ESG Focus: ASX300 Galloping Into Transition

ESG Focus | Sep 23 2022

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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: 
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ESG Focus: ASX300 Galloping Into Transition

Companies reporting on transition initiatives surged in the second half of FY22, as management seized on growing green opportunities to showcase in the August reporting season, and many outlined battle plans to deal with volatile energy costs.

-Decarbonisation accelerates as companies deal with rising fuel costs
-Companies pile their plates at the green-revenue banquet
-Net zero and scope-emissions reporting escalates
-Property’s time has come
-Biodiversity stages an entrance
-Water and recycling

By Sarah Mills

The FY22 reporting season proved busier than a palm tree in a hurricane on the ESG front, thanks in part to the Ukraine conflict which further incentivized decarbonisation in the June half.

As a result, FNArena is presenting a 3-part series drawn primarily from research generated by Macquarie, Jarden and JP Morgan.

This story – Part 1, summarises the major trends witnessed during the season with a major focus on the acceleration in commitments and net zero targets – a sign to future capital expenditure and strategic shifts. 

Many companies are likely to seek ways to offset rising fuel and capital expenditure costs, be it through carbon offset markets, carbon inset markets (more on this another day), alternative fuels, green revenue streams, and any other bankable opportunities that might cross their paths, illustrating a sharp shift in companies’ strategic focus.

Part 2 focuses on emissions and delves into specific company initiatives to build new green revenue streams, the search for alternative fuels, and efficiency and hedging initiatives. 

Part 3 examines A-REITs, biodiversity, recycling and social and governance developments.

Summary

What started as an ESG sprinkle in the December-half became a deluge in the June half of FY22 as ASX300 companies rushed to deal with a slew of challenges ranging from rising fuel costs to the green competitive landscape and inflation.

Decarbonisation took centre stage as the Ukraine conflict put a bomb under fuel prices, and Macquarie notes the conflict is now likely to drive a “disorderly global energy transition” (meaning a focus on decarbonisation at the expense of other ESG metrics).

Most commentators agree that the Ukraine conflict  (and resulting fossil fuel price volatility) is already accelerating the shift to a renewable energy economy, and that trend was definitely evidenced in the FY23 reporting season.

A key feature of the season was managements’ growing emphasis on fuel costs and the efficiency initiatives being undertaken to manage this, such as hedging energy costs, sourcing of alternative fuels, and a shift to gas from coal, all of which we discuss in Part 2.

Meanwhile, green commodities, particularly lithium miners, were often forgiven profit misses in what has otherwise proved an unforgiving market.

Capital expenditure plans for most major decarbonisers are rising, a fact mining and mining services were quick to recognize in their strategic commentaries.

Meanwhile, many miners and mining services companies announced they were delaying fleet upgrades until low-emissions equipment becomes more available, and Macquarie expects this could increase the sector’s maintenance capital expenditure for the next few years.

Evidence mounts in reporting season

This article is heavily weighted to green reporting as it provides an insight into the extent and pace of future capital expenditure.

From a strategic perspective, companies will be seeking new ways to offset this expense, which will likely pave the way for technology partnerships and mergers and acquisitions. 

The materiality of net zero strategies is likely to gain extra investor scrutiny in this respect.

Macquarie notes that the number of net zero commitments has risen to 67% of the ASX100, with seven new commitments reported in the June half, and a handful more since.

New net zero targets emerged from Cochlear ((COH)), Insignia Financial ((IFL)), Metcash ((MTS)), Cleanaway Waste Management ((CWY)), Jumbo Interactive ((JIN)), Ramsay Health Care ((RHC)), Ansell (ANN) Brambles ((BXB)), and nib Holdings ((NHF)).

In the ASX300, companies with a collective market capitalization of $1.86trn are covered by net zero commitments, – roughly 41% of companies, up from 35% in 2021, and which covers 96% of total ASX300 Scope 1 emissions, says the broker.

Strong progress was made on Scope 1 and 2 emission reporting and hence Scope 3 emissions made a belated but strong entrance onto the reporting scene as companies switched their focus to the grittier task of decarbonizing supply chains. 

This was combined with a growing number of company commitments to the Science Based Target initiative, and Macquarie reports that as at the end of August, 38 companies have subscribed, 25 have registered commitments and another 13 companies have set targets. 

Several small caps announced strategies and transformations that incorporate ESG and sustainability and rolled out 5-10-year plans and many provided targets for material ESG issues, with 57% of ASX101-200 companies now boasting detailed or comprehensive disclosure, according to ACSI.

Among the smallish caps with green revenue or recycling targets, Macquarie singles out Abacus Property ((ABP)), GUD Holdings ((GUD)), and Pact Group ((PGH)).

A few of the bigger corporates, particularly those with US interests, were tidying up their reporting heading into the expected mandatory SEC reporting rules in the US.

Woodside Energy ((WDS)) for example, announced in May that it had obtained all of the carbon offsets it needs to achieve its 2030 net zero target.

Evidence of transition mounts

Macquarie tallied up the number of companies’ targets and commitments.

It is a rather extensive and potentially boring list but has been included to indicate the scale of progress in the past two years (prior to which such reporting was virtually non-existent), and the extent of the rapidly accelerating scale of the green revenue business opportunity, which provides a natural segue to the next subheading: green revenue.

New companies to make commitments included: Australian Ethical Investment ((AEF)), AGL Energy ((AGL)), Aristocrat Leisure ((ALL)), Amcor ((AMC)), ASX ((ASX)), Bendigo Bank ((BEN)), Chorus ((CNU)), Domino Pizza Enterprises ((DMP)), Downer EDI ((DOW)), Flight Centre ((FLT)), Goodman Group ((GMG)), Inghams Group ((ING)), Iress ((IRE)), Lendlease ((LLC)), Lynas Rare Earths ((LYC)), nib Holdings, News Corp ((NWS)), Ramsay Health Care, Stockland ((SGP)), St George Mining ((SGQ)), TPG Telecom ((TPG)), Vicinity Centres ((VCX)), Ventia Services Group ((VNT)), Westpac ((WBC)) and Worley ((WOR)).

Those setting targets included: Auckland International Airport ((AIA)), Boral ((BLD)), Brambles, Dexus ((DXS)), Fletcher Building ((FBU)), Fisher & Paykel Healthcare, ((FPH)), Origin Energy ((ORG)), SkyCity Entertainment Group ((SKC)), Spark Infrastructure ((SPK)), Transurban ((TCL)), Telstra ((TLS)), Unibail-Rodamco-Westfield ((URW)) and Woolworths ((WOW)).

Another 24 companies committed to state science-aligned targets but not the SBTi and these included: Atlas Arteria ((ALX)), Ansell, Bega Cheese ((BGA)), Commonwealth Bank ((CBA)), Charter Hall Group ((CHC)), Charter Hall Long WALE REIT ((CLW)), Cochlear ((COH)), CSL ((CSL)), Charter Hall Social Infrastructure REIT ((CQE)), Charter Hall Retail REIT ((CQR)), Insurance Australia Group ((IAG)), Janus Henderson Group, ((JHG)), Metcash ((MTS)), National Australia Bank ((NAB)), Platinum Asset Management ((PTM)), QBE Insurance ((QBE)), REA Group ((REA)), Reliance Worldwide ((RWC)), Sims ((SGM)), Service Stream ((SSM)), SSR Mining ((SSR)) and Suncorp ((SUN)).

Origin Energy has since stolen the headlines, recently announcing it will exit fossil fuels for clean energy.

Green Revenue Opportunities

A slew of companies took the opportunity to showcase their strategies to build green revenue streams, particularly the mining services and building materials companies, many of which included technology partnerships.

Worley stole the show in the February reporting season, announcing a green revenue target of 75% of all businesses. Other mining services jumped on the bandwagon in the June half, with nearly all announcing initiatives or targets and plans.

We discuss the green revenue opportunity in greater detail in Part 2.

Property sector girds its loins

Property drew more than its usual share of attention heading into FY23. 

To date, the market’s focus has been on renewables and miners, particularly fossil fuel producers and green commodities, but that is all about to change as big capital turns its focus to the world’s biggest emitters. 

According to Forbes, property is world’s largest emitter constituting 40% of global carbon dioxide emissions. (Transport is second accounting for 27% of emissions but the electric vehicle transition is well underway.) 

Of these emissions, about 70% come from building operations and 30% from construction. 

A-REITs, in particular, were keen to present their credentials and ambitions, heading into what promises to be a turbulent time for a sector already beset with interest rate challenges. 

This sector is expected to become a key market for those offering emissions-saving products and technology; and A-REITs and developers are likely to set the bar for the construction industry.

We examine the transition leaders and laggers in Part 3.

Financials Jockey For Position

A focus on financed emissions targets on thermal coal mining, upstream oil and upstream gas extraction proved the flavour of the day in the financial services sector.

ANZ Bank's ESG briefing reports lending to oil and gas extraction rose 8% half on half, while lending to metallurgical coal eased.

Banks hold big emission exposures in property, agriculture, transport and energy – areas which accounted for more than 87% of Commonwealth Bank’s 2020 financed emissions reports, observes Macquarie. 

Commonwealth Bank hit new targets in this respect, as did Westpac. CBA also committed to end finance to coal by 2030, providing a tighter guide to fuel's future.

ANZ has since announced in its ESG briefing on the sector that it will set oil and gas and building products financed emissions targets by the end of the year, and expects National Australia Bank ((NAB)) will announce targets at its result. 

CBA has identified stranded asset risks. These include: home loans (3%, or $31bn of the banks home loans are vulnerable to natural catastrophes); and $14bn of assets are exposed to regions where more than 5% of jobs are linked to the coal-value chain. The other banks are yet to do so.

The ANZ brief revealed Westpac sharply lagged the majors in term funded and facilitated sustainable finance initiatives.

On the green revenue front, the banks already have a strong idea of how and from where they will derive their green revenue streams.

Macquarie says the banks are now exploring sector incentives and capital allocations, which FNArena expects should provide some interesting insights for FY23.

The ASX, meanwhile, is exploring carbon futures and highlighted electricity futures, along with sustainability courses as sources of income.

Banks generally have a big exposure to the high emissions property sector and this is also likely to come into focus in FY23. Ditto for insurers.

In a climate risk assessment, Challenger ((CGF)) identified property as its highest-risk asset class.

QBE reports that it is engaging at least annually with the top-10 highest emitters in its investment grade corporate credit portfolio.

Biodiversity And Water And Recycling

Biodiversity also made a noticeable entrance this season, with water being included under the biodiversity banner, giving at it least one bankable asset class (previously this was a major brake on rolling out the biodiversity concept). 

Macquarie says 25% of the ASX100 referred to biodiversity nature impacts, up from 14% in August 21, including The a2 Milk Company ((A2M)), GPT Group ((GPT)), Aurizon Holdings ((AZJ)), and a slew of resources companies.

Macquarie notes disclosure is high and expects Australia’s major corporations will start announcing targets in 2023 after the Taskforce on Nature-Related Financial Disclosures (TNFD) report is published.

All of this aligns with the recent push for a standardised global biodiversity certification scheme, with Australia's new Labor government already taking up the gauntlet.

FNArena feels that biodiversity’s time is approaching and plans  a 101 on the subject by year-end.

Water reporting was a focus for agriculture, resources and A-REITs, as usage was reported and harm minimisation efforts showcased.

While recycling continues to take a back seat, partly due to the “disorderly” transition triggered by the Ukraine conflict, which is accelerating the decarbonisation process, many companies announced progress, particularly in areas such as building materials for which recycling is also coupled with decarbonisation benefits.

On the recycling front, Pact Group announced it expected to derive an extra $25m a year in earnings (EBIT) by the end of 2025 observes Macquarie, and set a recycled content target of 30% of plastics by the end of 2025. 

Pact Group also showcased its progress in this respect, which included some small M&A and closures, and the start of its Albury-Wodonga PET plastic recycling operations. 

Orora ((ORA)) also announced initiatives.

Recycling was also a popular reporting theme for retailers.

JB-Hi-Fi ((JBH)) announced it had increased soft plastics recycling by 18% on 2021.

Super Retail ((SUL)) also set several recycling targets.

Mirvac ((MGR)) announced it has achieved a construction waste recycling rate of 94% and that recycling across its operations, office and retail portfolio jumped to 68% from 34%.

The company says that in regard to developments, the company is on schedule to secure 25% recycled concrete and steel (killing two birds with one stone given this should affect decarbonisation metrics), and to halve development waste.

BlueScope Steel ((BSL)) says it is targeting 40% scrap self sufficiency (which will require investment), and Macquarie report movements in obsolete and prime quality scrap should improve the company’s margins (pending already evidenced increased competition in this respect).

Boral says its Circular Materials Management concept is proven.

Social And Governance Initiatives

The S and the G took a big back seat to the E this year as a sense of emissions urgency beset the market, in part due to the Ukraine conflict.

On the “S” front, labour shortages and rising inflation proved a general malaise and largely outside company control, so it received a pass for the year.

The main feature was a deterioration in safety statistics from companies as high absenteeism and tight labour markets hit home, including deaths in mining operations, including Fortescue Metals ((FMG)), but again, this is unlikely to bring the wrath of big capital which is squarely focused on other priorities.

Governance

On the governance front, only two big strikes were recorded.

Shareholders took umbrage with Magellan Financial’s ((MFG)) $2.499m severance payment to ex-CEO Hamish Douglass, which was just $1,000 below the statutory threshold for a shareholder vote, observes Jarden.

And Terracom ((TER)) paid a $2.4m bonus to ex-CEO Craig Ransley, and only sought shareholder approval after the fact.

At a broader level, discontent was recorded as companies paid bonuses to executives despite missed targets, after the market took a tumble in the June half.

Many more companies introduced ESG metrics into management score cards, and sharply improved disclosure among small caps also featured.

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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