In this article, we share with you how typically over-looked Environmental, Social and Governance (“ESG”) factors can be telling about the sustainability of a company and its performance in the long run.
As a company’s ability to be sustainable and thrive in the long-run goes hand-in-hand, we will also discuss why you should consider ESG as a guiding framework to select your long-term investments.
There are various ways where ESG factors could impact a company’s investment returns, and in this article we will look at the two most common factors – (i) Consumer loyalty (or lack thereof) and (ii) Regulatory trouble.
i. Consumer loyalty (and boycott)
It’s innate. If we like something, we support it through our dollar or word of mouth.
The same logic applies for consumers – they are more likely to support the brands they believe in, especially those which provide high quality products or services and have values aligned with theirs.
The opposite is also true, consumers could also boycott the brands or spread ill about companies if they do not agree with how the businesses are run.
According to a survey by The Conference Board in 2017, close to 70% of consumers around the world
are now expecting companies to care about their environmental impact (Chart
1). This may lead corporations to be increasingly pressured to commit efforts to
meet such expectations.
Chart 1: Consumers are progressively more conscious about environmental impacts of companies and brands
Source:
The Conference Board - Global Consumer Confidence Survey, 2017
In another recent survey, market research firm Nielsen discovered that a substantial 46% of global consumers are willing to forgo a brand name, in exchange for environmentally friendly products. The results revealed an emerging threat to the incumbents, many of whom have long enjoyed their customers’ support, and have no intention of aligning their product range with changing consumers’ beliefs.
Closer to home, the global push for environmental sustainability has also taken hold in Singapore. Nielsen has also found that 81% of Singapore consumers are willing to pay a premium for products that contain “organic / all natural ingredients”, while 80% would pay for “environmentally friendly / sustainable materials” (Chart 2).
Chart 2: Majority of consumers in Singapore are willing to pay a premium for sustainable products.
Don’t believe consumers are capable of putting their dollar where their mouth is? Sales figures have shown us.
Interestingly, researchers at the Stern Center for Sustainable Business of New York University found that products that were highlighted as “sustainable” sold much faster than products which weren’t. In fact, in the last five years (2013 – 2018), those marked as sustainable grew 5.6 times faster than those who weren’t.
Unilever (NYSE: UN), a consumer goods giant, reported that their Sustainable Living Brands grew 69% faster than the rest of their business in 2018, as compared to 46% in 2017. In fact, these brands delivered 75% of the company’s growth! CEO Alan Jope acknowledged that “Two-thirds of consumers around the world say they choose brands because of their stand on social issues, and over 90% of millennials say they would switch brands for one which champions a cause”, which has shaped the way they provide their services.
Consider the rise of Beyond Meat (NASDAQ: BYND). By committing themselves to conserving natural resources, respecting animal welfare and having a positive impact on climate change, they have created meat replacements with plant protein. With changing consumer preferences and millennials switching to healthier and more environmentally-friendly alternatives compared to traditional meat, Beyond Meat saw a sharp growth in sales. Their net revenue increased 5.4x in the last 2 years, from USD 16.2 million in 2016, to USD 87.9 million in 2018 (Chart 3).
Chart 3: Beyond Meat is a prime example of how working towards an environmentally-friendly purpose is actually beneficial for business.
Source: Beyond Meat, 2019
Their recent announcement of 9M 2019 numbers showed that they had more than doubled 2018’s full year figures, as they work towards their targeted net revenue of USD 265 – 275 million for the year of 2019.
While Beyond Meat (along the plant-based meat industry) were met with resounding success, the same cannot be said for the traditional meat industry. In the period of 3 years spanning March 2016 to 2019, annual sales of plant-based meat rose 42% to USD 888 million, while sales of traditional meat only grew by 1%. This underscores how a paradigm shift in consumer preference can quickly shape an entire industry, even in one as old-fashioned as meat.
ii. Regulatory trouble
Aside from consumer perception, regulatory issues can be a massive (and expensive) nightmare for corporations.
Firstly, they can negatively impact firms’ bottom line once fines are imposed and legal fees start to pile up.
As regulatory troubles facing the firm goes public, the bad press can cast the firm in a negative light. Employee morale, consumer trust, shareholders’ confidence will likely be affected as well, leading to further damages to the company’s operations.
USD 10.2 million fine for one of the world’s most hated companies
For endangering the environment, community and their own workers, Monsanto (a unit of pharmaceutical giant Bayer AG that specializes in crop sciences) was fined USD 10.2 million in 2014 for the apparent breach of the Environmental Protection Agency’s 2013 ban. In this incident, Monsanto has breached all three ESG aspects.
- Environmental: The company knowingly sprayed a banned and hazardous pesticide, Methyl Parathion, on crops in Maui, Hawaii
- Social: Sent workers back into the area after 7 days even with the knowledge that the safe period should be 31 days
- Governance: Lack of internal processes and checks which should have prevented Monsanto from using banned pesticides and mistreating workers
In short, Methyl Parathion interferes with the nerve and brain functions. It can cause death, loss of consciousness and vomiting, amongst a variety of other illnesses in humans and has been found to jeopardize the survival of dozens of endangered species.
And that’s not all. Investors familiar with Monsanto’s notorious ways and long list of haters have more bones to pick with the company. To keep the history lesson short, Monsanto is one of the producers of Agent Orange (used in chemical warfare during the Vietnam War, infecting millions) and DDT (synthetic insecticide that is now banned in the US for environmental impact).
Having recently been embroiled in over 42,000 lawsuits from non-Hodgkin lymphoma patients due to their popular weedkiller, Roundup, the Methyl Parathion incident is just the tip of the iceberg for Monsanto’s unsustainable ways that are gaining visibility.
Bayer AG, which acquired Monsanto in June 2018 is seeing the effects of their investment too. With the resounding bad news, Bayer’s share prices have fallen drastically. Since their acquisition of Monsanto in June 2018 to early December 2019, their share price has fallen -31% (Chart 4).
Chart 4: Bayer AG’s declining share price at critical moments of their relationship with Monsanto
Data as of 3 December 2019
Shaking up Corporate Governance in Japan, and out
You may be familiar with the Nissan-Renault alliance, and the high-profile jailing of Carlos Ghosn. Once thought of as an internal political takedown, it evolved into a criminal case in the courts of Japan about incomplete compensation disclosures, potentially violating Japan’s securities laws.
The dramas of the case have also exposed the lack of corporate governance within Nissan’s operations. Apart from a near USD 100 million to be received after Ghosn’s retirement, there were other practices which raised eyebrows:
- A 50,000 euro charge to Nissan for the rental of Ghosn’s Chateau de Versailles wedding in 2016;
- Alleged usage of USD 600,000 in Nissan funds to pay for his children’s university tuition; and
- Nissan did not have separate board committees overseeing audits, appointments and remuneration even though 75% of the largest Japanese companies did. This meant that the top management at Nissan could effectively decide on their own pay.
To close off the case, Nissan forked out USD 15 million in penalties. In the wake of the aftermath, it turns out that Nissan’s shareholders are the ones who have been truly penalized in the short and long-term.
Investors, clearly shaken by the sustainability of Nissan’s business, saw their share price fall by over -30% in the span of one year, dating from Ghosn’s arrest on 19 November 2018.
The companies have also lost their leaders - Renault lost their chairman while Nissan lost their CEO. Instead of focusing on the company’s already declining performance, their attention had to be partially diverted from their main business to spending additional time and effort dealing with litigation and reputation issues.
With such negative news regarding the company's management exposed wide in the open, it may lead to poor morale and confusion amongst the staff, which can continue to weaken Nissan’s financial performance in the long-term.
Sustainability is important when it comes to long-term investments
Sustainability is a crucial trait that is often overlooked by investors, especially when compared to other attributes like earnings growth and valuations.
However, as long-term investors, the importance of sustainability cannot be understated. It plays a part in determining if these companies can maintain their business operations, competitive moat, as well as their ability to retain the loyalty of their customer base, which in turn drives long-term organic growth.
To that end, ESG investing serves as a useful framework for investors to determine the sustainability of a company based on Environmental, Social and Governance factors. It pinpoints the potential pitfalls of the company, provides guidance in which the firm could possibly win over consumers and regulators with their focus on these 3 factors, and eventually emerge as an industry leader in the long run.
In the upcoming articles in our brand new series on understanding ESG
investing, we will also be sharing with you on how you too, can get in on
ESG investing for the long run.
Related Articles:
3 approaches by institutions to achieve sustainable investing
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