The COVID-19 pandemic has only served to increase interest in the so-called fourth industrial revolution, or Industry 4.0 -- in other words, the use of digital technologies such as Web-enabled devices and the industrial internet of things (IIoT) to better manage physical assets. As such, a slew of industrial companies are either buying or investing in software and IoT capabilities, while the pure-play software companies are forging relationships with industrial companies. It's an exciting industry, and it's going to change the way investors think about the industrial sector.
The established industrial companies -- General Electric and Honeywell
Investors shouldn't be quick to dismiss industrial software as a mere "add-on" to the established industrial companies. On the contrary, it's a key part of their business models.
For example, in a recent presentation, the CEO of General Electric's (GE -0.15%) digital business, Pat Byrne, outlined the importance of the "businesses role in transforming GE. Byrne claimed that digital was three years ahead in the average "rate of adoption due to COVID-19." As such, GE Digital is a $1 billion business by revenue, with most of it falling in the power and renewable energy segments.
To give a few simple examples, IIoT sensors attached to GE's power turbines or wind turbines gather data that can be used to monitor and gauge performance of the physical assets to better predict servicing needs.
In addition, managing the transmission and distribution of electricity in the grid is going to be a lot easier while using data analytics to create actionable insights. As such, it's going to play a key role in the transition toward renewable energy because the variable energy produced by renewable sources places challenges on the grid.
For GE, its growing digital business is a key part of its plans to expand power and renewable energy segment margins to those of its peers -- a key part of the investment case for the stock. As such, it's an integral part of the company's operations.
In addition, to GE, other industrial giants are also investing heavily in IIoT solutions. For example, Honeywell (HON 0.43%) management aims to turn transform Honeywell into becoming a software industrial company. In a nutshell, its Honeywell Forge solutions use IIoT to collect data that can then be analyzed and acted upon. For example, airlines can cut costs by lowering maintenance costs and increasing fuel efficiency, and commercial building owners can reduce operating costs by generating energy savings of 20%-30%.
The pure-play software companies -- PTC and Aspen Technology
While IIoT is a key driver of future growth at GE and Honeywell, investors may want to find companies with more pure-play exposure, and that's where PTC (PTC 0.73%) and Aspen Technology (AZPN) come in.
PTC currently generates the bulk of its revenue from its core computer aided design and product lifecycle management software businesses, and management sees them growing at a high-single-digit rate over the medium term. However, the really exciting part of its business is its IIoT and augmented reality (AR), solutions which management expects will have compound growth rates of 26% and 60% on a compound annual basis from 2019 through 2024.
In a nutshell, PTC's IIoT solutions connect a company's physical assets with the digital world -- the heart of Industry 4.0 -- and helps users better monitor equipment performance. Meanwhile, PTC's AR solutions present the physical environment in a digital way, therefore enabling equipment to be monitored and serviced even without the presence of a technician.
Again, it's a solution that will significantly improve profitability. As such, PTC is expected to grow revenue at a mid-teens rate for the next few years at least.
Aspen Technology is an intriguing company. It's a leader in asset optimization software for the process industries. In plain English, this means it makes software solutions to analyze and asses the functioning of, say, a chemical processing plant or an oil refinery.
In addition, oil and gas engineering and construction companies use Aspen's solutions to develop solutions for clients. Given that these sorts of processing plants tend to generate huge amounts of revenue every day, it's imperative to reduce downtime and/or for an engineering company to deliver a plant that a client can use immediately. Aspen's smart solutions help companies to do just that.
Stocks to buy?
All four are attractive in their own right, and they are all about to change the industrial sector for good. However, if you're looking for a pure Industry 4.0 play, then PTC and Honeywell are the best placed. GE Digital will certainly help GE, but to buy the stock, you need to be comfortable with prospects at GE Aviation.
Aspen Technology is very interesting, but its current valuation of 42 times earnings means there is little room for error for any earnings disappointments -- something on the cards for any company with heavy exposure to oil and gas in 2020. As such, Aspen is one for the watch list.
Honeywell Forge is another reason to buy Honeywell, and the company's management is positioning it well take advantage of any opportunity in the post-COVID-19 environment. Finally, PTC looks very well set to profit from any pull forward in spending on Industry 4.0 resulting from the pandemic, and its long-term drivers look very well placed, too.