Incorporating environmental, social, and governance (ESG) analysis into an investment process can help uncover hidden risks or provide an early warning signal of risks that investors may be underappreciating. A recent report by Sustainalytics examines ESG-related risks that are becoming more material in 10 industries and how companies in those industries are addressing these issues.
Oil Firms Prepare for Low Carbon Future
Changing patterns of energy consumption driven in part by carbon regulation are likely to have major impacts on the profitability of oil and gas firms. Investors are pressing for greater transparency, as evidenced by majority shareholder votes last year at Exxon Mobil (XOM) asking for climate-risk disclosures.
Oil and gas companies at greatest risk in the low-carbon energy transition are those with higher average production costs, greater involvement in carbon-intensive projects and those that have made little progress diversifying their products.
Sustainalytics' evaluation of the greenhouse gas risk-management capabilities of the world's 10 largest publicly traded oil and gas companies. The leaders include Royal Dutch Shell (RDSB) and Total (TTFNF). Laggards include BP (BP) and Exxon Mobil as well as firms from China and Russia. Royal Dutch Shell, the report says, is the only firm on the list that has set carbon reduction targets and it's also diversifying its product lineup by entering the electric-vehicle market.
Food and Drink Firms Hit by Sugar Concerns
Concerns over the health effects of excessive sugar consumption are resulting in shifting consumer preferences, regulation, and litigation for food and drink companies. Soft drink companies are trying to address the risk through reduced-calorie products and marketing restrictions but, the report notes, the industry is also under increased scrutiny for using its influence to mislead the public about sugar-related health risks.
Danone (DANOY) and Nestle (NSRGY) lead the way because of their disclosure of relatively robust product health, marketing, and political involvement policy commitments. Coca-Cola's (KO) low score, on the other hand, reflects its high spending on lobbying.
Tech Firms Under Scrutiny
As firms like Google parent company Alphabet (GOOG), Facebook (FB), and Microsoft (MSFT) have consolidated market power, anti-competitive concerns have emerged, raising the possibility that these tech giants could face anti-trust litigation and eventually be broken up.
The collection of massive amounts of consumer data and the platform content that drives it are leveraged for advertising and sales revenue. That not only creates significant competitive advantages – it also raises issues surrounding privacy and concern over the spread of disinformation. Regulators, particularly the European Commission, are beginning to question whether the concentration of power in technology companies is beneficial for consumers over the long run. Firms such as Alphabet have been hit by multi-billion dollar fines, which may force technology companies to rethink their advertising-based business model.
ESG as a Financial Risk
Environmental, social, and governance factors are often thought of as a set of criteria that apply uniformly across industries and that are not necessarily financially material to a firm. On the contrary, ESG can be more accurately described as financially material risks related to the broader contexts in which an industry and its firms operate. They are often not fully incorporated into financial analysis but a fuller appreciation of them can provide key insights for investors.
