From time to time, Morningstar publishes articles from third party contributors under our "Perspectives" banner. Here, Virginie Maisonneuve and Katherine Davidson of Schroders dig into one of the key tasks for global investors--to assess the sustainability of earnings growth in companies. If you are interested in Morningstar featuring your content, please email submissions to UKEditorial@morningstar.com.
Markets are notoriously fickle in the short term. But more than ever since mid 2011, they have been reacting to the most immediate macro events of the day. Their focus has swung from one event to another, each with an equally short time horizon.
This has been at the expense of a more long-term analysis of company fundamentals. However, it is our view that key to strong investor performance is the assessment of sustainable growth beyond the immediate crisis. Given today’s ecological stress, finite natural resources, burgeoning debt levels, population ageing and strong shifts in global competitiveness (to name but a few of today’s challenges), companies must continually assess their ability to tap into sustainable end demand.
The debate on the sustainability of corporate growth focuses on issues such as demand, resources and debt. In particular, we find that given the deleveraging process and fiscal discipline tying the hands of much of the developed world, finding sustainable growth will mean exploring the power of emerging market demand.
Leaving aside the quality of management that companies require to be successful, we believe that key themes such as demographics, climate change (and related issues such as energy availability and security) and the “Supercycle” (or the evolving role of the large emerging market economies in the global economy, especially regarding consumer demand, resources and geopolitics) are inseparable from the sustainability debate and must be considered very carefully by companies and investors alike.
Natural Resources
Planetary resources are finite and experts claim we are approaching critical limits. Thus far, predictions of Malthusian catastrophe (dating back to 1798) have not been borne out.(1) Are there good reasons to believe that this time is different when it comes to resource scarcity?
One reason the situation is more critical is the location of the population growth. The big growers of recent centuries – the US, Western Europe, Japan – are relatively small in population terms. In 1900, the combined population of Western countries was little over 350 million. By 2000, this had roughly tripled, but still accounted for less than one-sixth of the world’s population, versus over half of the world GDP. In contrast, today’s big growers are emerging markets.
China alone account for 2.5bn people, over a third of the world’s population, and are expected to reach 3bn by 2050.(2) Africa is expected to double its population by 2050 and treble by 2100. GDP growth in these countries will therefore have a much larger effect on global resources. China already accounts for almost 50% of the world’s iron ore consumption (compared to 9.5% of world GDP), 47% of coal, and 46% of pigs.(3)
While many investors did not believe in the Chinese “economic miracle” 25 years ago, consensus has now shifted. However, on the basis of extensive first-hand experience, we remain convinced that China’s impact on the world over the next 20 years is not fully discounted.
Material Limits
The impact this population boom – and especially the growth of emerging markets – will have on the world’s finite resources is borne out most clearly in the commodities sector.
For minerals and hydrocarbons, price is the best indicator of scarcity. Remarkably, commodity prices have fallen over the last century, despite vastly increased consumption. Technological progress in mining and agriculture allowed resource productivity to rise such that supply outpaced demand. The argument that “necessity is the mother of invention” is compelling but allows us to avoid the inconvenient possibility that we are actually reaching the end of our ecological tether, and makes it tempting to regard recent price spikes as a blip in the long-term trend. We believe this on-going commodity and energy price behaviour in fact reflects important structural shifts.
The boom of emerging economies discussed above is the principal reason we strongly believe we are experiencing structural change. Recent work from our ESG team suggests that ecological stress has reached unprecedented levels. We are already living on 1.5x our planet’s biocapacity in terms of CO2 emissions, and have surpassed planetary boundaries on several ecological measures, including climate change, nitrogen levels and rate of biodiversity loss.(4)
Agricultural land and water per capita are both shrinking at an alarming rate. If everyone in emerging markets consumed like a European, we would need 3x the ecological capacity; 4.5x if we consumed like Americans.
Human ingenuity still offers the best hope of resolving these problems. For example, no-till farming has the potential to dramatically improve agricultural productivity, reduce emissions and prevent soil erosion. Nuclear, renewable energy and alternative sources of hydrocarbons, such as shale gas, mean that “peak oil”, should it transpire, will likely be less catastrophic than first thought.
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