vs. stay-at-home and trading down within retail, seeking discounts.

Opposite consumer demand, you have businesses and industries, which we refer to as enterprise demand.

While consumers are feeling pressured, quality businesses have in large part been the beneficiaries of high demand and able to pass-through at least some inflationary costs.

Most businesses have been impacted by hybrid work environments, tight labor markets and inefficient supply chains. These themes have underscored a secular demand for necessary enterprise spend toward infrastructure that will protect and support future growth.

Some of the enterprise spending themes we are following include cloud/data infrastructure within IT, freight/aircraft capacity and utilities infrastructure.

Investing in Enterprise Spending

The challenges brought upon by COVID-19 have created many short-term beneficiaries, but also accelerated long-term, underlying challenges.

Work from home was the most notable of these trends,
and while workers largely embrace the modern-day hybrid approach to traditional office jobs, most companies realized they were behind on their “digital transformation” efforts.

Enterprises have been pouring money into their unique digital transformation journeys – including enhancing data storage, security, artificial intelligence (AI) and app innovation.

Last week, VMWare (VMW) extended their ongoing collaboration with Microsoft (MSFT) to service corporations looking to scale their cloud platforms.

“Digital transformation holds the promise of enabling new business models, improving customer experiences and delivering better outcomes for organizations,” says Kathleen Mitford, corporate vice president, Azure Marketing, Microsoft Corp.

Consider the average worker that worked in the office 9-5 and typically left their laptop at work.

Now that same laptop has been traveling regularly, is being used at the dinner table and includes more personal use.

This requires more security, storage and servicing. Also consider the drawbacks of lower productivity from being remote or labor shortages, or just the compounding quantity of data being
recorded across firms – this has generated demand for more AI capabilities.

IBM is looking to capture enterprise spend demand with its “edge computing” strategy – as companies struggle to find and afford PhDs, IBM sees “millions of potential AI applications that exist at the edge and are driven by several billion connected devices.”¹

Along with technology, we’ve seen enterprise spend across freight and supply chains. The long backlogs across supply chains have prevented the likes of autos and aircrafts from being delivered to enterprise buyers.

As commercial aviation has rebounded dramatically since Spring 2021, airlines have been unable to replenish their fleet.

High demand and tight labor capacity have caused existing aircraft to be run harder than ever before, and aircraft manufacturers have cited record backlogs as evidence of the enterprise demand.

Airbus (AIR), through July, has delivered just 343 of their target 700 aircrafts for the full year. Similarly, Boeing (BA) announced a surge in new business orders in July, while deliveries slipped to a five-month low.

Further, aircraft manufacturers have transformed a large percent of their commercial aircraft inventory into cargo planes to support demand and address challenges within freight capacity.

Demand in railways has been robust, and Union Pacific (UNP) recently announced a huge $1 billion deal with Wabtec to modernize 600 locomotives, with the goal of improving efficiency and sustainability across its service territory.

Even if consumer demand slows, this infrastructure demand is inelastic for businesses that want to compete in the future economy.

And lastly, shifting climate has created flooding and heatwaves, causing changing demographics to tolerate the effects of strained or inadequate water and power infrastructure.

Just recently in the U.S., a record number of households are behind on surging utility costs, California has declared a power grid emergency and the south is experiencing a water crisis due to heavy flooding.

All areas of the U.S., whether directly or indirectly, are being impacted by inadequate utility infrastructure, and these problems are even more dire in Europe.

Rather than blanketing short-term problems by releasing
emergency petroleum reserves, limiting power use and sending emergency aid, the long-term infrastructure problems need to be solved.

Motivating Enterprise Spend: Capturing Subsidies and Capturing Market Share

Government tends to be the largest provider of capital when it comes to subsidizing mass infrastructure enhancement. The U.S. government has passed action related to transportation and
electric grid infrastructure, but much work clearly lies ahead.

Company IT budgets rely less on government backing and more on a motivation to grow and compete without being dragged down by inefficiencies and security constraints.

Low carbon goals and high fuel costs are encouraging companies to invest in better fuel efficiency, while tight labor markets encourage more autonomous and AI solutions.

Whatever the motivation, secular demand is the underlying theme behind enterprise spend, and we’re finding ways to selectively capture these themes, while reducing cyclical risk, within our barbell equity portfolios.

Click here to read last week’s Weekly Wisdom (8/31).

SOURCES

¹ Source: Forbes

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