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Royce Investment Partners: Challenges and Opportunities of the Current Labor Shortage

By Brendan Hartman and Jay Kaplan

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Sydnee Gatewood
Sep 15, 2021

Summary

  • PMs Brendan Hartman and Jay Kaplan discuss how the current labor shortage is affecting their holdings.
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Brendan Hartman—The shortage of skilled labor has had an impact on many industries we invest in. It’s been a tailwind for some companies, such as temporary staffing firms or industrial distributors, that are effectively solving their customers’ problem.

One example is Lawson Products (

LAWS, Financial), which distributes industrial maintenance, repair and replacement parts to their manufacturer customer base. Lawson’s sales reps regularly visit their customers’ facilities and replenish their stock of parts and supplies, effectively outsourcing a critical component of their operations to Lawson employees. This generates a very loyal and “sticky” customer base that allows Lawson to increase share of wallet as well.

Another direct example of skilled and semi-skilled labor outsourcing is temporary staffing firm TrueBlue (

TBI, Financial), which provides temporary manual labor for light industrial customers in the warehousing, hospitality, wholesale, and sanitation industries, among others. They use technology and a large and diverse labor pool to source from and effectively match supply and demand for temporary labor.

On the other hand, airlines and trucking companies face pilot and driver shortages, respectively, that cannot be easily alleviated by outsourcing solutions. While this shortage is creating challenges for trucking companies, it also serves to limit supply in a tight market and is thus keeping pricing and margins elevated, particularly given how much consolidation many of these industries have experienced over the past decade. These are long-term trends that have existed for years, often ebbing and flowing, depending on the strength of the economy and relative end market demand. But we think they’ll persist for the foreseeable future, creating both challenges and opportunities for different industries and companies. We’re always cognizant of how these factors may impact our holdings in both positive and negative ways, so we spend a fair amount of time discussing them with management teams throughout our due diligence process.

Another secular trend that has been in the works for decades, but is becoming a critical core competency for many manufacturing firms today, is automation and robotics and sophisticated enterprise resource planning software, or ERP, systems that help firms do more with fewer workers. Amazon is not the only company with automated warehouse facilities—even the smaller public companies that we invest in have been adapting automation over the last several years.

For example, we visited a state of the art plant built by aerospace and industrial controls manufacturer Woodward (

WWD, Financial) outside Rockford, Illinois several years ago where they manufacture sophisticated aerospace fuel system components. While the facility was larger than several football fields, there were less than a dozen employees on the shop floor, and the preponderance of orange robots and software-based control systems were worlds apart from their legacy facilities just down the road. Although it’s a long-time Royce favorite, we’re not currently holding this company in the portfolios I help to manage, but it’s a great, straightforward example of how companies are focusing on robotics and automation.

Jay Kaplan— I would first of all emphasize that the labor shortage is very real and is affecting many different kinds of businesses, from companies that need highly skilled labor to those that use a lot of unskilled or entry level workers. They’re all feeling the pinch. It’s taking longer to fill positions, and once they’re filled, companies are paying more. So far, most of these businesses—including those that I hold—have been able to pass on these increased costs to customers, though with a lag. We’re also seeing the effects in long wait times for autos, appliances, and furniture. As Brendan mentioned with regard to his portfolios, this is creating tailwinds for some holdings and headwinds for others—which we hope are temporary.

Those companies currently benefiting most are those involved in staffing and related services. Kforce (

KFRC, Financial), which specializes in IT staffing, has been seeing insatiable demand for personnel. Resources Connection operates a similar business, as does executive staffing specialist Robert Half International (RHI, Financial), and both are experiencing similarly high demand. But there’s another tailwind that may not be as clear for these last two businesses, as well as for Korn Ferry (KFY, Financial), which runs an outsourcing staffing arm for other companies and also offers talent acquisition, leadership development, organizational strategy, and other services.

Each company’s consultant businesses are doing as well, if not better, than the staffing side because they’re able to help other businesses deal with the labor shortage and other challenges in various ways. I liked all four of these companies before the effects of the labor shortage made an impact, but they’re all definitely seeing the benefits of the current difficulties many companies are having finding skilled and/or experienced people.

Other holdings have been dealing with the shortage by trying to compensate via robotics and additional automation. For example, Alamo Group (

ALG, Financial) manufactures and distributes industrial lawnmowers, maintenance equipment, and replacement parts for the industrial and agricultural markets. The company has markedly ramped up its continuing efforts to add robotics to compensate for labor shortages. So far, I think it’s been managing this process effectively.

So the labor shortage hasn’t really been an investment theme for me as much as it’s something that’s affected many of my holdings. It’s been a regular topic of conversation with management teams recently—and an issue I’ll continue to watch very closely. The key question is whether or not labor inflation will stabilize and roll off a year or so from now. We don’t have an answer, so I continue to look for those companies that have been executing most effectively through what remains a very challenging period.

Mr. Hartman’s and Mr. Kaplan’s thoughts and opinions concerning the stock market are solely their own and, of course, there can be no assurance with regard to future market movements. No assurance can be given that the past performance trends as outlined above will continue in the future.

The performance data and trends outlined in this presentation are presented for illustrative purposes only. Past performance is no guarantee of future results. Historical market trends are not necessarily indicative of future market movements.

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Disclosures

I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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