European Industrials: Recovery or decline?

0:01Patrick Coffey:Welcome back to the Barclays Brief. It's Patrick here and we're recording this one remotely because my guest today, George Featherstone, our industrials analyst in Europe, is over in Miami. So George, thanks for joining. Why don't you explain to the listeners why you're in Miami and what you're going to be talking about and doing this week? Yeah, thanks, Patrick, for having me on.

0:22George Featherstone:And it's a pleasure. I'm at our industrials conference this week in Miami. We have over 140 of the largest global industrial companies present. And there are really three things on top of the agenda. The first is who has pricing power. We've had sharp increases in metals and chips prices recently. Can any of these companies offset this and expand margins in 2026? The second key thing related to some of the sharp market moves we've had on AI, which has sort of dominated the narrative recently. Technology changes are occurring at a very rapid speed in data centers. And we're keen to hear basically who is going to win or lose from this from an industrial standpoint.

0:58Patrick Coffey:And then thirdly, is this the year finally that we see European industrial activity recover? Okay, so I feel like this conversation could go one of two ways. We could talk about AI and it's suddenly been a wild few weeks. You've had this indiscriminate AI disruption narrative that's taken grip of markets and it's lurching from sector to sector with little regard really for fundamentals. But the European angle is really interesting to me because, you know, coming out of Davos and at the start of the year, it felt like there was a bit more investor optimism around European industrials picking up again, better sentiment, German stimulus and other headlines.

1:37Patrick Coffey:So why don't we talk about that? But before we do, remind our listeners, what do the companies in the industrial sector in Europe actually do?

1:44George Featherstone:Well, simply put, these are the companies that you interact with every day, but you've probably never heard of. So, for example, if you took the Lyft in your office, you were using a Kona or Schindler product, most likely. If you're using ChatGPT, then the cornerstone of the infrastructure powering that AI are products from Schneider, ABB, Legrand and Siemens. So from minds to AI and power generation and transport, these are the companies that make it all possible. Okay, so they make our world go round.

2:10Patrick Coffey:Let's talk about Europe. So this whole optimism around a European recovery, what's driving that view from investors right now?

2:18George Featherstone:Well, a lot of it comes down to expectations being really low. We've been in an industrial recession for, well, for quite some time actually in Europe. And because of that underperformance, there's a sense of inevitably things have to improve. And to be fair, there are some genuine green shoots, right? Consumer spendings improving, housing permits in France and Germany, they're stabilizing. And manufacturing utilization in Germany, it started to tick up a little bit alongside stimulus. So from an investor psychology perspective, it's actually not that surprising there's some optimism returning.

2:49George Featherstone:I know you well enough to know there's a degree of cynicism to your tone.

2:52Patrick Coffey:Do you agree with that more constructive view on European industrials recovering or you're a little bit more cynical?

3:00George Featherstone:Well, you do know me well, Patrick, of course. And yeah, I'm much more cautious. I think that Europe can see a cyclical improvement from very depressed levels, but that's really not the same thing as a strong or durable recovery. The problem is that Europe runs into structural challenges very quickly, and those haven't changed. So yes, there's definitely a better outlook at the margin, but I'm sceptical that this turns into sustained momentum, particularly relative to the US or even parts of Asia.

3:29Patrick Coffey:Okay, I'm sure we're going to talk about US and Asia later, but let's talk about Germany, the beating heart of European industry. Utilization there is improving. Stimulus is back in the conversation. So surely Germany is very well placed to lead Europe in that recovery.

3:45George Featherstone:It's absolutely right to say that Germany is still considered the industrial epicenter of Europe, but the sheer magnitude of the decline in recent years is perhaps not that well understood. So if we look at industrial production, it's roughly 20 % below 2018 levels. The war in Ukraine, it did accelerate the decline. The underlying issue though is energy. So Germany had cheap, reliable Russian energy and feedstock. That underpinned German competitiveness for decades. That advantage is gone. Stimulus can support demand. It doesn't really fix the cost structures though. High energy prices, they've permanently altered the economics for energy intensive industries.

4:23George Featherstone:and they were the bedrock of German industry. So it's hard to see it acting as the engine that it once was.

4:30Patrick Coffey:Okay, but surely now energy prices have come down from those extremes. So that's a tailwind, right?

4:35George Featherstone:It is at the margin. It doesn't solve the bigger problem. So European industrial electricity costs, they're still structurally high relative to the US and China. That matters enormously for competitiveness and for decisions, frankly, about where to build new factories. Without cheap, stable baseload power, it's very difficult to support growth areas like AI and data centres and advanced manufacturing. Grid investment is a clear bright spot in Europe, but unless energy policy becomes more pragmatic, Europe remains an expensive place to run or build a factory.

5:09Patrick Coffey:Okay, help me out. Put some numbers around that for me. You know, Europe, say, versus China or the US or both.

5:15George Featherstone:Well, let's take Germany and the UK as examples. Industrial electricity costs there are currently two to three times higher than they are in the US and China. And since 2010, the EU has lost roughly two and a half to three million manufacturing jobs. That's about an eight to nine percent decline. Meanwhile, the US has added around the same magnitude. So clearly, even when comparing high cost from a labour perspective, there is something else driving the decline for Europe, which I think is largely explained by these energy costs.

5:45Patrick Coffey:Right. Okay. So energy is clearly a structural issue in Europe. We're not seeing an obvious change there straight away. Another concern we hear a lot about is China. How much pressure does rising Chinese exports have on Europe?

5:59George Featherstone:Well, with weaker domestic demand in China itself, and now higher trade barriers with the US, Chinese exporters increasingly have an eye on Europe. and they often come with a lot lower cost bases versus European manufacturers, for example, on energy, as we've discussed, labor too, and in many cases, they're state supported. So even if European demand rebounds, European producers may not capture all of that upside. They'll likely have to share it with these lower cost competitors, which inevitably puts pressure on pricing and margins.

6:32Patrick Coffey:Okay, so you're painting a fairly bleak picture for me here. What about if we wanted to be more constructive on European industrials? what would actually need to change for you to become a bit more optimistic?

6:44George Featherstone:It's funny, our head of European economics put it well when she said, Europe will adapt, but not transform. So a ceasefire in Ukraine, that would meaningfully improve confidence and sentiment. But outside of that, I'd highlight the following areas. First, energy policy. I've mentioned it a lot. Europe simply needs affordable, reliable base load power. Secondly, some incentives. European companies, They're highly innovative, have been for hundreds of years, but they need reasons to invest in Europe itself. Right now, other regions are simply more attractive. So they probably ask themselves around the boardroom table, is the juice worth the squeeze?

7:21George Featherstone:And thirdly, on demographics, we have an increasingly aging population in Europe, and that is a really hard problem to solve. If you're worried about how many 30-year-olds there are today, you needed to worry about that 31 years ago. So changing it is really hard.

7:37Patrick Coffey:It's a very fair point. So what about AI? There's a lot of discussion about AI being a two-horse race between the US and China. Where does Europe sit? Is it sort of squeezed in the middle or does it have a seat at the table?

7:51George Featherstone:Europe has a stool at the table at the minute. I wouldn't call it a seat. This needs to change dramatically to see the benefit of this big spend on AI. We aren't building data centers anywhere near the pace that the US is. So we need a clearer mechanism to benefit from that right now. It is like a once in a generational opportunity and we're missing out.

8:12Patrick Coffey:Okay. So tell me about investing given this backdrop, George. Can you talk me through a few ideas at the forefront of your mind? Because it's a very tricky and thorny situation in Europe if you're thinking about the industrial sector right now.

8:24George Featherstone:Absolutely. We prefer atoms over bits right now. And a lot of the best risk reward that we see in the sector is in the old economy machinery businesses. So for example, we're at the beginning of a strong mining equipment cycle driven by a gold rush and also copper demand linked to electrification. We're also still very constructive on grid infrastructure demand and cables manufacturers, they will have solid earnings talk to that.

8:50Patrick Coffey:Okay. And for listeners, obviously last week, we talked about copper and gold. And I think this whole concept of the old economy versus the new AI economy is increasingly in the conversation in markets right now, given this huge disruption we're seeing in stock markets globally. George, thank you so much. I can't pretend I'm not jealous about you being in Miami and me being here in cold England. Have a great week and we'll chat to you soon. Thank you very much, Patrick. And thanks for everyone for listening. Okay. So to wrap up, a few things have stood out for me from this conversation. Clearly, Europe really matters for the industrial sector.

9:25Patrick Coffey:And whilst there are some reasons to be optimistic, it's the structural headwinds of energy policy, incentives, demographics, and that lack of AI investment relative to the US and China that mean that unless we see some radical change, those structural headwinds will persist and make it increasingly challenging for the European industrial sector to see some sort of major rebound. Thanks for listening to the Barclays Brief. If you enjoyed today's conversation, do hit subscribe wherever you're listening, and we'll see you again next week. Thank you.