Active investment commentary & analysis

The importance of environmental impact

Environmental impact is an increasingly important risk factor for company valuations. Assessing this risk can be difficult, particularly where different methodologies are used by different companies and in different jurisdictions.

One particular issue we often have to raise with potential investee companies is the failure to focus on the absolute levels of emissions the company produces as opposed to a level which is measured against a denominator such as revenues or tons of production. This is commonly referred to as an intensity ratio. For industries with large fixed cost bases we tend to discourage the use of intensity ratios as the results can be flattered by higher levels of production. A chemicals company cannot be assessed in a positive light simply because the level of greenhouse gases (GHG) per ton of production is declining if at the same time the absolute level of production and hence the overall level of GHG’s is ballooning. For some businesses, however, an absolute level of decline is an inappropriate target to set and we seek alternative measurements and this does not necessarily mean the intensity ratio which can in some cases be difficult to measure.

A recent example of this was our engagement with fast growing machine rentals company Ashtead whose business model, with little in the way of central costs, makes reducing the size of the overall business the only possible method of bringing down absolute GHG emissions. For obvious financial reasons this is not something we would push for as shareholders. Indeed, the company has an almost impossible task measuring the overall emissions level of the fleet, known as scope 3 emissions, as the data simply cannot be collated with any degree of accuracy. In order to overcome this problem, we have suggested to the company that they consider producing figures which show the average emissions for the total in place fleet effectively ignoring its utilization with the end customer. This is far from a perfect measurement but it at least allows us to encourage the company to avoid the worst-case scenario where not only is usage per unit of machinery increasing but at the same time GHG emissions from each unit may be deteriorating. This would be a substantial improvement from what the company is currently reporting.

At the same time Ashtead are also taking a good look at their overall ESG reporting with a view to improving the data they provide to investors. In order to further encourage this, we have written to Ashtead’s chair of the remuneration committee requesting that any new ESG targets become embedded in senior management’s long-term incentive packages. This form of company engagement can only help Ashtead navigate both the financial and reputational pitfalls that are likely to arise if a proactive approach is not taken to pressing environmental concerns and gives us a further insights into the environmental risks the company faces.

This publication and the views expressed in it are for information purposes only and should not be considered as an offer, investment recommendation, or solicitation to deal in any of the funds or securities mentioned and does not constitute investment research, investment recommendation or investment advice. At the time of writing SVM Asset Management Ltd may hold positions in the securities mentioned in this article.