By Sam Korus, Associate Portfolio Manager
This article on the impact of automation on the economy is a sequel to previous ARK research papers, What can we learn from agricultural automation And The potential impact of automation on production profitability. In this article, we explore how automation could affect aggregate stock market valuations over the next five to ten years.
Based on the history of agriculture and manufacturing, automation and operating margins are positively correlated: as automation increases, the share of manpower revenue tends to decrease and, as the share of labor decreases, operating margins tend to increase. We investigated whether or not that correlation could apply to many sectors, leading to higher operating margins and equity market valuations overall.
Robot density measures the number of physical robots per 10,000 employees. Automation density converts software-based automation into “robot” density.
All things being equal, ARK research suggests that in the absence of sales growth, increased automation could double the operating margins and enterprise value (EV) of equity markets by 2025. Compared to the ~ 25 years it takes to to reach current levels of automation in manufacturing, automation economically could reach similar levels within the next five years due to the convergence of technologies and the increasing rate of innovation. For example, the IRS reduced the time to complete a task from one year to 72 hours using UiPath’s robotic process automation. Furthermore, the launch of autonomous robotic axes alone could rapidly increase automation density. According to our latest research, automation density across industries could increase from around 30 robots per 10,000 employees today to around 170 per 10,000 employees in 2025, a level consistent with robot density in manufacturing in 2015.
According to our research, the density of robots in manufacturing has increased from 20 robots per 10,000 employees in 1991 to 176 in 2015, as shown below.
In the manufacturing sector, as robot density increased from about 50 to about 170 per 10,000 employees, labor pay as a percentage of revenue fell by more than 10 percentage points, as shown below.
In the second part of this series, ARK highlighted a positive correlation between automation and manufacturing profitability. For the economy as a whole, the same relationship appears to hold: labor pay as a share of revenue is negatively correlated with operating margins, as shown below.
By how much automation could the operating margins increase? Compensation for manufacturing labor as a share of revenue decreased by approximately 15 percentage points as robot density increased from 20 to 176, as shown below. If the same relationship were to apply broadly, labor compensation as a percentage of GDP or national income could similarly decline over the next five years.
* Note that the robot density does not reach 200 as in the first chart because the dataset for the share of manufacturing labor in the United States only goes up to 2015.
Automation has impacted agriculture profitability far more than production, as shown below. Each percentage point of decline in labor compensation as a share of revenue increased agricultural operating margins by 3.8%, more than 12 times 0.3% in manufacturing, as shown by the slope of the lines below. Across all sectors, if labor compensation as a share of revenue were to decrease by the same 15 percentage points as the manufacturing sector, corporate operating margins would double to around 20%.
Based on discounted cash flow models, a doubling of operating margins would double the multiple of enterprise value on sales. For example, the Russell 3000 could double its “fair” EV / sales multiple from around 2.2 to nearly 4.5, with no top-line growth, solely due to increased automation profitability, as shown below.
That said, everything else may not stay the same, suggesting that automation could impact parameters other than operating margins, including wages, pricing, and capital investment. Wages and capital investments could rise more and prices less than otherwise. In turn, real GDP may be higher and the return on investment (ROIC) lower than it otherwise would be.
Additionally, history suggests that some industries and businesses will automate quickly, increasing productivity, profitability and sales, while others will lag behind. The impact of automation on the wider economy could be catalysed. Indeed, a handful of innovative companies may adopt automation early and aggressively, operating far more profitably than others and catalyzing adoption across the economy.
1. The work share is the percentage of profits paid in the form of wages.
2.https: //www.bloomberg.com/press-releases/2022-02-01/irs-implements-robotic-process-automation-technology-from-uipath-within-its-finance-and-procurement-divisions? sref = 1f7Aj053
4. Based on average operating parameters for the Russell 3000 between 1991 and 2018.
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Editor’s Note: The summary bullet points for this article were chosen by the editors of Seeking Alpha.