Two decades ago, it was the stuff of sci-fi nightmare. Today, it’s just a fact of life. The machines really are taking over. Not everywhere, of course, but most certainly in the manufacturing realm. A group of Credit Suisse analysts led by the bank’s head Multi-Industry and Electrical Engineering research analyst, Julian Mitchell, first pointed out last year that companies that make and sell industrial automation technology that both monitors and runs industrial manufacturing processes are an attractive long-term investment target. The $152 billion global industrial automation market has grown 6 percent a year, on average, since 2003, the analysts reported, which is nearly twice as fast as overall industrial production.
The future seems likely to bring more of the same. China, in particular, is set to drive significant growth in demand for robots and other industrial automation technologies. A diminishing supply of workers has finally pushed wages higher in the country, and automation is looking more and more competitive to human labor from a cost standpoint. Robots also never ask for salary increases and can work efficiently for hours without a break. Wages are also rising in other emerging markets, analysts pointed out, which means that simply moving operations to a cheaper wage-cost locale is less of an option as well.
The long-term case for industrial automation growth remains solid, but Credit Suisse analysts have recently pointed to several shorter-term drivers of opportunity for investors in the space.
First, manufacturing activity is picking up around the world, Credit Suisse economists noted this month in an update entitled, “Pulse of Global Industry: The North Atlantic Still Outweighs China.” Global industrial production levels have increased for seven months straight, and though production took a slight dip in May, it appears likely to pick back up in June, the economists wrote. Growth will likely continue to slow in China, the world’s manufacturing powerhouse, in the second half of the year, but not as rapidly as it did in the first half. Chinese exports should soon start to benefit from improved economic conditions for trading partners like the U.S. and Europe. At the same time, manufacturing activity seems to be improving in the U.S. and Europe. In the June purchasing managers’ index (PMI), a monthly survey that is a bellwether of manufacturing activity and sentiment, businesses in both regions reported an increasing number of new orders. In the euro zone, PMI rose above 50 – the threshold that separates an expanding manufacturing economy from a contracting one – for the first time in more than two years. All of that industrial activity paves the way for new investments into processes and equipment, including automation technologies.
Second, there is increasing consolidation among makers of automation technology. Companies have been looking to expand horizontally, by making products for different types of manufacturing, and vertically, by targeting different levels of manufacturing operations. Thus, the sector has become ripe for mergers and acquisitions activity, Credit Suisse equity research analysts said in a recent note entitled “Summer Trade Ideas” that ticked off six key summer investment themes, including industrial automation. Most recently, Schneider Electric, a French electrical and industrial giant, put in a $5 billion bid to buy Invensys, a British industrial automation company that works with oil refiners, nuclear power plants and chemical companies, largely to improve Schneider’s offerings in something known in industry jargon as “process automation.”
Here, a little background is in order. There are two major forms of manufacturing. “Process” manufacturing involves refining raw materials of various kinds into a finished product – petroleum products, chemicals, and pharmaceuticals fall into this category. “Discrete” manufacturing, on the other hand, involves joining together pieces of a whole that are themselves highly engineered – such as building a semiconductor or assembling the parts of a car into a functioning automobile. Process manufacturing operations are usually focused on the flow or mixing of raw materials – oil, for example – while discrete manufacturing relies much more on mechanical actions to build something. Historically, the makers of automation technologies have focused on one of the two, Credit Suisse pointed out in a major August 2012 research note entitled “Global Industrial Automation: The Next Phase.” Both Siemens and Mitsubishi, for example, offer a wide variety of products that automate discrete manufacturing for a customer base that includes carmakers. But neither has a strong presence in process manufacturing,
But these traditional silos are breaking down. Take Schneider, which has a historical focus on discrete manufacturing. Acquiring Invensys would add a valuable process manufacturing franchise in remote monitoring and control of heating, temperature and safety systems for energy companies. Siemens and Rockwell Automation, two other big players in automation technologies for discrete manufacturing, are also looking to expand into process production, Credit Suisse analysts have noted. And Zurich-based ABB, a power and automation technology company, though traditionally strong in process manufacturing, is trying to strengthen its discrete manufacturing capabilities.
Automation businesses are also looking to vertically integrate by targeting new pieces of the manufacturing process, the bank’s industrial analysts noted in the 2012 report. Companies that make robots to work on individual tasks on an assembly line, for example, have been seeking to branch into higher-level systems that coordinate automation at the plant level – in other words, creating the machines and software that oversee and regulate the work of numerous robots, assembly lines and machinery. In process manufacturing, companies that make sensors and valves are likewise aiming a step further into products that oversee entire plants. In part, companies want to expand into higher-value businesses out of fear that competition from China and elsewhere could turn instruments into a commodity product with low margins.
Companies that already make plant-level automation systems are also seeking to broaden their reach, and are aiming at “enterprise level” systems, which are higher-level automation tools geared toward fulfilling big-picture business objectives. Some of those systems gather and share data among many areas of the business, including customer relationships, sales, maintenance and manufacturing. Others keep track of how resources are being used throughout the life of a product. Others aim to allow businesses to better coordinate design and manufacturing teams, making it easier to speed products with very detailed specifications to market. Siemens has acquired a number of software companies since 2007 with vertical integration in mind. In 2011, for example, the German conglomerate’s Industry Automation division purchased Massachusetts-based Vistagy, which builds design software specifically geared toward the composite carbon fiber materials used in aerospace engineering and wind turbines. At the time, Siemens said Vistagy’s technology would help with something called “product lifecycle management (PLM)” – an industrial term for the process of shepherding and tracking products as they move through design, production, maintenance, and ultimately, disposal.
Siemens is not the only company to focus on beefing up its software offerings. Credit Suisse said in a recent report entitled “Industry Software Deep-Dive” that industrial automation software will enjoy 8 percent compound annual growth between 2013 and 2016, compared to 4 percent for automation hardware, with higher profit margins to boot. “We believe that industry software is becoming more attractive to a wider range of customers because the data management costs associated with using software (cloud storage of performance metrics, operational data) are improving payback times on software investment,” the analysts explained. “New manufacturing technology such as 3D printing is also driving demand for product design software.” The growing interest in software has also been driving M&A activity. This year, Siemens bought a company called LMS International, which specializes in simulation software that allows manufacturers to model and test products virtually, for $800 million. Dassault, a French company that also makes industrial automation products, recently bought manufacturing software company Apriso for $200 million.
Companies that make industrial automation tools are expanding into new lines of business just as industrial activity around the globe is beginning to recover. With labor costs rising even in low-cost manufacturing countries, the smart machines are here to stay, and smart investors may want to pay attention.