20 December 2019
Real belief in the principles of sustainability
Understanding sustainability’s place within a company’s culture is crucial to assessing inherent business risks. Many large European consumer staples companies have embraced sustainability principles for decades and are ahead of their Asian and North American counterparts. While some companies adopted them sooner than others, sustainability is today an integral part of how most are run. However, the process of adoption has been far from smooth and sometimes forged in response to disasters.
Chart 1: European staples companies beat their US counterparts on ESG
For example, in the 1970s, Nestle was at the centre of a storm around baby formula as preparation with dirty water led to deadly consequences and boycotts of the company. Nestle responded by transforming its corporate culture: it established new, stricter standards which apply not only to employees but also to third parties acting under its authorisation; it developed a comprehensive process for reporting and dealing with violations; it adopted technology to minimise risks, most recently incorporating blockchain to track product origin and quality. Today, Nestle is a leader in sustainability in a sector that is at the forefront of it. As investors, we can apply their blueprint to staples companies in other regions, as well as to other industries.
The motivation behind sustainability matters
The motivation behind a company’s practices can be a useful clue to the extent that sustainability is embedded in its culture. For instance, a company committed to responsible agriculture may be motivated by fostering an image of product quality - and profits - rather than improving its environmental footprint. In a future decision, it’s not clear whether that company would opt for a sustainable course or the most profitable one. While sustainability and business performance can align, it’s important to question what is driving a practice: is it to lift short-term sales or does it reflect a true, lasting commitment to sustainability?
To be sure, accommodating sustainability considerations to pursue profit is not necessarily negative and can be an important catalyst for the long-term shift in a company’s priorities. A good example is the rising consumer awareness of the environmental damage that plastics cause. As a result, soft drinks companies are pushing to get deposit return schemes and recycling infrastructure in place. Companies have also realised that they need to do more to educate the public on some of the nuances around plastics. Plastic is cheap and light, resulting in overall lower carbon dioxide emissions over the material’s life than alternatives such as glass or aluminium.
The impact on supply chains
Given the complexity and interconnectedness of supply chains today, most large companies depend on a vast array of suppliers, so the scope for influencing other companies is significant.
Both Nestle and Unilever have used their scale to affect how their suppliers and counterparties operate. By engaging in practices such as sourcing and tracking palm oil through on-the-ground verification methods, partnering with coffee and tea farmers to boost yields and using satellite imaging to ensure suppliers don’t contribute to deforestation, habitat degradation or indigenous rights abuses, these companies demonstrate that they are taking ESG considerations seriously across their different relationships.
However, there remains room for improvement at the supplier level. Fidelity’s engagement with a Japan-based supplier of palm oil to Nestle prompted it to increase its supply chain transparency with periodic progress reports, to avoid the operational risks of big customers terminating their contracts if any violations emerged. These changes also helped the company score higher marks from an ESG ratings agency. Separately, Fidelity engaged with another palm oil producer in Singapore, to help it to meet its certification targets as well as the standards set by the major companies that buy its products.
Beware of the limitations of data
Investors should be wary of judging a company’s environmental impact on headline numbers alone. Absolute metrics can be misleading as different products within the same industry sector have inherently less impact than others. For example, the carbon footprint of selling a lipstick is much smaller than that of selling a box of laundry detergent, yet everyone will agree that washing clothing is essential. Instead, to understand the extent to which a company prioritises sustainability, investors should focus on how companies are evolving their business models, the ambition behind their ESG improvement targets and their track record.
Companies with a longer history of incorporating ESG, such as Unilever and Danone, can usually demonstrate that its principles are truly ingrained in their corporate culture. This includes ESG targets in management incentive schemes and explicit board level commitment to sustainability. It’s common practice for investors to assess management remuneration policies to understand how company leaders may behave; that same approach can easily be extended to sustainability. Most large European consumer staples companies now also include an ESG component in their quarterly updates. This helps investors track progress while sharpening management’s focus on fulfilling their ESG agenda.
Blazing the trail for investors
European consumer staples companies have led the way in incorporating sustainability. While some of these changes were initially brought about by external pressures, the groundwork was laid for a real conviction that sustainability goals are not just important to their bottom lines, but crucial to communities and the long-term future of their businesses.
While there is still room for improvement, consumer staples companies are setting standards that can inspire companies in other industries. As investors, we can seek businesses in other industries that have gone through similar cultural transformation. This helps us identify the most sustainable businesses that are likely to make the best long-term investments.
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