Geopolitical risk and manufacturing bottlenecks are causing corporations to rethink their supply chains, making them shorter and closer to home. As this trend begins to unfold, the infrastructure underpinning “nearshoring”1 has become a theme in Reaves’ essential service infrastructure portfolio.
The following reviews the trend, and how the infrastructure companies tied to it embody the characteristics Reaves seeks.
COVID Creating a Supply Chain Rethink
Since the 1980s, most manufacturers have operated utilizing just-in-time principles - where physical inventories are minimized and materials arrive when needed or “just in time.” This has enabled manufacturers to improve capital efficiency by tying up less working capital as well as floor space.
The technique has relied on careful synchronization of the movement of unfinished goods within a supply chain. As these supply chains have become more sophisticated, they also have become longer and more complex.
While companies always seek efficiencies in their manufacturing, COVID proved disruptive for long supply chains, causing many companies to look at both shortening the supply chain and bringing it closer to home. Geopolitical tensions with China have also caused many U.S. companies to move manufacturing to the U.S., Canada, or Mexico.
These changes have large implications for select infrastructure businesses. It creates demand for more warehousing space to store inventories. It also creates a need to make those warehouses more efficient. Finally, as more firms move manufacturing to the U.S., Canada, and Mexico, it creates more transport demand within North America.
New Niche, Same Investment Playbook
Each of those themes are represented in Reaves’ Long Term Value Strategy2 through its holdings in warehouse companies, logistics firms, and railroad operators. While such stocks represent a new niche in our portfolios, they draw upon the same investment playbook that has served Reaves for years. We search for companies providing essential infrastructure that the economy depends on, and often have sustainable, competitive moats around their businesses that would be difficult to disrupt or replicate.
We believe that companies with these characteristics have the ability to generate consistent, sustainable cash flow and revenue. The resiliency of their business models should also help the stocks compound value over all market cycles
Below is a description of the competitive moats for each of the industries tied to the nearshoring trend:
- For warehousing facilities, the competitive moat is location. There are limited, large spaces in urban areas and near major highways or railways that can house large storage areas and facilitate large trucks moving in and out of a facility. As cities continue to grow, that space commands more of a premium.
- For logistics companies, the competitive advantage is in the technology. There are a limited number of companies that can efficiently design, run a warehouse, and bring to bear the specific robots and automation tools a company needs to make their warehouse more efficient.
- Finally, the railroad networks are truly unique infrastructure assets; new rail systems are near impossible to build on account of modern population density and ensuing construction limitations. Most of the current North American network was built in the latter half of the 19th century. The result is a modern oligopoly of only seven North American operators.
As the trend of nearshoring pushes forward, we think each of these business models will continue to benefit, and that the competitive advantages inherent in these companies make them prototypical Reaves essential service infrastructure stocks.