Evolution not revolution: transforming ‘boring’ industries

Choice is something we can acknowledge capitalism for giving us. A functioning market with healthy competition is an ideal that, when effective, benefits consumers. Yet paradoxically, too much choice can leave one feeling fraught with frustration. Indeed, it is a well-known sensation for those who have ever scrolled through endless reams of films on Netflix.

This sensation also rears its ugly head within the investment world, unsurprisingly in relation to those industries that have been through decades of stability. Good luck trying to name all the banks in Europe, every brand of car to pass your house in the next hour, or even the housing developer building the tasteful three-bedroom homes on the other side of town. These businesses are usually dictated by commoditised products with low profitability and generally raise the pulse of very few investors.

There is a conspicuous antidote to this stagnation however: innovation. AI may dominate news columns today, but ‘progress’ and the pace of such has long been a key driver of investor flows. Whether it is the ‘dot-com’ companies or blockchain-exposed names, these disruptors and forward-thinking companies capture the imagination of people scouring the horizon for an investment utopia.

This makes the irony of spending our working days dreaming of the advancement of society, before jumping into our petrol cars to return to homes heated by gas boilers, even more delicious. The internal combustion engine and the gas boiler can trace their roots back as far the 1870s, and while advancements have been made over the years, notably in the forms of combustion boilers and diesel engines, these merely rocked the apple cart. In short, they represent evolution rather than revolution. All good things come to an end however, and the day when we look at 1870s technology as ‘old fashioned’ might not actually be that far away after all. The car engine is less of a surprise of course, with Tesla, Polestar and Nio – among others – frequently in the news and giving rise to the writing of obituaries for the internal combustion engine.

Less has been said of the house of tomorrow. Our team recently visited a project created by Barratt Developments, in conjunction with Salford University, Bellway Homes and Saint-Gobain, to try and create a considerably more environmentally friendly house. This research project – named the ‘Energy House’ – is attempting to find commercial solutions that enable the housebuilding industry to build zero carbon homes at scale, thereby driving the future of sustainable housing. The number of features in these houses is impressive, from heat pumps, solar and UV panels, to ventilation heat recovery and timber frames, to name but a few. There is seemingly no stone left unturned in the quest to analyse what works, what doesn’t, and what could be the most feasible solution in a bid to turn a traditionally ‘grubby’ industry green.

Whatever the solution is in the housebuilding industry, it is extremely unlikely to be a ‘winner takes all’ situation. The line of thinking is that it will be a host of features, where the resulting picture is a form of mosaic theory: a collation of strategic 'tiles' whereby multiple solutions and businesses are required. For example, heat pumps will work wonderfully in your detached house, but you won’t see them bolted to the outside of a block of flats anytime soon. The conversation isn’t too different to that of the lithium battery versus hydrogen cell argument within automobiles; it stands to reason that we are entering an era of multi-modal solutions. The days of a new technology turning up, revolutionising, and dominating industries for 150-odd years looks increasingly outdated.

In our never-ending thirst for progress, the multi-faceted and exquisitely complicated solutions may have investors and outsiders salivating, but the technical challenge of bringing these to the market in a reliable and stable way at scale is an extremely tall order. These challenges are housebuilding’s iPhone moment.

Barratt and Bellway are deeply immersed in the ‘Energy House’ project and, as two of the largest housebuilders in the UK, they will be involved both in setting the regulatory path of the future, and in building these zero-carbon homes for the wider UK population. The latter will be more than possible for these titans of business, thanks to their wide array of contacts and active procurement divisions. But what of the boutique housebuilders and local builders? With outdated skillsets and resources that simply cannot compete, their business models look increasingly unsustainable.

This is not a new phenomenon and certainly isn’t unique to housebuilders, but it does serve as an example of what we’re seeing across a plethora of industries. As technical and investment requirements become larger in increasingly complicated industries, the moat gets larger, and this rather inevitably leads to the big getting bigger. The fight for survival for boutique players is on as the drawbridge gets raised before their very eyes.

As this trend develops, it is extremely important for investors to be wary of which side individual businesses may fall. Our strategy targets high quality companies with significant investment moats, and accordingly we see our positioning as strong. We believe it is these companies that will take increasing market share, while those that are sub-scale, ineffective, and/or poorly run will fall by the wayside in the capitalist ritual of survival of the fittest.

The medium-term impact of this corporate pruning will likely be a more concentrated market. This trend is being complimented further by the recent trend of share buybacks (2023 was the first year that buyback activity in Europe matched that of the U.S.)^[1]. This realignment of supply versus demand within the European market should be a tailwind as reduced share count, coupled with a healthier and higher margin market, may well lead to a narrowing in the European discount versus the U.S. market.

An industry in flux is always an intriguing time for investors. Whether the natural cultivating of the current landscape, or an influx of new and interesting companies, it is an exciting time for seemingly staid industries such as housebuilders. Maybe progress isn’t such a bad thing after all.

^{[1] Bernstein, 2023}