ESG Focus: ASX Top100 Accelerate Green Push

ESG Focus | Dec 15 2021

This story features WORLEY LIMITED, and other companies. For more info SHARE ANALYSIS: WOR

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future: 
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/

ESG Focus: ASX Top-100 Accelerate Decarbonisation 

Decarbonisation has been in the ASX headlines in the past fortnight, several majors announcing big-dollar strategies, including Worley, Rio Tinto, and Woodside Petroleum. 

-Worley throws some big commitments into the ring
-Rio Tinto plans to use commodities sales to ratchet up green performance
-Woodside Petroleum pledges high but unconvincingly

By Sarah Mills

Australia’s largest companies are accelerating their 2025 decarbonisation plans, transforming the nation’s industry in the race to stay profitable.

Worley ((WOR)), Rio Tinto ((RIO)) and Woodside Petroleum ((WPL)) have all announced big carbon-reduction commitments.

The announcements follow hot on the heels of COP26’s agreements on carbon markets, which, combined with China’s commitment to renewables, are expected to drive massive change within five years.

Committed companies are bringing forward 2030 decarbonisation targets to 2025, a confirmation of the power of the world’s largest, well-funded companies to pivot swiftly into the transition.

Some analysts have criticised the announcements, saying they are big on numbers but low on specifics and caution against ESG euphoria.

All three companies have said traditional energy projects will continue to play a key role in their business, suggesting a tightrope walk on the risk front. 

The other disappointment has proven to be the lack of innovation in the announcements. Brokers had been expecting new metals announcements, or mergers and acquisitions or even asset sales. 

Innovation and additionality will be critical to driving ESG value.

Worley ready to pivot

Worley staged the biggest surprise at the showcasing of its energy transition strategy, saying it aimed to draw 75% of sales from sustainability projects by 2025. At present, it draws 32%.

It is a big number, and indicative of the scale of the global shift expected within just four years. 

For example, China is accelerating its arc-furnace steelmaking and the US will be playing climate catch-up, all of which is expected to underpin strong demand for green projects.

The world, flush with covid funds and driven by big capital through the investment fraternity and government policy, will be turning to companies such as Worley to provide green infrastructure.

Some analysts believe Worley is just currying investor favour, but assuming management is committed, it augurs well for the company’s long-term prospects. 

Of all the above-mentioned decarbonisers, Worley appears to offer the best conviction given it has every incentive and much to gain.

As a strong early mover, the company will gain experience, and reputational and brand advantages over its competitors.

Worley issued the first Australian sustainability bond into the European market mid 2021, which was significantly oversubscribed. 

The company faces substantial penalties if it fails to meet aggressive key performance indicators linked to decarbonisation, so Worley has considerable incentive to meet these targets. 

Worley’s transition strategy focuses on nine sustainability growth markets where it has skills, client relationships and project experience.

These include: decarbonising existing assets, industrial hubs, carbon capture and storage projects, green hydrogen, offshore wind, power networks, water, sustainability advisory and environmental consulting.

Analysts diverge in their assessments

UBS hired an energy transition consultant to help it with its appraisal of the strategy – particularly regarding the company’s role of project engineer.

The consultant found a natural adjacency for an oil and gas engineer in areas such as green hydrogen, carbon capture and storage, offshore wind, direct air capture, industrial hub development, and decarbonising or decommissioning assets; although they are more complex than traditional projects.

But time is on Worley’s side given many of the targeted projects have yet to be commercially scaled – perhaps one reason for the cynicism of some analysts.

Reinforcing the importance of gaining early-mover status, UBS’s consultant noted global scale is critical, as is balance-sheet capacity, given technology fragmentation signals massive M&A.

Digitalisation should also be a key differentiator.

UBS reiterates its Buy rating, saying the strategy offers Worley significant earnings leverage to a potential four-fold increase in global energy investment and decarbonisation projects.

The broker forecasts a 10-year earnings compound annual growth rate of 10%, which assumes 11% growth in energy transition investment, offset by a -3% decline in fossil-fuel related investment.

Citi says the strategy should increase margins given sustainability work within the project backlog and factored-sales pipelines have already risen 9% and 12% this half.

The broker expects higher-than-consensus margins from FY23 onward as a result.

Citi retains a Buy rating and $11.28 target price.

Ord Minnett proved to be the voice in the wilderness, saying the commitments couldn’t distract from the fact that 47% of revenue was still tied to hydrocarbon projects and that debt financing for large-scale oil and gas projects was becoming tougher to source. 

The broker expects the green transition will prove to be a drag on Worley’s long-term growth.

Ord Minnett has a Hold rating and cuts its target price to $10.50 from $11.30. 

Morgan Stanley upgrades to Overweight from Equal-Weight and pegs a $12 target price. 

The broker thinks the company is approaching its last period of earnings growth, noting signs of pressure in 2021.

Macquarie retains its Outperform rating and $12.25 target price.

The FNArena database shows four Buy and two Hold or equivalent ratings for a consensus target price of $11.61.

Rio Tinto also announces some big numbers

Rio Tinto meanwhile has pledged US$10bn to halve emissions by 2030, dwarfing BHP Group’s ((BHP)) $400m ESG pledge two years ago. BHP probably will emerge with a new pledge in the not-too-distant future.

Rio renewed its Euro10bn European Debt Instruments Program in May, with sustainability-finance optionality.

Rio has set a new target to reduce its Scope 1 and Scope 2 emission by -50% by 2030 – more than tripling its previous target – from a 2018 baseline.

Most importantly, it brought forward its 15% emissions target by five years to 2025, reinforcing the global acceleration theme.

Rio says US$7.5bn will be dedicated to lowering emissions between 2022 and 2040.

The company’s investor day focused strongly on its aluminium output. 

All this will come at a cost, and management provided capital guidance (unchanged at -US$7.5bn for 2021) of -US$8bn in 2022 and between -US$9bn and -US$10bn for 2023 and 2024.

A good percentage of this will be funded through transition-focused commodities such as iron ore and copper. 

Rio Tinto expects the transition will spur strong demand, and it plans to prioritise delivery of these by doubling capital expenditure growth to about $3bn from 2023, while simultaneously targeting bottlenecks that reduce operational variability and increase resilience.

Rio will also accelerate funding to projects that help its customers decarbonise. The company divested the last of its coal in 2018.

The company says it is taking a “staged approach” to decarbonisation “without compromising business competitiveness”. 

Critics read this as a business as usual approach, which could pose risks should the world move faster than Rio Tinto.

On the broader ESG front, Rio has operational safety as a sustainability KPI. Its two targets for sustainability-linked finance are decarbonisation and social metrics.

Aluminium hot to trot

Aluminium proved a focus of the company’s roundtable, analysts honing in on Chief Executive Rio Tinto Aluminium, Ian Vella's presentation, given the division is expected to underpin earnings growth for the next five years.

The company plans to continue to develop technologies like ELYSIS for carbon-free aluminium and multiple pathways to produce green steel. (It has a partnership with Bluescope Steel ((BSL)) to that end.)

Rio Tinto Aluminium, formerly a decarbonisation recalcitrant on some fronts, has changed its tune and plans to switch the Boyne Island and Tomago smelters to renewable energy.

NSW’s Minister for Energy and Environment Matt Keane, has been pressuring the company to take the ammonia/green hydrogen route for Tomago for some time, so the move is likely to be well received by markets.  

Goldman Sachs says Rio Tinto already has a low-emission aluminium exposure, being one of the highest margin, lowest carbon-emission aluminium businesses globally thanks to strong hydro-power production, and expects the ELYSIS inert anode technology could provide a billion-dollar windfall.

The company says the technology is on track for commercial scaling in 2024.

Goldman Sachs retains a Buy rating and pegs a $121 target price.

Morgan Stanley expects the US will drive demand for green commodities over 2022/23, pinpointing electric vehicles (EVs) and packaging as key growth markets, although spies some risk to EV demand from green steel shortages.

The broker notes a shift in the aluminium cost curve thanks to rising alumina, manganese and electricity prices (but management doesn’t expect a long-term shift) and expects this will roll forward.

Morgan Stanley holds an Overweight rating and $120 target price.

Credit Suisse says higher carbon costs should steepen the aluminium cost curve opening up a cost-competitive advantage and new growth opportunities. Aluminium is the broker’s top commodity pick.

The broker expects a December trough for the iron-ore price but expects China’s 2022 budget (published in March) could spark a price recovery.

Macquarie was more circumspect on the ESG hype, noting the company revealed no plans for divestment of high-emissions assets.

But Macquarie expects aluminium will be a strong growth driver and holds an Outperform rating and $133 target price. 

Citi names Rio Tinto as its preferred pick in the diversified mining sector given the pleasing carbon profile of its aluminium business.

The broker notes the ELYSIS venture should cut operating cost -15%, increase anode life by 30 times and can be retrofitted to existing smelters.

Citi holds a Buy rating and $115 target price.

Ord Minnett begs to differ and downgrade its rating to Hold from Buy, based on a forecast cut in China steel production assumptions, and pegs a target price at $102. The broker also spies operational challenges.

UBS chimes in with a Sell and a well-below consensus target price of $80.

The broker expects iron-ore capital expenditure and unit costs will remain high, noting tight labour conditions and rising iron-ore port inventories, despite a likely uptick in demand from China in 2022.

Morgans views the plan negatively. The analysts says the announcement marks a material change for Rio Tinto with a return long-dated at best, whereas the broker was expecting a clearer push into new metals or acquisitions.

Morgans downgrades its valuation. Target price $104. Hold rating retained.

The database shows four Buy, two Hold and one Sell or equivalent rating for a consensus target of $107.21.

Woodside Petroleum bites the bullet

Woodside Petroleum will invest –US$5bn in decarbonisation projects by 2030, bowing to the global shift in investor sentiment towards renewable energy.

Of the three, Woodside’s commitment drew the most scepticism.

Shareholder advocate ACCR’s director of climate and environment Dan Gocher described the company’s targets as uninspiring and business as usual. 

“Woodside’s newly announced target to reduce equity carbon emissions by 30% by 2030 is deliberately evasive and misses the bigger picture of its entire supply chain,” says Gocher.

He notes the targets only apply to equity share emissions, but its operational emissions (which include Scope 3 – supply chain emissions) are nearly three times larger than its equity share emissions and that the company plans to achieve its targets through carbon offsets, which is not considered best practice.

Woodside spies opportunities in hydrogen, green ammonia and solar. The company plans to leverage its LNG experience to expand into hydrogen as the market matures. That could be some time away.

Analysts gave little attention to Woodside’s announcement, focusing more on opportunities from its traditional LNG business to be used as a transition fuel.

Macquarie reports high-quality growth options in the Gulf of Mexico, Trinidad & Tobago, and Bass Strait. The broker holds a Neutral rating and $24 target price.

Morgan Stanley questions the LNG-funded hydrogen move, citing unresolved questions on cost and uptake, and is under rating restriction.

But the broker does expect LNG demand to rise at twice the rate of supply through to 2025. 

Ord Minnett says the announcement appears incongruous with the merger with BHP’s petroleum business but, like Morgan Stanley, expects gas demand will underpin the energy transition, providing support.

The broker notes Woodside plans several hydrogen projects and is targeting near-term opportunities that leverage hydrogen for heavy transport and ammonia for power.

Ord Minnett is under rating restriction.

Morgans says that while the company is keen to stay ahead of the industry’s pace of change, it sees little advantage in being an early mover. The broker holds an Add rating and $29.95 target price.

UBS Holds a Buy rating and $28.30 target price.

The database shows three Buy and tow Hold or equivalent ratings for Woodside, with two restrictions.

Elsewhere, Bluescope Steel (BSL)) has signed a memorandum of understanding with Shell to collaborate on Port Kembla projects, include a renewable hydrogen electrolyser for use at the steel works’ blast furnace. 

Infinity Lithium Corp ((INF)) has has partnered with ThyssenKrupp AG to explore using green hydrogen in lithium production.

FNArena's dedicated ESG Focus news section zooms in on matters Environmental, Social & Governance (ESG) that are increasingly guiding investors preferences and decisions globally. For more news updates, past and future: 
https://www.fnarena.com/index.php/financial-news/daily-financial-news/category/esg-focus/

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For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED

For more info SHARE ANALYSIS: WOR - WORLEY LIMITED

For more info SHARE ANALYSIS: WPL - WOODSIDE PETROLEUM LIMITED