Tools for Valuing Business Sustainability

Report
Tools for Valuing
Business Sustainability
Prepared for:
The Research Network for Business Sustainability
By:
Dr. John Peloza, Simon Fraser University
and
Mr. Ron Yachnin, Yachnin & Associates
www.sustainabilityresearch.org
0
Research Question
• Identify the business tools with which
managers can value the business case for
sustainability. In which contexts have these
tools been applied? What are the collective
results?
1
Motivation
• Move beyond the rhetoric
• Hard measures for the CFO
2
Systematic Review
• Criteria for Inclusion
– Quantitative calculation of business value
or process for calculating it
• Time
– Academic – all time periods
– Practitioner – 2001+
3
Results
4
Stages of Metrics
Sustainability Initiative
•Environmental
•Social
5
Results
• How sustainability is measured matters:
– Environmental sustainability = 65%
positive correlation to financial
performance
– Social sustainability = 55% positive
6
Sustainability Metrics
• How sustainability is measured matters:
– Environmental sustainability = 65%
positive
– Social sustainability = 55% positive
• Some are outright negative:
– South Africa (75% negative)
– Mutual fund screens (45% negative)
7
Stages of Metrics
Sustainability Initiative
•Environmental
•Social

End State Outcome Metrics
8
End State Outcome Metrics
• Included in 91% of all observations
• Most common:
– Share price (78)
– ROA (26)
– ROE (23)
9
Results
• Accounting measures more positive
(causality?)
80
70
60
50
40
30
20
10
0
P os itive
N egative
N eutral
M arket
A c c ounting
10
Stages of Metrics
Sustainability Initiative
•Environmental
•Social

Intermediate Outcome Metrics

End State Outcome Metrics
•Market (e.g., share price)
•Accounting (e.g., ROA)
11
Intermediate Outcome Metrics
• Relatively rare (included in 16% of studies)
• Only 9% included both an intermediate and
end state measure
• Most common:
– Changes in cost (13)
– Cash flow (12)
12
Stages of Metrics
Sustainability Initiative
•Environmental
•Social

Mediating Metrics

Intermediate Outcome Metrics
•Cost changes, revenue increases,
cash flow

End State Outcome Metrics
•Market (e.g., share price)
•Accounting (e.g., ROA)
13
Mediating Metrics
• Extremely rare (used in 8% of all studies)
• Only 3 included consideration of mediation,
intermediate and end state metrics
– Epstein and Roy (2001)
– sdEffect (2006)
– JP Morgan (2006)
14
Mediating Metrics
• Extremely rare (8% of studies)
• When mediation is considered:
–
–
–
–
Employee related
Cultural innovation
Input/output
Reputation related
• Most mediation is considered at the conceptual
level (versus empirical)
15
Mediating Metrics
• Very little sector specific work, more than
half coming from practitioners
3
C hemicals
8
3
Utilities
Forestry
4
Food Processing
4
Mining
16
Mediating Metrics
• Is access to data an issue?
– Mediation is examined extensively in the
academic literature but rarely with financial
outcomes attached
– Internal measures such as cash flow are
used more extensively in the practitioner
literature (11 out of 31, versus 1 out of 129
in academic)
17
Practitioner Tools
Some examples
18
3 Examples
• SAM and World Resources Institute
– Changing Drivers. The Impact of Climate Change on
Competitiveness and Value Creation in the
Automotive Industry, 2003
• Citigroup
– Towards Sustainable Mining. Riding With the
Cowboys or Hanging with the Sheriff, 2006
• Yachnin & Associates, Sustainable Investment
Group Ltd. and Corporate Knights Inc.
– Translating Sustainable Development into Financial
Valuation Measures, 2006
19
SAM and
World Resources Institute
Changing Drivers. The Impact of Climate
Change on Competitiveness and Value
Creation in the Automotive Industry, 2003
20
Authors (Organizational)
• SAM Sustainable Asset Management
– “A Zurich based independent asset
management company specializing in
sustainability-driven investments”
– Key player in Dow Jones Sustainability
Indexes
• World Resources Institute
SAM/WRI
– “A Washington, DC based environmental
research and policy organization”
21
Purpose
• “to help investors make better informed
decisions regarding automotive company
stocks in light of emerging ‘carbon
constraints’ – policy measures designed to mitigate
• “Carbon constraints could affect some of
the industry’s traditional value drivers (e.g.
costs and innovative capacity) and alter
competitive balance”
22
SAM/WRI
climate change by limiting emissions of carbon dioxide
(CO2) and other greenhouse gases”
Focus
• 10 leading automobile original equipment
manufacturers (OEMs)
– BMW, Daimler Chrysler (DC), Ford, GM,
Honda, Nissan, PSA Peugeot Citroen,
Renault, Toyota and VW Group (US, EU, JP)
SAM/WRI
• 2003-2015
23
Approach – 3 Steps
2.
3.
Quantify the risks associated with emerging carbon
constraints in a measure of “Value Exposure”
Quantify the related opportunities in a measure of
“Management Quality”
Aggregate cost estimates and management scores
and express them as discounted EBIT forecasts
(Earnings Before Interest and Taxes)
SAM/WRI
1.
24
Step 1
Value Exposure Assessment
• Ask
– “What costs do OEMs face in meeting higher fuel economy
standards in 2015, given their initial sales levels + vehicle mix?”
• Recognize
– The costs incurred by each OEM will vary depending on its
product portfolio and the current sales-weighted average fuel
economy of its fleet, and on the costs of achieving CO2
reductions for different vehicle types
• Calculate/Model
SAM/WRI
– The lowest-cost combination of technologies each OEM must
add to its existing fleet to meet new standards (measure:
additional costs per vehicle) (Key factors: 2002 sales/fuel
economy + access to incremental technologies, diesel + hybrid
technology)
25
Step 2
Mgmt. Quality Assessment
• Ask
– “Which OEMs have the strongest potential to capitalize on their
investments in lower-carbon technologies and so benefit from
carbon constraints?”
• Recognize
– OEM’s ability to capitalize on carbon constraints depends on a
wide range of management attributes regarding lower-carbon
technologies – not just technological development capabilities
– Management quality using modified competence model
developed by SAM Research (measure: SAM score 1-100) (key
factor: positioning relative to ability to capitalize on various
carbon technologies)
26
SAM/WRI
• Calculate/Model
Step 3
Results + Implications for Valuation
• Aggregate
– Risks and upside strategy opportunities
• Differentiate
– among companies in terms of their positioning
• Assess
SAM/WRI
– implications for valuation by expressing in
terms of discounted EBIT forecasts
27
e.g. Honda – lowest
value exposure
because of high fleet
efficiency
SAM/WRI
e.g. Toyota – highest
management quality
because of strong
position in technologies
28
Step 3
Results + Implications for Valuation
SAM/WRI
• EBIT a foundation for valuation estimates in the auto
sector
• Changes in an OEM’s EBIT offer useful insights into
possible changes for overall return on invested capital
and thus shareholder value
• Converting cost estimates and management quality
scores into EBIT figures sets results in context of
business performance/financial position
29
Step 3
Results + Implications for Valuation
• Translation – Value Exposure
– Carbon related costs ($) will increase the costs of goods sold
and so reduce EBIT
– VE costs integrated into baseline EBIT forecasts
– Changes the rankings of companies relative to cost only
rankings
SAM/WRI
• e.g. BMW improves markedly – highest costs to meet carbon
constraints, luxury brand has higher than average price margins and
better ability to tolerate cost increases
• ensures that the EBIT implications of its value exposure are less
damaging than the cost-only figures would suggest
30
Step 3
Results + Implications for Valuation
• Translation – Management Quality Assessment
SAM/WRI
– Extensively studied but difficult to integrate into valuation models
– permeates balance sheet
– Possible impacts on a number of financial variables, including
increases in EBIT margin, ROIC and sales – magnitude difficult
to measure
– To integrate MQA scores assumes OEM with the strongest
management quality (i.e., Toyota) would see its projected EBIT
margin increase by 20 percent, while the OEM with the weakest
management quality (i.e., PSA) would see no increase
31
Range from +8% for Toyota
to -10% for Ford
SAM/WRI
Significant upside effect
Upper limit = MQA alone, Lower limit =
VEA alone, Point = combined impact of
both assessments
32
Citigroup Global Markets
Towards Sustainable Mining. Riding
With the Cowboys or Hanging with
the Sheriff, 2006
33
Author
• Citigroup
– A major New York headquartered financial
services company
– Among the largest companies in the world
– Currently operates as Citi
• Global Markets/Mining Group
Citigroup
– Brokerage and investment analysis in the
mining sector
34
Purpose
– To show that “the ‘five factors’ that make
up sustainable development (SD) will
affect long-term shareholder value and
that those companies which are reacting
most effectively to these challenges are
likely to outperform”
– To make investment recommendations
based on sustainability-oriented analysis
35
Citigroup
• For the mining sector:
Purpose
• Sustainable development in the mining sector presents
companies with a number of choices
Citigroup
– Seek out low-regulation, low-cost environments for their future
development – “riding with the cowboys”
– Develop a new business model that places a premium on
environmental responsibility and social progress – “hanging with
the sheriff”
– Try to operate in the old way in the new world and go out of
business – “going to jail”
36
Focus
• 17 large mining and metals companies
– Rio Tinto, BHP Billiton, Anglo-American,
Alumina Ltd., Alcoa, Newcrest, Lonmin,
Xstrata, AngloGold Ashanti, Impala Platinum,
Anglo Platinum, Lihir Gold, Antofagasta,
Vedanta, Norilisk Nickel, CVRD, Kazakhmys
Citigroup
• 2006
37
1.
2.
3.
4.
Sets out the five factors of SD Citigroup considers
have the potential to add or destroy value for mining
and metals companies globally
Develops a Sustainable Mining Index to identify those
companies best positioned to create (or destroy) value
based on their sustainability profile
Calculates alternative risk-adjusted discount rates
based on a company’s integration of sustainabilityrelated risk/valuation impacts
Makes investment recommendations in favour of
specific companies (and in disfavour of others) based
on this analysis
38
Citigroup
Approach – 4 Steps
Citigroup
Step 1 – Five Factors of SD
See handout
39
The bulk of the variation is on
company-specific Factors such as
Mine Development, HSE in
Operations and Sustainable
Governance
See handout
Step 2 –
Mining
Index
Citigroup
Most companies perform well on
Commodity Exposure and CountrySpecific-Exposure
40
Step 3- Risk Adjusted Discount Rates
Traditional valuation based
largely on country-specific
exposure and bond indexes
Winners and best
bets are large,
diversified companies
= valuation upside of
23% to 30%
Citigroup
Scenario analysis based on
mining index builds in additional
company-specific factors
41
Step 4
Investment Recommendations
Citigroup
• Citigroup sees largest upside to valuation
occurring for the large diversified mining
companies such as Anglo American, BHP
Billiton, and Rio Tinto – 23%-30%
• Generally platinum companies show valuation
upside while gold companies show downside
• On this basis Citigroup recommends buying
stand out companies BHP Billiton, Anglo
American, Alcoa Inc together with risk adjusted
upside in Lonmin and Impala Platinum; and
selling Kazakhmys
42
The sdEffect
The sdEffectTM – Translating Sustainable Development
into Financial Valuation Measures, 2006
43
Authors
• Yachnin & Associates
– Ottawa/Toronto based management
consulting company
• Sustainable Investment Group Ltd.
– Toronto based consulting company
• Corporate Knights
sdEffect
– Toronto based media organization
44
Purpose
• To translate the impact of specific corporate
sustainability initiatives into financial valuation measures
so that additive value (+/-):
sdEffect
– can be demonstrated in financial terms that are familiar to and
easily used by all representatives of the financial/investment
community; high level integration into workings of marketplace,
address externalities
– can be measured, reported, compared, communicated, and…
invested in in the same way as other business elements
45
Focus
• Five Canadian mining companies
– Alcan
– INCO
– Noranda/Falconbridge
– Placer Dome
– Teck Cominco
sdEffect
• 2006
46
Approach
SD measures from sustainability reports
Five valuation techniques
–
–
–
–
–
•
Ratio Analysis
Discounted Cash Flow (DCF) Analysis
Economic Value-Added (EVA) Analysis
Rules of Thumb
Option Pricing
10 calculations (7 SD measures) of “The
sdEffect” on overall company valuation + share
price (3 environmental, 2 social, 2 economic)
47
sdEffect
•
•
e.g. INCO Solid Waste Diversion
• Non-hazardous solid waste is diverted
from municipal landfill to companymanaged tailings disposal area
sdEffect
– Cost savings = $2.4 million per year
– DCF value = $31 million
• Equivalent to $0.16 per share value
– P/CF value = $0.06-$0.08 per share
48
e.g. Placer Dome Community
Involvement Programs
• Community involvement and investment
allow fast-tracking of expansions and
permitting of new projects
sdEffect
– Large projected fast-tracked by 1-year
– DCF value of early start = $337 million
• Equivalent to $0.81 per share value
• 5.5% equity value lift
49
Conclusions
• Measure where impacts are expected
Environmental sustainability
Social sustainability
50
Conclusions
• Research only recently considering
company/firm and initiative level
measures
– Useful to take us beyond the generic
business case argument
– Mediation measures required for causality
and comparison between initiatives
51
Conclusions
• What do we really know about the business
case?
– Causality not addressed
– Are measures comparable?
• Need to move beyond the generic
business case to specific initiatives,
structures and processes to examine
business case at firm and initiative levels.
52
Where Do We Go From Here?
• Increased use of mediation metrics, and
inclusion of all 3 types within the same
case study.
• More company/firm initiative specific
measures are needed - collaboration
between practitioners and academics.
• Matching access to data with measurement and
modelling expertise.
• Consistency among sustainability
measures. ISO? Classification of effects?
53

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