Supply-chain stress may have peaked already

Don't look now, but the worst may be over for the supply-chain snarls that have plagued shipments of everything from Coca-Cola Co. ingredients to paint, toys and industrial fasteners. 

Average ocean freight rates have declined for three straight weeks. A composite index of global container prices has fallen back under $10,000 for a 40-foot box for the first time since Labor Day, according to data released Thursday by maritime advisory and research firm Drewry. The cost relief is modest: The freight rate benchmark remains almost 300% higher than it was at this time last year. But the feverish climb in shipping costs at least appears to be waning. Rates had climbed for 23 straight weeks before the recent step back, Drewry data show.

Carrying goods across the ocean is just one part of the supply chain. More than 60 container ships wait to enter the ports of Los Angeles and Long Beach, according to the Marine Exchange of Southern California. While that's still very high relative to historic levels, it's an improvement from the record 73 ships that were anchored or idling further offshore in mid-September. 

Once a ship can be unloaded, its contents are often packed onto a train and ferried across the country to railyards, then picked up by a truck for the last mile of their journey to company distribution centers or factories. Industrial distributor Fastenal Co. typically negotiates an overarching rate with steamship freight lines, which coordinate the whole process. But the dearth of shipping containers has forced the company to cut out the railroad middle man and instead manually unload goods at the port and pack them onto a semi-truck. The extra logistical legwork is significantly more expensive. So while shipping rates are up fourfold, Fastenal's total door-to-door cost is up more like six-fold, Chief Executive Officer Dan Florness said this week. Even here there's some good news, though: Fastenal had to manually unload about 45% of its shipping containers in August. By September, it was unpacking 28%.

"I don't know if it's coming down and it's going to continue," Florness said. "One month isn't a trend; it's a data point." He's right, but at least it's a positive data point for a change. 

The shipping crunch may have been exaggerated in recent months as companies over-ordered to ensure they had enough product and wouldn't miss out on sales. Retailers in particular appear to have moved up their holiday-season shipping to July-September, from the usual September and October, Bank of America Corp. analyst Ken Hoexter observed in a recent note. Even in normal times, the window to get goods in time for holiday shopping would largely be closed by mid-October and certainly by Thanksgiving. So there soon should be more availability for everything else. 

President Joe Biden's administration this week announced a plan to operate the Port of Los Angeles 24 hours a day, seven days a week to further ease the congestion. It's a rather simple proposal for an incredibly complicated problem. Even if the ports were operating perfectly, labor shortages and bottlenecks elsewhere would continue to gum up the system. But the White House plan might make another dent in the logjams, and a dent is better than nothing. Authorities are also working to set up inland "pop-up" terminals and speed the application process for commercial truck-driving licenses. 

The Covid-related factory restrictions in Vietnam and Malaysia that have contributed to shortages of industrial parts and semiconductors also appear to be easing. Units of Intel Corp. and Samsung Electronics Co. aim to resume full operation of their Ho Chi Minh City plants by the end of November, Bloomberg News reported, citing Le Bich Loan, the deputy manager of the Saigon Hi-Tech Park. Toyota Motor Corp. is working with pandemic-stricken suppliers in Southeast Asia on a plan to ramp up production starting in December and recover some of the output it's lost due to shortages, Reuters reported this week. 

Of course, the global supply chain is still nowhere close to normal. Fresh headaches may emerge — like the typhoon that shut down China's Yantian port this week. In any case, early reports indicate that even at its peak, the freight crunch may not have been the earnings killer investors feared — at least not for every company. At Fastenal, average daily sales growth actually accelerated in September from the July and August pace despite substantial disruptions. The company used price increases to offset what CEO Florness called "brutally high" inflation in the third quarter and expects to do so again in the final stretch of the year.

Large companies have more leverage with suppliers and shippers than smaller ones. In Fastenal's case, it also helps that the company operates on a highly decentralized basis and empowers local employees to do whatever is necessary to fill product gaps with alternative domestic suppliers. Fastenal also has its own trucking fleet; while it's still expensive to move products that way, the company has an advantage over those who rely on third parties. But Honeywell International Inc. and Dover Corp. have also gotten creative about finding ways to push product out the door. Emerson Electric Co. this week reaffirmed its sales outlook — a notable development after others, including Allegion Plc and Eaton Corp., trimmed their forecasts on supply-chain woes.

Investors are prepared for a particularly ugly industrial earnings season, and there will probably still be plenty of ugliness to go around. But there may also be some positive surprises. 

Kahyaoglu was writing about the latest hiccup with Boeing Co.'s 787 Dreamliner. The company has reportedly discovered that titanium components made by a subcontractor for one of its largest suppliers, Italy's Leonardo SpA, are weaker than they should be and will need to be replaced on certain planes built over the past three years. The flawed parts include spacers, brackets and clips that are used in sections of the airframe, a person briefed on the matter told Bloomberg News. Boeing said the defective fasteners pose no immediate safety concern for in-service 787 jets. But the company hasn't been able to deliver a Dreamliner since May while the Federal Aviation Administration reviews changes to analytics and process controls that Boeing put in place to address a separate problem involving tiny wrinkles on the plane's carbon-fiber frame.

About 100 undelivered Dreamliners are parked at Boeing factories or in the desert gathering dust rather than producing much-needed cash flow. Kahyaoglu is taking the positive view: Boeing and the FAA are leaving no bolt unexamined, so once this process is over, the Dreamliner should be relatively issue-free. But the litany of production flaws does little to help perceptions of Boeing's quality control. The Wall Street Journal reports that 787 deliveries may not resume until November at the earliest. 

The Big Idea

This will be a new, monthly feature. For the most part, I'll focus on technology and products, but big ideas may also include strategy shifts and new ways of interacting with employees or investors. Want to suggest something I should highlight? Email me at bsutherland7@bloomberg.net

What Is It? Honeywell this month introduced Anthem, a cloud-connected aircraft cockpit system that can be customized and scaled according to pilots' needs and the type of aircraft. 

What Does It Do? Anthem's two-way connectivity enables enhanced data transmission and real-time visibility. Dispatchers can alert maintenance crews and coordinate with fueling companies hours before a plane lands at its destination, while pilots can upload flight plans from their hotel rooms. The system is "always on," meaning authorized users can access information even when the plane itself is powered off. A secure web browser will allow access to third-party applications such as live weather cameras at the destination airport. Other features include a runway alert system and enhanced mapping functions. The Anthem system is 50% lighter and smaller than the current generation of avionics suites — a key selling point in an aerospace sector where weight equals money. The user interface is also getting a major facelift, with touchscreen capabilities, modernized aesthetics and next-generation visualization technologies. 

Why Should We Care? It's been two decades since Honeywell last rolled out an avionics overhaul on this scale. The company likened the upgrades to transitioning from a flip phone to a smartphone. At an unveiling of the new technology in New York City in October, Vipul Gupta, Honeywell's vice president and general manager for avionics, joked that he'd been instructed to channel the legendary Apple Inc. CEO Steve Jobs in his presentation. Consumers accustomed to the iPhone's easy-to-use interface may be shocked at how old-school current flight decks look. Making airplane cockpits look like something from this century feels obvious, but if it were easy to do, someone would have already done it. The FAA is likely to pay particularly close attention to Honeywell's cybersecurity plans. It remains to be seen how big competitors such as Rockwell Collins (owned by Raytheon Technologies Corp.) will respond. Honeywell says Anthem could eventually be used to automate more tasks on an airplane and enable single-pilot or reduced-crew operations. 

Deals, Activists and Corporate Governance

Emerson Electric officially agreed this week to merge some of its software assets with Aspen Technology Inc. Emerson will own 55% of the combined entity. The idea is that a separate, publicly traded company can be a better vehicle for growth and future software acquisitions than the industrial parent. It's a creative structure that should pay off for Emerson over the long term. But some of the specifics left investors scratching their heads. While Emerson had previously identified $1.1 billion of "stand-alone" software assets, it turns out not all of this business can actually stand alone. Emerson will instead contribute about $350 million of revenue to Aspen through its OSI Inc. and geological simulation software assets. The remainder of Emerson's data-management businesses will remain with the industrial company because they "are intrinsically tied to control systems or sales channels," CEO Lal Karsanbhai said in an interview. "They don't lend themselves to pure-play software." Emerson assigns a value of $2.5 billion to the software assets it's merging with Aspen and will pay another $6 billion in cash on top of that. So one way to frame the terms is to say Emerson is "paying" $8.5 billion for its majority stake, RBC analyst Deane Dray writes. That implies a rich valuation of nearly 32 times the combined company's expected earnings, before accounting for revenue and cost-saving benefits. Perhaps that's worth it if both Emerson and the new software company trade at higher multiples than they did before. Future software deals by Aspen and a potential breakup of Emerson's legacy industrial businesses may make the math work.  

Dover Corp. agreed to sell its Unified Brands commercial cooking equipment business to Swedish appliance maker Electrolux Professional AB for $244 million. The price works out to just shy of two times Unified Brands' expected sales in 2021. That's a lower valuation than food equipment rival Welbilt Inc. is set to receive in its pending $4.8 billion sale to Ali Group, a discount that perhaps reflects weaker profitability for the Dover asset. There may be more divestitures to come from Dover's refrigeration and food equipment unit. The business carries lower margins and is more volatile than the rest of Dover. Another breakup just three years after the spinoff of Dover's energy operations would raise again the question of whether partial industrial splits actually work. As I wrote in 2018, a diverse conglomerate that becomes a relatively less diverse conglomerate is still going to have a degree of puts and takes to its earnings. Spinning off one laggard asset may simply refocus investors' attention on the next weakest link. 

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