ESG Focus: ASX200 Off And Running, Part 1

This story features BORAL LIMITED, and other companies. For more info SHARE ANALYSIS: BLD

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: ASX200 Off And Running

The February reporting season revealed a step-change in ESG ambitions over FY21 with clear signs that some companies are breaking from the pack, aiming to establish a lead in what is shaping up as the world’s Great Race.

-Shift from identifying and managing risk to strategy and execution
-Decarbonisation, circularity and modern slavery dominate along with a splash of M&A
-ESG funds inflows quadrupled in 2021 setting the stage for transition
-Green and circular highlights

By Sarah Mills

The February 2022 reporting season revealed a step-change in the ASX200's ESG ambitions.

In FY21, the corporate focus was primarily on incorporating ESG statistics into reporting metrics, and announcing progress on those metrics as companies sort to identify and manage risks. 

A handful of companies also announced ESG capital expenditure.

But the February reporting season provided a platform for Australia’s ESG belles of the ball to strut their stuff and there was general preening and even downright aggressive behaviour on display.

In the first half of FY22 (for most), several companies broke from the pack, identifying ESG business opportunities, innovating and executing. 

The main ESG themes addressed by the ASX200 during reporting season were decarbonisation, circularity and modern slavery, with low hanging social fruit such as gender diversity and safety metrics just managing to gain a look-in.

This year companies such as Boral ((BLD)), South32 ((S32)), Alumina Ltd ((AWC)), Cleanaway Waste Management ((CWY)), Orora ((ORA)), Wagner Holding Co ((WGN)) and Fortescue Metals Group ((FMG)), among numerous others, have started to report material and specific ESG operational and strategic initiatives. 

Other companies reported strong targets, plans and the occasional roadmap, such as Worley ((WOR)), which announced 75% of its revenue would be sourced from green projects by 2025, and BlueScope Steel ((BSL)).

Worley provided more details on green revenue streams in its February report, as did Downer EDI ((DOW)) and several companies such as Fletcher Building ((FBU)) and Boral announced sustainable revenue opportunities from green products. 

Meanwhile, future-facing ESG commodities rocketed in the December half and continued hot to trot into 2022.

Some companies already at the centre of the ESG theme, such as Sims Metal ((SGM)), appear to have nominated mergers and acquisitions as the most important initial step in their ESG strategy, over clear strategy rejigs that might be considered more impactful such as vertical integration or innovation. 

In fact, ESG M&A and divestments were common during the half as companies reshuffled and repositioned with ESG priorities in mind. The pulled-forward closure of Origin Energy’s ((ORG)) Eraring coal plant also garnered headlines.

Morgan Stanley says ASX200 company commentary on ESG issues rose 46% in the half. Interestingly, analysts’ questions on ESG only rose by 11%.

Not All Strategies Are Created Equal

Some of the reporting season’s initiatives were intrinsically more aligned and in the spirit of ESG than others, keeping in mind circularity, vertical integration and impact remain the holy grails.

In that sense, clear leaders are starting to emerge. The rest of this article documents some developments but is far from exhaustive.

Analysts report two thirds of ASX200 have a clearly defined sustainability strategy, with 44% of them articulating how it is integrated into their corporate strategy. 

But some of these are more credible than others, and it is up to investors to sort the wheat from the chaff. 

Analysts note a strategy without a plan, a timeframe or measurable targets is more a statement of intent rather than a genuine strategy. 

Short, medium and long-term plans are required and carbon pledges are to be treated sceptically unless a pathway and timeline are identified, says Morgan Stanley.

In this article, FNArena touches briefly on social reporting trends, and the main decarbonisation developments before moving to circularity and then to the 2022 outlook.

We cover February reporting season’s developments on the energy transition and broad ESG M&A in a separate story.

Social announcements run a poor third

The “S” in ESG also took a backseat to the environment in the February reporting season, but Ansell ((ANN)) did announce the completion of a supplier management framework and risk assessment.

The company advised it is in the process of bringing on Wave 1 suppliers (which include finished goods, cotton and recruitment agencies) and continued auditing suppliers primarily for non-conformance.

JB Hi-Fi ((JBH)), generally considered an ESG laggard, meanwhile announced it is working with suppliers to embed its ethical sourcing policy.

BHP Group ((BHP)) replenished its 30% female board representation after resignations left the miner denuded and notably short of targets. BHP aims to achieve gender balance by 2025.

Other common social trends in the half, included an increase in companies linking ESG to executive remuneration, and improved reporting on absenteeism and safety and injury reporting.

Morgan Stanley forecasts strong changes to Australian work-and-recreation practices over the next few years. These include an inflexion in infrastructure utilisation rates and discount rates.

ESG Equity Fund Inflows Soar In The Half

Meanwhile, Calastone’s Fund Flow Index reported that the amount of cash Australians invested in ESG equity funds more than quadrupled in 2021 to $3bn with $1 out of every $5 placed in equity funds last year invested in ESG strategies.

Calastone is the network that processes 95% of Australian managed fund flows.

This compares with $4 out of $5 in the UK in 2021, suggesting the trend could well accelerate in Australia, either in 2022 or later. 

On the fixed-income front, Calastone reports for every $10 put into fixed income funds last year $4 went to fixed income funds focused on ESG strategies, making Australia a world leader in this respect. 

Calastone’s CEO Teresa Walker says ESG capital will soon surpass the amount of money in traditional managed funds and that ESG funds are likely to steal funds under management (FUM) from traditional funds. 

This was already a feature in 2021, with the likes of Pendal Group ((PDL)) suffering a sharp FUM outflow in the December half associated with ESG reallocations. 

On the finance front, several of the ASX200 members announced sustainability-linked loans tied to various targets, including: Spark New Zealand ((SPK)).

Decarbonisation – Some Companies Break From The Pack

Credit Suisse notes the energy transition dominated ESG reporting ambitions and observes a shift from preparations to decarbonise in 2021, to execution.

Some of the more interesting concrete announcements on the decarbonisation front (there were plenty of interesting less concrete announcements) came from Fortescue Metals (which announced progress on hydrogen and battery transport prototypes within its operations) and Boral, which announced a new recycling division.

Less specific, but significant in scale, were commitments to decarbonisation capital expenditure, Rio Tinto topping the charts after announcing the largest decarbonisation expenditure on the ASX at US$7.5bn between now and 2030.

The company announced another US$3bn in capital expenditure in future-facing commodities.

New green revenues were also among the most cited initiatives during the December half, both Fletcher Building and Boral reporting increases in demand for green products such as low-carbon cement.

Other companies reported plans to decarbonise operations, but such announcements are barely enough to keep up with the pack. 

Macquarie notes the number of ASX100 companies to commit to net zero rose to 60% from 40% over 2021.

New emissions targets were set by Adbri ((ABC)), Auckland International Airport ((AIA)), Atlas Arteria ((ALX)), Brambles ((BXB)), Healius ((HLS)), Link Administration Holdings ((LNK)), Medibank Private ((MPL)), Scentre Group ((SCG)) and Stockland ((SGP)). 

Having said that, Credit Suisse reports Australia’s REITs demonstrated such massive strong progress towards decarbonisation over 2022, they now lead the world – a sign they should continue to gain the favour of big capital in the near term.

Bloomberg Data says only 25 of ASX200 companies have an absolute emissions target.

Macquarie reports decarbonisation disclosure rose sharply during reporting season.

BHP Group, Transurban ((TCL)), Newcrest Mining ((NCM)), Sims Metal ((SGM)), Goodman Group ((GMG)), JB Hi-Fi, Treasury Wine Estates ((TWE)), Ansell, South32 and Telstra ((TLS)) all reported renewables agreements and investments.

In the back leg of the decarbonisation field, some companies were fiddling with less admirable options such as offsets, carbon-capture storage, and far less ambitious and less strategic announcements.

And of course, there were the serious laggards.

Circularity Highlights

There was movement at the station on the circularity front.

Sims Metal, Pact Group ((PGH)), Orora and Cleanaway all cited growing demand for recycling and made announcements of varying interest in the December half.  

Boral was the most interesting to report in the segment, announcing recycling as a new strategic plank in its Redefine strategy, which aims to create a new revenue stream and support quarry rehabilitation.  

This aligns closely with one of ESG’s holy grails – vertical integration.

The proof of Boral’s strategy will be not only in the execution, but also in the pudding. Analysts will be running a keen eye over the model to see whether it pays and how it will stack up against competitors for construction waste such as Cleanaway. 

The news accompanied an announcement from Cleanaway that it plans to expand its construction and demolition arm to 100% from 48% (previously Macquarie’s Bingo Industries held the balance). Analysts say the fastest way to do that would be to make a material acquisition.

Cleanaway also plans to increase its exposure to energy from waste and move further down the value chain in terms of resource recovery projects, notes Credit Suisse.

That the company did a deal with Macquarie to that effect is fascinating, and we will investigate this further in a separate article once we manage to secure a copy of the company’s Blueprint 2030 Strategy, which the CEO was brandishing on results day but little has been seen from it since.

This too would require potential capital but analysts expect expenditure is more likely to be funded by project finance than raisings.

We address Cleanaway and Boral’s circularity strategies in a separate story.

Pact Group has been forging ahead on plastic recycling, planning to recycle 50% of milk bottles and 100% of recycled PET beverage bottles, and upgrade its mobile garbage bin manufacturing capability to prepare for better waste collection.

While the plastic theme has taken a backseat to decarbonisation in the past few years, this may be about to change.

The United Nations Environment Assembly agreed in early March to establish an intergovernmental committee to negotiate a legally binding treaty to tackle the proliferation of plastics.

Commentators say that once completed, the agreement will rival the Paris Accord.

Credit Suisse says waste conversion gives Pact Group an edge in supplying consumer goods companies with packaging from recycled content, thus giving it a potential premium by enhancing its ability to sustain market share.

ESG Starting To Dominate Market Trends

The ASX200 gained 2.1% total return during February, and while value stocks continued to outperform growth companies (including those with an ESG focus), due to interest rates and inflation fears, the big story was in future-facing commodities.

Energy and materials were among the best performing stocks, leaving other ESG plays such as technology and health stocks meandering on the edges. 

The reporting season suggests that critical ESG mass is growing and markets should start to witness serious innovations within the next few years as companies get their strategies in place.

Calastone’s Teresa Walker expects the ESG boom into funds will continue in 2022.

“ESG equity funds are taking new capital market share from traditionally managed funds, a trend that may begin to feature in Australia’s fund market,” says Walker. 

“Nevertheless, the value of ESG funds under management is still dwarfed by traditional categories so there is a lot of headroom to grow further, which is good news for active fund managers.”

ESG-based mergers, acquisitions and divestments are expected to gather pace during 2022, as suggested by the sheer scale of many of the decarbonisation allocations.

Meanwhile, Morgan Stanley believes 2022 will be a transitional year for infrastructure and utilities and expects a growing focus on cybersecurity after several high-profile global incidents. 

Geopolitical tensions have cast the cat amongst the pigeons and are likely to witness gas returning to favour as a transition fuel, although it is possible the pace of deflation in renewables will cause a reckoning.

Commentators believe recent gas price crunches further support the rationale in favour of accelerating the green transition and gaining energy self-reliance.

Morgan Stanley also expects scenarios such as stranded gas assets or retrofitting for the hydrogen economy are likely to feature.

We examine recent decarbonisation and circularity initiatives in more detail in Part 2 of this series.

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/

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

FNArena is proud about its track record and past achievements: Ten Years On

Click to view our Glossary of Financial Terms