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Investing in the Building Blocks of the Economy

Brian Bath, CFA

In today’s market, it’s important that we don’t overlook the companies that are underlying drivers of our economy. The drastic changes and innovation we are seeing in energy, infrastructure and automation do not always get the attention they deserve, yet these companies are critical to many end markets. We see these types of companies benefiting from the return of manufacturing to the US and the resulting supply chain implications, the push for increased efficiency and clean energy, investment in infrastructure and previously underdeveloped end markets that are looking to upgrade.

As the world looks to transition to clean energy and electric vehicles, one thing has become abundantly clear — significant investments in supply chains are badly needed, and more specifically, increased efficiency at mine sites is critical to starting new projects to meet future demand. This is where construction and mining equipment manufacturer Caterpillar comes in. The company has invested heavily in the automation of mining equipment, allowing for increased efficiency and longer hours of operation. As we see ore grades decline, which necessitates moving more earth to access the same amount of usable materials, machines that can optimize mine efficiency are crucial. In addition, the mining industry has underinvested in new equipment since the prior peak in 2012 and 2013, pushing the average fleet age into replacement range. As we look toward a world of electric vehicles, we must also consider what it takes to achieve that futuristic goal and the companies that will help get us there.

Another area where Caterpillar stands to benefit over the long term is construction. Globally, we are seeing governments step up infrastructure spending to support green initiatives or to make up for years of underinvestment. Here in the US, there is an additional boost from the housing market as we remain in a housing deficit with more households created than new homes built, and residential construction will be in demand until this imbalance is corrected. Lastly, as we see a push for more domestic manufacturing and bringing more of the supply chain onshore, we are seeing an increase in non-residential construction tied to production facilities and warehouse space to support this push. Each of these scenarios increases usage of current fleets and supports investment in new machinery for years to come.

Another segment of the market that is benefiting from the push for increased efficiency and clean energy is railroads. In the US, railroads have been increasing their operational efficiency and becoming a more attractive option for commercial shippers. With larger construction-related goods needing to be moved, the gradual return of manufacturing to the US and a more attractive offering for customers, we should see more goods move by rail, thus increasing demand for rail equipment.

Locomotives have a long useful life; however, advancements in technology have made today’s locomotives far more efficient and cost-effective than those of 20 years ago. Railroad equipment provider Wabtec offers customers the ability to upgrade their operation through a new locomotive or extend the life of existing equipment through a rebuild. In either case, customers will drastically reduce their cost of ownership and produce fewer emissions. Management has invested heavily in energy efficiency and automation, which provides customers with a safer and cleaner piece of equipment than previously available. As uptime and efficiency become more important in a PSR-driven (precision scheduled railroading) world, Wabtec is positioned to provide customers what they need to be successful. Global infrastructure and green initiatives are also a net positive for Wabtec long term, as governments are investing more in public transit to increase efficiency and encouraging consumers to use personal cars less frequently. On the commercial side, investment in railroad networks will allow for greater efficiencies and more on-time deliveries, in turn increasing the attractiveness of freight by rail.

Our long-term focus and disciplined investment process allows us to see the whole picture and evaluate second- and third-order effects of economic and societal changes we see around the world. Often the most overlooked, foundational companies can present the most exciting investment opportunities, and our bottom-up investment process helps us uncover these businesses.

As of 30 August 2022, Diamond Hill owned shares of Caterpillar, Inc. and Wabtec Corp.

The views expressed are those of the author as of September 2022 and are subject to change without notice. These opinions are not intended to be a forecast of future events, a guarantee of future results or investment advice. Investing involves risk, including the possible loss of principal. Past performance is not a guarantee of future results.

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