Global industrials: beyond
the AI winners

Global industrial companies associated with data centres and the AI build-out have enjoyed significant share price gains of late. Our portfolios have benefited from this trend through direct investments in semiconductor companies, which we believe offer some of the purest exposure to the theme.

At current valuations, we’re cautious about increasing exposure to AI-related industrial businesses. Instead, we are finding attractive opportunities among high-quality companies in the sector that are benefiting from longer-term structural trends but have attracted far less investor attention.

A changing industrial landscape

At first glance, the global manufacturing sector has appeared relatively weak in recent years. Traditional manufacturing surveys have pointed to sluggish conditions and contraction, yet many US industrial companies have continued to deliver solid growth.

The reason is that growth has been concentrated in a few powerful themes rather than spread evenly across the economy. One of these is the massive investment being made in data centres and digital infrastructure.

The other is the tariff-driven reshoring of manufacturing, particularly in the US, where companies are increasingly investing in domestic production facilities and supply chains. New US factory construction is running at roughly two and a half times its pre-pandemic pace. The winners are not the companies selling the end products, but rather the ones that build, equip and service the facilities.

These trends are structural and likely to play out over many years. They are also less dependent on consumer spending than is typically the case in the industrial sector, helping to explain why traditional manufacturing indicators have been a poor guide to performance.

What we look for

When assessing industrial businesses, a handful of characteristics consistently separate the highest-quality companies from their peers:

• We favour companies that operate in markets with long-term growth potential. Air travel, for example, has historically grown faster than the global economy. Similarly, the amount of electronic content in vehicles, devices and data infrastructure continues to increase over time.
• We look for businesses with strong competitive positions. The most attractive industrial companies often supply components or systems that become deeply embedded in their customers’ operations. Once installed, these products can be costly and disruptive to replace, creating long-lasting customer relationships and pricing power.
• We value disciplined management teams that allocate capital sensibly throughout the cycle. This includes using downturns to buy back shares when they’re cheap, rather than at the top of the cycle.
• The final ingredient is price. Even the highest-quality company can deliver disappointing returns if purchased at too steep a cost. With much of the market’s attention focused on AI-related businesses, we believe there are opportunities to acquire industrial companies at more reasonable valuations elsewhere.

Beyond data centres and AI

Many of the industrial businesses linked to AI are excellent companies. European franchises such as Schneider Electric, ABB and Siemens hold leading positions in attractive markets and continue to benefit from growing demand for data-centre infrastructure. If the build-out extends as far as some expect, current earnings forecasts could well be exceeded.

Our caution is not about the quality of these businesses. Rather, it reflects their current price and the overlap with exposure we already hold through semiconductor investments. In many cases, these companies are being driven by the same underlying AI theme.

Should valuations become more attractive, they could certainly warrant consideration. For now, however, we’re finding more compelling opportunities in other areas of the sector.

Companies on our radar

One company that stands out is Motorola Solutions. Despite sharing a name with the former mobile phone business, Motorola Solutions today focuses on critical communications systems used by police, fire and emergency services. Once these networks are installed, they are difficult to replace. Nearly 40% of revenue is recurring, margins are excellent, the balance sheet is healthy, and the current share price does not fully reflect the company's growth prospects.

We’re also interested in two specialist aerospace businesses: TransDigm Group and HEICO Corporation. Both supply proprietary aircraft components that airlines continue purchasing for decades after an aircraft enters service. The long-term growth in global air travel provides a powerful tailwind for both businesses.

The key difference lies in their financial structures. TransDigm employs more debt, which can amplify returns but also increases risk. HEICO has a more conservative balance sheet and an exceptional operating record, but this quality is well recognised by investors and reflected in its valuation. At present, TransDigm appears more attractive from a valuation perspective, while HEICO remains a business we’d watch for a better entry point.

Another company attracting our attention is Honeywell International. Honeywell is in the process of separating its operations into more focused businesses. Of particular interest is its aerospace division, which has many of the characteristics that make companies such as TransDigm and HEICO attractive: recurring aftermarket revenues, strong competitive positioning and exposure to the long-term growth in air travel.

Looking ahead

The businesses that interest us today are not dependent on AI enthusiasm or short-term economic cycles. Instead, they combine durable competitive advantages, disciplined management teams and exposure to long-term structural growth trends.

We don’t currently own any of the companies discussed above in our global direct equity portfolios. However, they are firmly on our radar, and we may become more active in this area should valuations and opportunities align with our investment criteria.