This article was originally published on Forbes on Apr 1, 2022,01:24pm EDTForbes on Apr 1, 2022,01:24pm EDT
Aggregate Inventories Have Recovered but Auto Inventories Remain Under Pressure:
Supply chain issues have been a well-publicized event that has been hard to predict. While there have been improvements in supply chain management since the harsh production halts enforced during the pandemic, semiconductors continue to be a bottleneck in numerous industries, especially automotive.
Furthermore, the semiconductor bottleneck has had a ripple effect and has impacted industries outside of automotive production, such as ad-tech. In fact, ad-tech has been one of the most beaten-down industries due to the supply chain crisis. This is because automotive is a significant category of ad spend, and without inventory to sell, advertising budgets have been slashed. Nonetheless, we expect that this is only a temporary concern and that ad-tech will rebound in 2022 as supply chain issues begin to normalize. We especially look for discounts in tech that stem from a transient yet external issue outside of any individual company’s control.
The I/O Fund team went beyond relying on management commentary and studied the data to better understand the supply chain bottleneck. We found that aggregate inventory levels have generally recovered, but automotive inventories remain under pressure. I/O Fund Financial Analyst Bradley Cipriano notes that an analysis of automotive inventory composition suggests that the supply-chain issues have likely bottomed and will improve going forward.
The I/O Fund chose to be aggressive during the Q4 earnings season between January and March by building ad-tech positions for this reason. We expect that improving inventory trends will lead to a sharp rebound in automotive advertising in the back half of the year, driving topline growth for the ad-tech sector. We discuss why we believe that the supply chain crisis will ease around H2 2022 below.
Supply Chain Management: Aggregate Inventories Have Recovered but Auto Inventories Remain Under Pressure
The pandemic began in early 2020 and resulted in a whipsaw effect that impacted both supply and demand. With governments enforcing strict shelter in place orders, production of goods declined in 2020 but consumers still demanded goods. Government stimulus further bolstered demand and there was less of a contraction in total demand than there otherwise would have been. This dynamic led to the supply shortage that many sectors have been working through.
Since inventories are essentially the difference between production and sales over a period of time, the dynamic of reduced production but increased demand led to a sharp reduction in inventories in 2020 and 2021. As shown below in Chart 1, changes in private inventories, which is a measure of the value of the physical volume of inventories that businesses maintain to support their production, materially declined in Q2 2020. In fact, the $300 billion drawdown in inventories in Q2 2020 was the steepest drawdown in history.
However, while Q2 2020 represented the steepest decline on record, Q4 2021 represented the largest increase on record, as inventory levels bounced back by over $200 billion. This sharp rebound helps highlight that production is catching back up with demand
Chart 1. 50-year Trend of Changes in Private Inventories
Source: U.S. Bureau of Economic Analysis - I/O FUND
Source: U.S. Bureau of Economic Analysis - I/O FUND
In Chart 3 (below), inventories are also rising relative to sales, suggesting that there has been a build in inventory levels. Furthermore, the metric is above the five-year average, implying that inventories are not tight on a systemic scale.
Chart 3. Five-Year Trend of Private inventories to Final Sales
Source: U.S. Bureau of Economic Analysis - I/O FUND
While the above charts highlight that there has been a strong recovery in inventory levels in the economy, it fails to take into account the types of inventories. Specifically, despite the recovery in aggregate inventories, automotive inventories have fallen to all-time lows.
