The Sustainable Investor

Could healthier food finally be in reach? The sustainability transitions will throw up some exciting, and financially viable, opportunities for companies. But many of them are not easy to turn into a commercial reality. Yes, some are (our electricity system is a good example). But what about the food we eat. What does healthier food look like, from a food producer perspective? And could Nestle be on the cusp, prompted by a run of slower profit growth, of being the big food company that answers this question? We all know what a healthier diet looks like. More fruit and vegetables; less salt, sugar and fat; less ultra processed food, and less meat (especially red meat). And probably, at least in western countries, fewer calories. So how does a food producing company use this information in a way that helps them build competitive advantage and generate financial value? It's not obvious that just making their existing food healthier is enough. Being cynical, there is a good reason why the industry as a whole produces 'ultra processed' food. Because consumers buy it. Maybe for all the wrong reasons but ... Hold that thought in your head, the answer from a company perspective is more complex than just making healthier food. Add to this a 'fact' that all investors know - a crisis often causes a company to rethink its strategy. The logic behind this is easy - if things are going well, the pressure to change is easy to resist (inertia). But what about when the financial results start to slide. When you go from industry leading, to the middle of the pack, and maybe worse. I was thinking about this as I recently rewatched the recent Nestle capital markets day. The old Nestle model of financial growth seems to have broken. It's beyond the scope of this post to examine what has happened, but there is some detail in the related blog. All we need to know at this stage is that Nestle needs a new financial model. And I would argue that one of the principal foundations could be food that tastes good (that we want to buy) AND that is better for us. I am the first to admit that knowing exactly what this will look like is not easy. But then if the solution was obvious, everyone would be doing it, and it wouldn't generate competitive advantage. In which case the companies all keep selling more ultra processed food. Which is why I invoke the spirit of nespresso. When it was launched it was not obvious that it would succeed, at least to outsiders. But it did. It was a massive success. Why ? Because it mixed hard analysis with innovation insight. It went somewhere new. This could be the model for Nestle to follow in healthier food. Yes, crunch the numbers but also think outside of the box. Could this be the approach that restarts the old Nestle financial model? We talked about this in a recent blog for The Sustainable Investor, which you can read for free. Just follow the links in my profile. And remember, this is not financial advice.

Are we talking about stranded assets in the wrong way, at least when we talk to investors? Or putting it another way, is the financial bad news for the company already in the share price? When this statement is true, we probably need to refine our engagement message. For non financial people it's easier - stranded assets are those for which there will be a smaller (or even zero) demand in the future. Typical examples that get talked about in the press are Oil & Gas, traditional fossil fuel powered cars, and gas boilers. But this also can cover things like steel made with blast furnaces using coal. And the argument broadly runs like this. Over time, we will replace the goods these assets produce with others that generate fewer GHG emissions, or that are better for our planet in other ways. And so the assets we use to make these products (gas reserves, automotive plants etc) will be used less and less. And so will be worth less and less. And this all makes perfect sense. Where it gets more complicated is when we say to investors - don't invest in these assets as they will be worth a lot less than you think in the future. In other words, they are a bad investment. Much of the debate I have read about the future value of these assets talks about the events (new technology, regulation etc) that will destroy the value in these assets. But in engaging in this debate, we also need to bear in mind that sometimes the market already knows this. Financial people talk about efficient markets. What we mean by this is that all known future events are already anticipated and reflected in the current value of the asset (the share price). If this is true, then the financial markets have already anticipated the bad news about asset values. When this happens, it often becomes clear to outsiders if the company is cheap on traditional valuation metrics such as PE and EV/EBITDA. But, financial markets are not always efficient. Sometimes the market thinks the negative event is a long way in the future, and the change happens faster. And when the change happens, the asset value collapses. And sometimes investors know about the risk, but don't act on that knowledge. Why might they do that ? Because the share price is going up, and investors hate missing out on rising share prices. I am not arguing that the market is properly anticipating sustainability transition risks. What I am saying is that we need to tailor our message. If we think that the bad news is already in the share price, target reduced investment in assets at risk of decline. And if the risk is known, but some investors are not acting, focus on the events that we see coming that could make the risk very real. Because when they happen, the share price will respond (fall). The bottom line is that we need to understand market expectations. https://lnkd.in/edVCTjh9

One of my frustrations is that we don't work hard enough to link sustainability to business strategy and long term financial value creation. My pitch is simple. If we continue to primarily focus on the societal and moral arguments for improved sustainability, then we make it easy for companies and governments to fob us off. How do they do this. By focusing on long term targets that have no real meaning or that they are not really committed to delivering. Or by creating rules that have so many loopholes they are effectively meaningless as triggers for action. Yes, we have made some good progress, especially in transport and electricity generation, but let's be honest. It's not enough. Which is why a recent report from the Cambridge Institute for Sustainability Leadership (CISL) entitled 'Survival of the Fittest: From ESG to Competitive Sustainability' is so important. The report authors argue that we need to "revisit the fundamentals of business and sustainability". What do I think we could we do better? Two things. First, more of a focus on sustainability as a long term financial value creator. If it makes financial sense to companies they are much more likely to act (rather than just promise). And second, establish regulations that are aligned with the incentives (both carrots & sticks), giving companies visibility on the speed and scope of the changes that they need to respond to. As an investor I had three simple 'rules'. Rule 1 was every business model reaches an end. Even the most successful ones. And for many companies the sustainability transitions are going to be that end ! So plan for your new future. Don't ignore it. Rule 2 was, it's always better to start early. Change is harder to deliver than we think, start now. And Rule 3 .... show the financial imperative for change. This one might seem obvious but it's scary how often it's missed. If you explain to shareholders how the new strategy creates long term financial value, they are much more likely to support the change, even if it involves more investment now (for future benefits). I wrote about this in more detail (with examples) in a recent Sunday Brunch for The Sustainable Investor (read it for free by following the links in my profile). And please read the CISL report. Like me, you might not agree with all of it, but we need to start thinking differently.

How to talk to asset managers ! Business 101 - first understand how the people you want to influence actually think. This also applies to those who want to influence companies and asset managers. Start with how they think and tailor your message to focus on what they see as important. One good thing about taking some time off in September, other than missing the school holiday rush, is that it gives you time to think. Plus do lots of reading. And one issue I have been reading some more about is 'why are we finding it so hard to get asset managers to act on sustainability, at least at scale'. There has been a lot of talk within the sustainability community about why the current approach to getting companies to act on sustainability doesn't seem to be delivering the changes people want. Intuitively it has felt that part of the problem has been that we have been approaching this challenge from the wrong direction. Companies and asset managers care a lot about financial return. It's what keeps them in business. And so we should be ensuring that our communication with both groups reflects this fact. We should be emphasising where good sustainability practice makes good business sense. And of course, at the same time lobby governments and society to bend the rules toward more sustainable practices. But, up until now I really haven't had concrete evidence to back this 'feeling' up. Which is why a recent research paper from Edmans, Gosling & Jenter was so useful. They looked at what asset managers actually do with regards to sustainability. I really encourage you to read this research, I will put the link in the comments. And guess what? Traditional and Sustainable asset managers are a lot more alike than we think. And they both care a lot about financial performance - partly I would argue because that is how they are remunerated, not just directly by clients, but also as a contributor to making their funds bigger, and more profitable. The good news is that this tells us a lot about how we can best talk to asset managers in a way that they are likely to respond. Focus on the ES issues that can have the greatest financial impact on a company. Educate asset managers as to why these issues are something they should care about. And get companies to explain, in detail, how they are going to prepare for the future. This doesn't mean that the other ES issues are not important. But the lever for them is less about getting investors to act, and more about social and political pressure. You can read more about this in a recent Sunday Brunch for The Sustainable Investor, just follow the links in my profile. It's all free to read.

Resilience - being prepared for an uncertain future. At one level that means investors asking 'does the company's strategy properly anticipate the changes that are coming'. Which is what the new sustainability accounting standards (IFRS S1 & S2) are set up to address. But having a single 'best case' forecast of how the future will develop is not enough. We also need companies to prepare for greater uncertainty. Not just what the outcome might be, but when and how we get there. What has this to do with finance? Let's illustrate it with the supply of critical minerals? With my financial hat on - I argue that we not only don't know exactly how much of a particular critical mineral we will need in the future, we also don't know for sure where they will be sourced from. Will they come from new mines, or will they come from recycling? Or will we reconfigure the product so that we use a different set of inputs. And how quickly might this happen? I started on this train of thought after reading a really good blog from S&P Global on how long it takes to get a new mine from discovery to full commercial operation. The answer is 15.7 years. Yes, it varies by region and mineral, but the short answer is, it takes a long time. So, as investors, how do we react to this. Do we accept one argument that says, this is a serious problem. If we cannot fix it the sustainability transitions will fail - so we must relax the rules around permitting of new mines? I am sure you can see the problem with this idea. Mining exists on the back of social licence. As we have seen from the recent plans for a new Lithium project in Serbia, public opposition can cause delays. And US examples show that new mines can get bogged down in the legal process for years. Cutting though this might seem appealing, but it risks an even tougher backlash. A good report from RMI titled 'the battery mineral loop' examines the alternatives to new mines in some detail. One redesign example is the shift in battery chemistry from what is known as nickel manganese cobalt (NMC) to lithium iron phosphate (LFP). While NMC still offers better energy density (more power and/or range), LFP is making a major comeback thanks to its safer, more accessible materials and improving performance. You don't need to understand battery chemistry to spot that LFP batteries do not contain cobalt. Which is something we, as investors, need to be aware of! When we know that the future is going to look very different from the past, but we don't know exactly how & when (uncertainty), we want the companies we are invested in to be prepared (to be resilient). To have plans that prepare them for the various outcomes. If the company you are invested in thinks everything is just going to carry on as normal, maybe you need to test their logic just that bit harder! https://lnkd.in/ebDPiu8h

Doing nothing can also create financial risks. What happens when companies and investors 'know' that a risk is coming, but choose to ignore it? We all know the kodak story, but this is a recent update - Thames Water. To misquote Chuck Prince - sometimes we need to stop dancing. The company and it's investors must have 'known' that providing a poor level of service, regardless of whose fault it was, would likely end badly. And that adding more and more debt was only going to shut down their options when the inevitable happened. But they still decided to do nothing. Or more strictly, to keep on doing the same thing as before. Despite the risk of the change destroying their business model. “But as long as the music is playing, you’ve got to get up and dance.” Chuck Prince then CEO of Citigroup. The quote from Prince has come to symbolise everything that was wrong with the financial system in the early 2000's. But it's not just finance companies that assume that they can carry on as normal. We see it in all sorts of other industries. Changing nothing, assuming the future will look like the past, is more common than we think. And inaction can bring with it massive risk. There have been numerous others over my thirty year career in finance. Companies that have seen the potential negative impacts coming, but assumed that they could carry on just that bit longer. Maybe they thought the regulator would 'rescue' them. Or maybe they hoped that lobbying would soften the blow. Or maybe it's just human nature? A bit like the urban myth about frogs and boiling water - we wait until we 'have to' change, rather than prepare. And then it's too late. And tied up in this is a common fallacy about debt. I frequently hear that lenders don't have to worry about a company's long term risks. After all, most debt matures (gets paid back) in only a few years time. And so the lender will be long gone before it all goes wrong. But this ignores what is known in the industry as refinancing risk. Where a company has to raise new borrowing to pay off existing debt. The bottom line - all financial investors should be worrying about the longer term. And if the company you are involved with is not facing up to the upcoming changes, and properly preparing for them, you really should be questioning why you are invested. Sometimes you need to stop dancing and do something different. Especially when faced by sustainability related transitions. https://lnkd.in/enrnszrw

Why do we keep on saying that the future needs to be different, but keep acting as if it's going to be the same? Yes, I know the way we do things now is comfortable, and that change is hard. But for many sustainability transitions doing things the old way will not work. We also need to change the associated ecosystem. A good example of this is our electricity system. The new system needs to change not just how we generate electricity, but also how we use it, and what we pay for it. The old ecosystem worked well before. And if it wasn't for climate I wonder if we would have changed it. But it is not going to be fit for purpose in the future, so we need a new one. And asking consumers to take the lead is unrealistic. Electricity grid operators and regulators all over the world are grappling with this, and with the associated cost question (who pays and when?). Australia is doing the same. There it's called a 'review into electricity pricing for a consumer-driven future'. Ron Ben-David, a Professorial Fellow at Monash Business School, recently posted his response to this process on LinkedIn. He rather aptly titles it 'Doing the same Expecting different'. One issue that he challenges is the underlying belief that if consumers are provided with more (better) information and price signals, they will respond ‘rationally’ to market opportunities. But is this true? If people decide which house to buy in somewhere between 40 mins and an hour, how much time will they spend on their electricity supply. They may be happy to switch suppliers every year, but responding to price signals in real time? I doubt it. One debate is about infrastructure vs trading? What will the future look like? Will it be more about the infrastructure owners, the electricity generating plants, the grid systems, and battery storage ? Or will they be overtaken in importance by the electricity traders? These are the people who track the movements in electricity prices, and take the outputs from the infrastructure owners, and turn it into a product that the consumers want to buy. I tend to think the future is going to be one for the traders. Why? Because they are best placed to buy electricity from all sorts of different types of supply, and repackage it in a way that consumers want it. Consumers don't care who their electricity comes from, and they don't want to be tracking when is the best time to buy (or sell). And traders are best placed to offer this. And the world they create could look very different from the current world of electricity retailing. And it's not just electricity. We appear to behave as if the new systems we will need for home heating/cooling, and the infrastructure for EV's, will look like the old systems, just greener. But, to take an extreme example, when horses replaced cars, the ecosystem changed as well. This was the topic of a recent Sunday Brunch for The Sustainable Investor, you can read it for free by following the links in my profile.

Sustainability impacts company fundamentals. But sometimes it's not fully priced in. With all of the noise and commentary it's easy to forget that financial markets are weighing machines, not voting machines. But that sentiment, the voting bit, can impact share prices over the short term. And the short term can be longer than you think. The famous Ben Graham quote talks about the market, in the long term, being a weighing not a voting machine. What is meant by this is that while market sentiment matters in the short term, it's a company's financial and accounting fundamentals that really drive long term share prices. Which means that sustainability issues, which are important longer term value drivers for companies, should matter to all investors. Joachim Klement, in his excellent blog Klement on Investing, recently highlighted a piece of research from Paul Geertsema and Helen Lu on this very topic. They looked at how well accounting based variables forecast future equity returns (pretty well as it turned out). They found that over longer time frames (year two and year three after the forecast) accounting-based variables do just as good a job as market-based variables at forecasting future share price movements. This really matters. If accounting variables are useful in this way, then investors should really care about them. Which means they should continue to read a company's report and accounts carefully, and in detail. Don't just follow market trends. And equally importantly, they should pay attention to the new accounting standards. Some of these relate to sustainability, including IFRS S1 & S2. They will be coming to a financial market near you shortly.   Sustainability issues are creating new risks and opportunities for companies. This might be via social pressure, regulations, customer demands and employee requirements. What a company reports in their accounts reflects these pressures. Some of this appears in traditional financial reporting. Sales and margin trends, capex, returns on capital, and free cashflow. Plus, we see it in the notes to the accounts. In their provisions, asset impairments, and liabilities. Going forward we will also see it in the company's sustainability reporting. Under IFRS S1 and S2, they will need to cover what key risks and opportunities are they facing, how are they building it into their long term financial strategy, and what are the potential financial implications. Linking sustainability more closely into financial reporting. If we want companies to change, to treat sustainability issues differently, we need to express our 'demands' in a way they can relate to. Which means speaking the language of finance. As Warren Buffet says, accounting is the language of business. So it's important that sustainability professionals need to learn to 'speak finance'. https://lnkd.in/eV9jZxZX

When we talk about the challenges in the so called 'hard to decarbonise' industries, are we asking the wrong questions? It's August, which means summer in the northern hemisphere, and so many of you are on holiday. Time to think. Which is why last week's Sunday Brunch was on 'why it's important that we focus on the financial aspects of the so called hard to transition industries'. I call them 'so called' hard to decarbonise industries because in many cases we actually already have a technical solution that works, but it's not currently financially viable. So rather than arguing about which technical solution is best, and sometimes waiting until we have a fully worked up and costed solution, I suggest it's better to start at the other end of the process .... which solutions can be made financially viable as soon as possible. And what do we have to do to reach this? I like Michael Liebreich's term ...'affordable to abate'. Because from a financial perspective it leads us to think about how we make something actually happen. As Akshat Rathi (a senior reporter on climate at Bloomberg News, and author of the Zero newsletter on LinkedIn) wrote recently "if it's 'just' a cost issue, then we should be pushing for more research and development, policy support, and investments that take the solutions from pilots to full scale commercialisation. " And where we think the alternative solution may never be as cheap as the fossil fuel based one (excluding externalities), we need to consider 'who pays' and how. Because that is really important. If no one wants to pay, then society has a problem. It's hard to ask companies and investors to change, if we still want the new greener product at the same old fossil fuel based price. Sometimes, not always, that is just not possible. In which industries do we have broad agreement on the technologies? To quote Michael Liebreich again (from his influential bog back in February 2024: Net Zero Will Be Harder Than You Think – And Easier. Part II: Easier) "for even the most challenging sectors we now have line of sight to decarbonization. In many cases we are seeing more than just pilots: in steel, fertilizers, mid-stream oil and gas, shipping, and even cement, billions of dollars are being invested". When you get back to your desk after the summer, instead of asking companies just to disclose their carbon emissions (among other items), why not ask instead 'what is your plan for transitioning from where we are now, to where we want to be? And what are the financial costs and benefits. And if the economics cannot be made to work, what do we need to change, politically and socially? https://lnkd.in/eytVQtyJ

When we talk about the challenges in the so called 'hard to decarbonise' industries, are we asking the wrong questions? It's August, which means summer in the northern hemisphere, and so many of you are on holiday. Time to think. Which is why last week's Sunday Brunch was on 'why it's important that we focus on the financial aspects of the so called hard to transition industries'. I call them 'so called' hard to decarbonise industries because in many cases we actually already have a technical solution that works, but it's not currently financially viable. So rather than arguing about which technical solution is best, and sometimes waiting until we have a fully worked up and costed solution, I suggest it's better to start at the other end of the process .... which solutions can be made financially viable as soon as possible. And what do we have to do to reach this? I like Michael Liebreich's term ...'affordable to abate'. Because from a financial perspective it leads us to think about how we make something actually happen. As Akshat Rathi (a senior reporter on climate at Bloomberg News, and author of the Zero newsletter on LinkedIn) wrote recently "if it's 'just' a cost issue, then we should be pushing for more research and development, policy support, and investments that take the solutions from pilots to full scale commercialisation. " And where we think the alternative solution may never be as cheap as the fossil fuel based one (excluding externalities), we need to consider 'who pays' and how. Because that is really important. If no one wants to pay, then society has a problem. It's hard to ask companies and investors to change, if we still want the new greener product at the same old fossil fuel based price. Sometimes, not always, that is just not possible. In which industries do we have broad agreement on the technologies? To quote Michael Liebreich again (from his influential bog back in February 2024: Net Zero Will Be Harder Than You Think – And Easier. Part II: Easier) "for even the most challenging sectors we now have line of sight to decarbonization. In many cases we are seeing more than just pilots: in steel, fertilizers, mid-stream oil and gas, shipping, and even cement, billions of dollars are being invested". When you get back to your desk after the summer, instead of asking companies just to disclose their carbon emissions (among other items), why not ask instead 'what is your plan for transitioning from where we are now, to where we want to be? And what are the financial costs and benefits. And if the economics cannot be made to work, what do we need to change, politically and socially? https://lnkd.in/eytVQtyJ