Motley Fool Hidden Gems Investing - Industrial Companies with Moats

Episode Date: October 30, 2022

“When the party is happening in the penthouse, this is a sector that’s in the basement.” Industrial companies aren’t the sexiest stocks, but that’s where investors can find strong moats. You just have to look at “micro-verticals” like fluid-handling, label making, and aircraft replacement parts. Nick Santhanam is the CEO of the Fernweh Group and a co-author of the new book “The Titanium Economy: How Industrial Technology Can Create a Better, Faster, Stronger America.” Ricky Mulvey caught up with Santhanam to talk about: - Why investors often misunderstand the industrial sector - How companies are using 3D printing and blockchain technology - Why family-run companies have key advantages for long-term investors - The biggest challenge for companies in the Titanium Economy Companies mentioned: GGG, HEI, SEE, BRD, CWST, AZZ Host: Ricky Mulvey Guest: Nick Santhanam Engineer: Dan Boyd Learn more about your ad choices. Visit megaphone.fm/adchoices

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Lady, wait your turn! Get more of what matters to you with the new Kia EV5. See kia.ca for details. Kia. Movement that inspires. really it is finding out companies with the point you made with very strong moves right where they have a very good operational performance they have a very good management team they have a very good product line and you'll identify the next hyco you'll identify the next draco you'll identify the next tracks and the beautiful part is you're not looking for a needle

in a haystack you're really shooting fish in a barrel which means you know you look you're going to find. I'm Chris Hill, and that's Nick Santhanum. He's the CEO of the Fernway Group and co-author of the brand new book, The Titanium Economy, How Industrial Technology Can Create a Better, Faster, Stronger America. Ricky Mulvey caught up with Santhanum to dig into some under the radar manufacturing companies, and talk about why family-run businesses have key advantages for long-term investors. You start the book with a heater. You're saying this sector is underappreciated, undervalued, disrespected by investors. Actually, I'm not even going to read the quote from the book because those are the themes. Talk to me about why you

believe that it's those three things. You know, Ricky, if you sort of ask one line to describe the industrial sector, it's exactly what you just said, right? Misunderstood, undervalued, unappreciated. Let's start with why is it misunderstood? First of all, you know, when people talk about industrials, people talk as if it's one monolith, one big sector. In reality, it's 90 plus what we call micro verticals. Think of it as Amazon rainforest on one end, the Sahara desert on the other. So which one are we talking about? The second actually very related to that, whenever you talk about industrials, most people and not all of them will have a rueful past. Oh, it was a great sector. The

fifties was wonderful. It was a sector which was lost, stolen, given away. And the reality is none of that is true. It's actually, we are on the beginning of a great innings. We are on the first innings. It's, we are, you know, the best things are yet to come. So let's start with that. It's completely misunderstood. Now then let's talk about undervalued. You know this way better than I do, Ricky, right? When people talk about companies, it's all about multiples. How quickly do multiples expand? That drives total return to shareholder value. And if you look at all sectors across, right, in S&P 500, industrials is a one sector where you saw pure margin, you saw pure value creation because margin expanded, right? Not because their multiples expanded versus every

other tech company or consumer company, the multiples expanded. So as Tina Turner used to say, I work hard for my money, or she works hard for her money. This is a sector which has worked hard for the money compared to a tech or a consumer or a SAS or pick any one of those where most of the value creation came because of multiples expansion. And then let's talk about unappreciated. This is, I think the best line to say is, you know, when the party is happening in the penthouse, this is a sector which is in the basement or put it differently. A lot of innovations you and I see around today are happening because of the industrial sector. And yet the credit goes to somebody else. People talk

about it. People think about it else. So when you look at it, you sort of say, wow, this is an amazing sector, which is a diamond in the rough. It's not even a diamond in the rough. It is a diamond. And yet very few people know about it. Very few people talk about it. I would probably go even that further to say it doesn't get the respect it deserves to get. And I can understand why there's, there's a couple of reasons. One of which is that, as you point out in the book, the founders need to be a little bit more forward about telling their story. And then there isn't a media angle, you know, for, if I'm looking at stories to talk about on the podcast, it's a lot more fun to talk about Netflix than a, than a fluid handling company, putting gels in capsules.

Absolutely. Ricky, you know, my kids are grown up, but when my son was young, he once came to me and said, dad, why don't you work for a cool company? And I said, why do you say that? He said, like, you know, like I talk to people and we are here in Silicon Valley. They talk about Google and Amazon and Apple. They're all cool companies. You know, you talk about companies like well-built and AZZ and JBT, because he used to eavesdrop me when I used to pick him up from school. And he's like, none of those companies are cool. You know, how can it be cool? Like you were working for a company, which makes an oven for a commercial kitchen. How is it cool that you're making a working for a company which is making these airports ducts. And for a five-year-old kid,

it was not cool. And I can tell you, Ricky, I'm pretty sure you probably don't consider it cool either, but they are the bedrock of what we do and everything we touch. It's very cool. I've also learned that what I think is cool isn't necessarily where I want to put my money. Good point. Good point. So I want to start with some trends. Titanium economy, we're talking about more advanced manufacturing. And one of the trends you highlight early in the book is 3D printing. And this was one of those, especially for investors, like a few years ago, 3D printing was all the rage. Longtime fool, Matt Greer, one of my colleagues would say, we're going to print out a pencil in your house. And there was a ton of investor interest in it. Now that's kind of been,

now I don't hear a lot of investors talking about 3D printing, but you still, in your book, you highlight this as a major trend for manufacturers moving forward. What is it about 3D printing that's got you excited? So look, it's like everything, when you talk at a high level or an average, it is very easy to miss a mistake or miss the nuances, Ricky, right? So you're absolutely right. Four or five years, or even maybe 10 years ago, when 3d printing came out, it's exactly what people said. Oh, I can print out my pencil and I can print out my, you know, toothbrush. The reality is you don't have to, and it creates no value. And so what ended up happening is all that hype you started out, people sort of said, I'm not going to spend,

pick a number, right? $100,000 or $10,000 to buy a machine to print out my toothbrush when I can go to a safeway and pick it up for a dollar. But you know what we talk about 3D printing in our book is 3D printing is very helpful. You know, when you're dealing with a lot of complex parts, onesies, twosies, you know, a big supply chain issue. And what you saw in the last couple of years during COVID, what you found is you were building a million dollar part or a million dollar component and you couldn't ship it out because you were missing a 30 cent part. And in that case is because you're waiting for it to come from somewhere. The logistics lead time was 12 weeks or 16 weeks. And then you sort of said, look, if I could make this 30 cent part,

because I need only one of them, but I needed to fill it, fill in a million dollar order, then it becomes important. So the context matters, Ricky. And I think in that context, we do believe as supply chain becomes complicated, convoluted as lead times become different, where you have high complexity, low volume mix, 3d printing is going to become important or it's already is pretty important. So that would be for a company like, like you highlight Heiko, which is making these parts for airlines or these airline interiors, where you need to be able to have a metal or casing insulation that can withstand extraordinary heat, cold, that sort of thing. And you need to specifically form it for these airplanes that even across a Boeing

line of 747s are going to be extraordinarily different in how they fit. Bingo. You hit the nail on the head and you want a different material. You want a different composite, right? You don't want a standard material, but you want a material which is slightly different, has an extra 0.1% carbon in it, 0.1% titanium. So you can really think of it customized to what you want, Ricky, right? And that's where 3D printing plays a role. Let's talk about another trend, blockchain, which I'm not getting into crypto, but I'm starting to think that the biggest use case now for blockchain across companies and in the titanium economy is for supply chains. You have a company like Sealed Air, which is a packaging company, and they're

using blockchains to track the chain of custody in terms of where the supplies, materials are coming from. When you're looking at these companies and you're looking at trends, is that ultimately the biggest use case for blockchain technology, is just monitoring supply chains? You know, Ricky, when people talk about blockchain immediately, within three milliseconds, people start talking about crypto, right? And within three milliseconds, they start talking about Bitcoin. So you, you hit the nail on the head. Look, I'm the last guy to talk about FinTech and crypto and Bitcoin. So let's take that out. But you hit the nail on the head. Blockchain at the end of the day is a very simple decentralized ledger, right? I don't know you, you don't know

me and you and I need to do a deal where we can get it based on trust, right? And not trust because I know you and I say, okay, I can come after you and I can sue you, but it's like a transaction, which is seamless, which is quick and can happen very quickly. So blockchain is going to take off or will start taking off Ricky in areas where you have a high value item, right? Like when you and I are buying something where it's a very high value, but high fidelity of data matters, right? You really want to know that this supply is real. There's not a fake product. You know, I put it into my supply chain, I get messed up. And third is, it should really cost me less, right? If I have to deal with a third party, and the third party is going to charge me 3%, put money into

escrow and lead time. And so in applications like that, Ricky, blockchain is absolutely going to play a role in supply chain. It's a matter of when, it's not a matter of if. So let's say I'm using a raw material to buy these steel for my airline parts, or I'm buying a specialized component. And in other cases, money would go in escrow before the part was shipped to me. But in this case with blockchain, you can just see where it is. So you don't have that escrow waiting transaction. Bingo. You reduce interaction time and you reduce interaction cost. In your book, you talk about micro verticals. I'm going to, I'm going to go, actually, no, I'm not going, I'm not taking a leap here. A micro vertical is pretty much a moat. So I want

to talk about some of the moats and micro verticals that these companies have created, because it's very specialized areas where these companies have really carved out a niche for themselves. What I'm particularly interested in is the Brady Corporation. It's ticker BRD. They're making specialized labels. You highlight how in World War II, they were essentially differentiating electric wires on boats. Now, they've got these fancy pants labels where you've got embedded holograms for hospitals. There's pharmaceutical companies using them to differentiate different medicines. As you've studied this company, how did the Brady Corporation really carve out this micro vertical, this moat in label making? I think you actually gave me the answer,

or you gave the answer to the audience on this, Ricky, right? They really focused on the micro vertical, right? So when you look at Brady Corp and they started, you know, they've been around for a long time. They sort of said, what are we good at? Right. And when they were good at, they sort of did a bunch of stuff. And you know, when you start doing a bunch of stuff, you get a bit fragmented, but then they sort of saying, no, no, no, let's really go back to our roots. Let's focus what you're good at. And you hit the nail on the head. They're good at identification, right? I mean, if you put it in a broad bucket, which is if you're in the hospital and newborn baby, you know, obviously it's very important for the mother and the parents to know

where the babies are. You want to track it. The hospital needs to know. So they said, look, we are going to get that technology and we're going to get that technology, right. And we are really going to be the best at what we do. And by doing that, they didn't focus on anything else. They didn't focus on making, you know, adhesive guns like Greco. They didn't focus on making aircraft parts like, uh, um, high code. They did not focus on waste management like Casela. They focused on their specification, right? A market they knew with a product they had with an application, they understood better. And by doing that very quickly, what you find, and this is the best part about a micro vertical Ricky is you're very good at what you do. And bluntly, you're very bad at

the stuff you don't do and that's okay. Right. And so if you look at each one, I mean, Brady Corp is a great example. Heiko is a great example. AZZ is a great example. We talk about this in the book. Everybody does one thing and that market is good enough, right? I mean, you don't have to be like, I have to do A and B and alpha and three and seven, right? You like, wait a minute. Those are not even same language, same things. You don't have to put them together. The one thing you do, you do it very well. And when you do very well, you understand the customer better. You understand the applications better. You really have a great product and a great solution. And when you do that, you know, everybody wins at the end. You make a lot of money, your employees make a lot of money,

and it's a win-win. So are these companies creating a moat then with just the amount of time they've spent in the market where they have the institutional knowledge built up that you can't really have a competitor come in? In the case of the Brady Corp say, you know what, we're going to be able to quickly make a cheaper identification tag for newborns in the hospital because, you know, I'm, I'm a dummy for me. It seems like you could get a bracelet and a QR code and that would be good enough. You know, you just hit the nail again on the head. Good enough. Right. But now if you're a mom, right. And you've given birth to a baby and I'll say, look, I can put a Brady, you know, I can put a, a label, which will make sure that, you know, you get your baby,

a baby, or it's a good enough, which one are you going to choose? Yeah. You're going to be like, and that's where it makes a difference. Right. Ricky. I mean, seriously, can you do a product which is good enough of course but in a lot of these industrial application unfortunately good enough is not good enough speaking of specific measurements let's talk about graco because this is one where you said that i found an interesting division if you will where you just talked about where you need to be able to do one thing extraordinarily well and graco which is a fluid control system so essentially they make sure you get the right amount of peanut butter in a package i think pharmaceuticals companies also use them to put

the right amount of, let's say, gel in a medicine capsule. So, is this a company, though, that might struggle from too much differentiation? Because they essentially, the founder, I think, told you when you were writing the book that they have to be an inch deep, mile wide in terms of being able to build these vastly different machines that don't have a ton of connection to each other. And it's a lot of onesies and twosies because the same machine that's doing, let's say, peanut butter filling is going to be significantly different from the machine that's doing the capsule filling. So in this case, Ricky, you sort of have to go back. What is their capabilities, right? They are very good at fluid handling and fluid handling can be, as you said, putting peanut

butter in a jar or can be putting a grease onto an engine at minus 30 degrees. If you are in Minneapolis, right. It's a fluid is a fluid. So I would actually say what they have done, And Mark Sheehan is the CEO of Graco. He's done an amazing job in steering the company along the right vectors. He used to be the CFO before. And what you find is he really understands what matters to the customer. This, again, goes back to the motor, right? He says, Ricky, I really don't care what industry you are in, but I know you as a customer care

about this or have this pain point. Let me go solve this pain point. And that is what makes him great. That's what makes the company great. I mean, as you probably know way better than I do, look at their multiples, look at their performance as being phenomenal, right? And again, fortunately or unfortunately, not a lot of general investor would know Graco, but they're probably one of the best performing stock out there.

And they've done very well over the years, both on multiples and economic value and terms like that. Any other micro verticals you want to talk about? I know you mentioned AZZ. We can talk about Casella Waste Systems. This is the beauty of it, Ricky. There are 90 micro verticals and every one of them are beautiful, right? So if you know, I'm serious, right? Like Casella is a great example of waste management, right?

They, I mean, everybody, I mean, you talk about it in the book, right? They were on the verge of going bankrupt. They turned around. They're one of the best performing stock. John Casella, who's a CEO. I mean, his story is a story of a true, what I call only made in America story, right? AZZ, you know, they're a company in Fort Worth, amazing story of where, you know, they're the leaders in hot dip galvanization, which is a protection against corrosion. And Tom Ferguson, who's the CEO, made a very good comment, right? He said, Nick, corrosion is 24 seven and we are 24 seven, right? I mean, that's an example of they do it, right? You know, and we can go list electrical infrastructure, right? I mean, we as Furnway

have invested in this company, which we spun out of AZZ, or they are still 40% owner. We are 60% owner, electrical infrastructure grid, right? Making enclosures and switch gears. You know, If you're a utility and given all the power issues we've been having, I think you'd be the first guy to say, look, I don't want my grid to go down. You make a product, right? So the list goes on. And what we find about each one of these micro vertical, Ricky, is they are critical for what we as a country and an economy is needed. And they do a great job, right? They are the unsung heroes, but they do a great job. And by doing this, they create great economic value, not only for their investors, which is fantastic, which is the focus for this show, but even for their

employees, right? I mean, you'll find there are a lot of employees who, after working there for 20, 30 years, end up with a million dollar 401k and leave, which I don't think you can say that is true in a lot of other sectors. We can absolutely talk about employees and community and that sort of thing, because the major challenge that you highlight is for a lot of these companies is they're offering, in a lot of cases, well-paying jobs, well-paying middle-class jobs. And yet talent retention is across the board. The talent attraction, I should say, finding people to take these jobs is the number one problem for every single one of these companies. Ricky, you, you sort of got to the second point, which I wanted to make, right? When we wrote this

book, as I said, we really wanted to tell the story because we really wanted to sell to two of our biggest suppliers, suppliers of labor and suppliers of capital, right? What you'll find in this industry is talent retention is not an issue, right? When people come in, they understand in every one of these companies, we talk to folks who had worked in the company for 20, 30, 35, 40 years, right? So unlike tech sector or Silicon Valley, where I am, you know, retention is an issue. Talent retention is not an issue. Talent attraction is absolutely an issue because people just don't know what an amazing sector this is and what kind of a great career and life you can have, right? I mean, let me just give you one statistic. An average manufacturing job pays

$63,000 a year. An average service job pays $30,000 a year, right? Two, in 460 counties in this country, industrial jobs and manufacturing jobs account for more than 20% of the jobs. So this is not a fringe thing. It's not like, oh, John, I'm going to be really doomed to not have a future. And so getting that message out is going to be absolutely critical because I strongly believe once we get the talent attraction, you're going to have a domino effect, right? You're going to have the multiplier effect happen. I'm walking by a school close to my neighborhood and it says basically college bound or college ready kids. And it's every day you have this banner up for these kids walking in to say, you need to go to college. And I think one

of the major problems that we haven't discussed here, but you discuss in the titanium economy is that there aren't a lot of other options for kids and people in high school outside of college to learn skilled trades like there are in other countries. Look, I'm not saying, I mean, if you want to go to college, you absolutely should, right? But I think it's also important to get the message out. Like that's not the only path, right? Today, if you see there are a lot of trade schools and conventional schools, convocation schools, community things, where you can go learn trade skills, whether being an electrician, a plumber, a roofer, a welder, which is a great skill, which this country desperately needs, where there's a huge gap and which

is very hyping, right? And in the companies we profiled, I don't remember the exact number, but there were multiple folks who didn't go to college and had done very well for themselves had moved up the career and where, you know, EVP of operations, EVP of supply chain, EVP of marketing, and even CEOs. So this, this is again, what we wanted to say is, look, you want to go to college? Absolutely do it. Right. That's a great thing. You don't want to college. It's not the end of the world.

There was a lot of great job opportunities in trade that you can do very well for both for yourself and for the community you're in, which ends up being a great thing. One advantage you highlight for a lot of these companies is that they're family owned, like Casella Waste Systems. One might think, and I'm guilty honest, I'm biased towards this because I watch Succession. Have you seen that on HBO? Yeah. So that's a family owned business. And that's why I think that would be a disadvantage for a lot of these companies is because then you have businesses managing family dynamics. There's infighting. you know, you could have a cousin who comes in, skips his way to skips his or her way to a

leadership role. And yet in your book, you're claiming that family owned businesses for a lot of these titanium economy, uh, companies is an advantage. So, so, so what got you to that? So two things, right? You, you bring up a very good point. We should, we can be just positive, right? We should also sort of highlight the deficiencies of negatives. So to your point, I would say a lot of these companies, even like Casella, Casella is publicly traded, right? It started by the founder. He's still the CEO. There were two brothers. What you find is when you have a founder, I'm going to go with the plus thing, right? They know the company. It is their idea. They make decisions fast, right? Nothing against corporate America, right? But if you just look

around, Ricky, think about how many companies have just been destroyed, have been run to the ground because it was, I don't know, I just made my job and nobody can make a decision, right? And everybody watches it like a freight train in slow motion or freight train accident, slow motion. And yet two years goes by 20 years goes by and the company dies. Right. And you're like, yeah, I knew it. And you're like, why didn't anybody do anything about it? It's like, well, it was not my job. And I think having a strong leader, and I want to be very careful, not a founder, having a strong leader who can make decisions makes a big difference. And companies which are founder started or founder driven, that makes a big difference,

right? So that's your advantage. But to your point about watching HBO succession, you're absolutely right. In a family owned company, what can happen is nepotism can kick in, right? And that has happened. But also I'll tell you on the bright side, Ricky, when we talk to a lot of these family owned companies, they are the first one to admit my son or my daughter or my cousin is not the right guy to take over this company. I want to professionalize my company and they're very open. And so I think it is awareness, Ricky, that's what I think makes a difference. I mean, by no means are they perfect. And obviously a lot of companies go down the trap, but what we found is in our industrial space, you had generation three,

generation four running a company. And for me, that gave me hope that, okay, you know, these guys have found a formula to at least, you know, to avoid the death trap. I'm not saying they're going to do it forever. I don't have the secret formula, but at least they found a way to continue it and having a decisive leader has made a big difference. Well, I guess to your point, that's the biggest thing is that these companies are able to think of in terms of generations rather than quarters. And that would be, if you're a long-term investor, that's the advantage of some of these family-run businesses. You got a little bit of criticism for the book that I want to give you a chance to respond to. And I think you're smiling. I think you know what I might be talking

about is Jeffrey Cain's Wall Street Journal review. He said, quote, the author's right that the Chinese government is dedicated to taking the lead by providing state funds for critical industries, but they never mentioned that the country which imports more chips than ever remains generations behind the American semiconductor industry and is far from its vision of self-sufficiency. So two parts to that question. Is China generations behind America in the semiconductor war? And what say you to Mr. Cain? Look, ocean on an average is four feet deep and you both, both of us know it's wrong, right? I I mean, it's neither four feet deep.

I mean, there's the shallow beaches and there's a marina trench. So I think Kane is right in that criticism. So let me start off with that, right? China is behind, but you have to be careful and say, what are you behind on? They are behind, and this is what I love about our industrial sector, they are behind on the manufacturing equipment side. So if you look companies like Applied Materials, Lam Research, KLA, Tencore, they are here in the US, you really don't have an analogy in China.

Check. But then when you look at the actual chip manufacturing itself, and again, I don't want to get into the political discussion because unfortunately, fortunately, I know very little about politics, but if you see what is currently happening in the, uh, the sanctions being put on, so on, you're actually sort of saying, Hey, look, you can't ship, ship the chip making equipment, right? So we are going to sort of control that, but there is already semiconductor manufacturing companies out there, right? Like YMTC, Yangtze memory chip company. I wouldn't say they're

generations behind. They might be a generation behind. Right. And then to his point, you're absolutely right. The question is whether they're one generation behind or three generations behind is a good question, but the question is, can they catch up to us? Right. And if you want to maintain your technology lead, what are we going to do about it? I think that's what we talk about the book is, we really need to be not looking backwards, but looking forward and saying, how do we continue to maintain our lead on this? I don't want to just end with someone in the Wall Street Journal criticizing your book. So let's end on a bit more of an optimistic note. You write that one of your points is that you think America can be a place where you have

a thousand Teslas. So how can investors identify these companies? How can they find companies with good quality revenue in these skilled niches? And why do you think we can ultimately see America build a thousand Teslas? Cause that's a lot of trillion dollar companies. So let me start with the second point, Ricky, with the good news, right? There already is thousand. There might not be thousand Teslas in market cap, but there are thousand Teslas already with great products, great customer satisfaction, filling in a niche, right? So the good news is they're out there, right? You just have to look now, how do you identify? I think this is the best part in the industrial sector, unlike the tech sector where you need to place a bet, right?

You play, if it was a 71 or 81, whenever that was, you bet on Microsoft, you won. If you didn't bet on, you know, or whatever, right. You bet on Oracle, you won, you bet on Sybase, you lost in industrial space. A good thing is this is a sector of live and let live. So there are a lot of companies, right. And as we've talked about in the book, there were more than 35 companies. We, uh, profile, there are more than 55 companies we looked at and there were multiple companies, right. Which has done better than S and P 500, which has done better than Fang. So as an investor, guess what the proof is in the pudding, right. We've already done it. Now the question is, and this is what the sectors have to do a great job, right. It's a two-way street. I think the

companies have to do a great job communicating, getting to the investor, letting them know what they're good at. But I think as an investor, really it is finding out companies with the point you made with very strong moves, right. Where they have a very good operational performance. They have a very good management team. They have a very good product line and you'll identify the next Heiko. You'll identify the next Graco. You'll identify the next Trex. And the beautiful part is you're not looking for a needle in a haystack.

You're really shooting fish in a barrel, which means, you know, you look, you're going to find. We didn't have time for Trex. Anyway, Nick Santhanum, he is the co-author of the titanium economy, how industrial technology can create a better, faster, stronger America. Thank you so much for spending some time with the fools. I really enjoyed your conversation. and I really enjoyed the conversation, and I think your book is a great resource for

investors looking to find some ideas in the industrial sector. Thank you, Ricky. Thank you for having us. Really appreciate it. As always, people on the program may have interest in the stocks they talk about, and The Motley Fool may have formal recommendations for or against, so don't buy or sell stocks based solely on what you hear. I'm Chris Hill. Thanks for listening. We'll see you tomorrow. you