There’s a disconnect between the macro and the micro picture – how do we connect the dots?

Longer-term trends underway in the markets we serve point to a curious disconnect between the macro and the micro picture that is worth a closer look at.

Most of the macro commentary at present leans towards the cautious, and there is fair reason for this.  Inflation, while climbing less steeply, remains at historic highs. Committed to tamping this down, central banks have raised rates at the briskest pace since the 1980s. The expected result is softening demand. Similarly concerning, economics and geopolitics are often inversely related, so just as forecasts cool, tensions around the world continue to warm.  Speaking of warm, environmental concerns, percolating for years, are reaching a boiling point.  The macro, in short, is pretty cloudy.

The micro, however, provides grounds for optimism, especially in our industrial technology corner of the world.  FY23 was a record year for Smiths in terms of topline and EPS growth.  Promisingly, we are not alone in this regard.  Over half of our 15 closest peers have delivered double digit growth across the same period. For us, this was not driven by a one-time bounce from COVID lows (although we do benefit from still-unmet demand in several end markets) or inflationary tailwinds that will eventually weaken (half our FY23 growth came from volume).  The trends we see in our business are longer-lived, with growth now extending over nine consecutive quarters.  The micro looks pretty good.

So, how do we reconcile the apparent disconnect of economic forecasts trending down but performance trending up?  A few important factors help connect the dots.

First, innovation is economically insensitive. In the period between the “Panics” of 1873 and 1893, Bell invented the telephone and Edison patented the lightbulb. A raft of skyjackings in the 1970s led to the introduction of x-ray scanning in airports. Wikipedia, Skype, Netflix, YouTube and Facebook were all formed shortly after the Nasdaq crash of 2001, and Uber and Airbnb were both launched during the global financial crisis of 2008-09.  Necessity helps, but capabilities and capital are the true mothers of invention.  Knowing that innovative companies extend their lead when storm clouds form, we increased our R&D investment by 14% in FY22 and another 6% this year. Returns on our investments are already clear.

A second factor bridging the gap is market selection.  All markets have cycles, but the most attractive ones cycle upward, in a northeast direction.  Energy and aerospace are good examples. Energy demand has a 5-to-10 year cycle. Growth in energy demand may soften in any given year, but it rarely turns negative.  In fact, global energy demand has only contracted three times in the past 50 years leading to a near-quadrupling of underlying demand across this time.  Close to a quarter of Smiths’ revenue come from energy markets, where we grew 20% in FY23.  

Consistent with other upward-cycling markets, continued energy growth will be driven by secular long-term forces such as decarbonisation.  Our world will invest around $100 trillion over the next 30 years to evolve to low and no-carbon energy sources.  Clean energy investment is up 24% in just 2 years and participants in this market are seeing surging demand.  Our pipeline of hydrogen and carbon capture opportunities, for example, more than doubled over the past 12 months.

The many benefits of portfolio balance are a third factor enabling industrial technology companies to shine, even against a cloudy macro. The highest-performing industrials typically serve multiple end markets (we serve four major ones). They often balance one-time equipment sales with recurring aftermarket service revenues (our business is roughly half-and-half). They earn more price than they absorb, especially important in high inflation environments (our delta was +£40m in FY23). And they are well-balanced geographically. Worldwide reach is a prerequisite for serving global customers, and upswings in one part of the world offset downturns in others. Smiths has people and resources in more than 50 countries and, aside from the US, no country accounts for more than 5% of revenues. Our business outpaced GDP growth in all major regions of the world in FY2023.

Looking forward to FY24, the macro and micro should converge.  After a period of serial downgrades, macro forecasts have recently started to improve.  Recent data published by the OECD, IMF, and World Bank all expect global GDP growth in 2024 to be modestly above 2023. Specific to Smiths, we’ve guided to 4-6% organic revenue growth.

As the global growth outlook improves and the macro and micro pictures converge, there are many reasons to remain positive.

Paul Keel

CEO, Smiths Group plc