Environmental, social, and governance or ESG investing is linked directly to a company’s ability to positively impact the environment as well as its stakeholders. Here investors aim to buy and hold shares of companies that derive financial gains by prioritizing investments towards clean energy solutions, among others.
Over the last few decades, the exponential rise in carbon levels due to energy generation via fossil fuels has accelerated the climate change process in several parts of the globe. This makes it even more imperative for companies to plow in additional capital and invest heavily in ESG initiatives.
According to a report from Forbes, the total assets under management for ESG investing is close to $20 trillion dollars. Comparatively, Canadian investors allocated $2 trillion in cumulative investments towards ESG companies, back in 2018.
Investors need to understand that ESG differs from socially responsible investing or SRI. For example, SRI excludes companies that manufacture tobacco or alcohol that have an adverse impact on society.
However, ESG investing is based on a multitude of factors that include reducing carbon footprint, water wastage, and greenhouse gas emissions. Companies are ranked on their ability to recycle products, use of renewable energy as well as the introduction of any related employee incentive programs such as carpooling and the use of public transportation.
In addition to the environment, it also accounts for a company’s social impact which depends on factors such as employee turnover rates, policies surrounding harassment and safety, employee diversity, customer service, and protection as well as the ethical procurement of materials across the supply chain.
Further, a company that ranks highly on the ESG scale should ideally have a vision that defines long-term policies and frameworks to improve overall diversity and transparency towards all stakeholders. There should not be a conflict of interest which means separate roles should be defined for the chairman and the CEO.
Factors impacting ESG investing
There is a multitude of factors that have shifted investor focus towards ESG investing. The world economy has changed dramatically which has also created a new set of risks for companies that include climate change and regulatory pressures. The increase in the number of female employees has accelerated social and demographic changes in the workplace, emphasizing the need for governance and harassment policies.
If these risks are not managed well, a company is under immense investor pressure. In the last month, we have seen that shares of gaming leader Activision Blizzard declined by more than 7% as the company was served with lawsuits for employee discrimination.
It’s quite clear that the new age of shareholders wants companies to score highly in terms of ESG factors as well. An MSCI report estimates millennials will invest anywhere between $15 trillion and $20 trillion in U.S.-based ESG stocks over the next two or three decades, making the transition all the more important.
The shift towards ESG investing can also be attributed to the advances in technology such as artificial intelligence and machine learning that have enabled easier extraction and analysis of huge data sets, thereby allowing investors to analyze and validate these factors transparently.
ESG and stock returns
While a company’s ESG score should be an important factor that might help you make an investment decision faster, let’s see how these companies have performed in the past. A Motley Fool report states that asset management company Arabesque established “companies in the top quintile for ESG outperformed those in the bottom quintile by more than 25% between 2014 and 2018.”
It also found stock prices of ESG companies experienced lower volatility. Even amid COVID-19, it was observed that companies with strong ESG scores delivered better returns over the last 18 months. Here, we take a look at five Canadian companies that score highly on the ESG meter and that can continue to outperform the broader markets in 2021 and beyond.
One of Canada’s largest renewable energy companies, TransAlta Renewables develops and operates several power generation facilities. As of March 2021, it owned 23 wind facilities, 13 hydroelectric facilities, seven natural gas generation facilities, as well as one solar facility, a natural gas pipeline, and one battery storage that consists of an ownership interest of 2,537 megawatts, up from 900 megawatts in 2000.
TransAlta Renewables has returned close to 90% in dividend-adjusted returns in the last five years. The company operates more than 50 renewable facilities across Canada, the U.S., and Australia. It aims to reduce 19.7 million tonnes of COze by 2030.
TransAlta has already reduced annual emissions by 25 million tonnes since 2005. It is one of the largest producers of wind power in Canada and the largest hydropower producer in Alberta. In 2020, its portfolio of energy facilities prevented close to 2.9 million tonnes of carbon emissions which is the equivalent of removing 630,000 cars from the road.
TransAlta continues to increase shareholder wealth while reducing its environmental footprint. Its comparable EBITDA from renewable energy generation stood at $353 million in 2020, up from $341 million in 2019.
Brookfield Renewable Partners
A global heavyweight valued at a market cap of $13 billion, Brookfield Renewable Partners is a globally diversified pure-play renewable energy company. With more than $57 billion in total power assets in 15 countries, Brookfield generates and distributes 19,000 megawatts of power each year.
The company claims its current portfolio as well as the ones in development will reduce 56 million tonnes of carbon dioxide emissions annually. This is equivalent to removing 12 million vehicles from the road.
Brookfield Renewable has a simple business model. It acquires and develops assets to ensure global electricity grids are decarbonized below their intrinsic value. The company also finances its business on an investment-grade basis and constantly aims to optimize cash flows to reinvest in capital expenditures and increase dividend payouts over time.
Brookfield Renewable Partners has improved shareholder wealth considerably in the last two decades. After adjusting for dividends, the stock has returned close to 18% annually in the last 18 years.
It continues to advance support for the green financing market allowing it to diversify its investor base as well. To date, Brookfield Renewable Partners has issued nine green bonds, a sustainability-linked loan, and green preferred units for $4 billion.
A mid-cap company with a market cap of $3.7 billion, Boralex develops and operates renewable energy power facilities in Canada, the U.S., the U.K., and France. Boralex ended 2020 with interests in 88 wind power stations, 16 hydroelectric power stations, two thermal power stations, and 10 solar power stations with a cumulative capacity of almost 2,500 megawatts.
These assets are backed by long-term contracts with an average duration of 13 years. Its business model has enabled Boralex to generate a steady stream of cash flows which has meant the company has increased quarterly dividend payouts from $0.14 per share in 2016 to $0.165 per share today.
After adjusting for dividends, Boralex has more than doubled shareholder returns in the last five years and has significant upside potential given consensus price target estimates. The company has also helped reduce carbon emissions by almost 300,000 tonnes in 2020.
It aims to increase discretionary cash flows from $59 million in 2018 to between $140 million and $150 million in 2023 while improving its installed capacity to 2,800 megawatts. Further, Boralex is focused on maintaining its payout ratio between 40% and 60% going forward.
Ballard Power Systems
Ballard Power Systems manufactures, sells, and services proton exchange membrane fuel cell products. Its products include heavy-duty modules, marine systems, backup power systems as well as material handling and fuel cell stacks. The company serves multiple markets that include transit bus, rail, truck, marine, and automotive markets among others.
Ballard Power Systems is part of a nascent industry and increased investor wealth multifold in the last five years. Since August 2016, the stock is up 550%. Despite these astonishing gains, the stock is also trading 60% below its record highs, allowing investors to buy the dip.
The company aims to reduce greenhouse gas emissions per employee by 30% in 2021. It was down 25% year over year in 2020. In the last year, Ballard Power also reduced non-recyclable waste per person by 8% compared to 2019.
According to Ballard Power Systems, the transport sector accounts for 24% of global greenhouse gas emissions each year and there is a need for zero-emission mobility solutions. The company’s fuel cell technology offers a value proposition for multiple applications such as heavy-duty mobility.
Analysts tracking the stock expect Ballard Power Systems to increase sales from $104 million in 2020 to $144 million in 2022. This will also enable the company to narrow its adjusted loss from $0.25 per share in 2021 to $0.19 per share in 2022.
Capital Power is the final stock on my list, a company that owns, acquires, and operates power generation facilities in North America. It generates electricity from multiple energy sources that include wind, coal, solid fuels, solar, and landfill gas. Capital Power owns around 6,500 megawatts of power generation capacity across 28 facilities.
The stock is valued at a market cap of $4.9 billion and has returned a stellar 185% to shareholders in the last five years, after adjusting for dividends.
According to the company’s sustainability report, it aims to achieve net carbon neutrality by 2050. Further, Capital Power plans to continue to invest in renewable energy sources and lower the amount of energy generated via coal going ahead.
The key takeaway
Here, I have discussed companies that are not just improving their own ESG score but are also actively involved in the ongoing shift towards the development of clean energy solutions. The transition towards renewable energy all over the globe will be a key driver of top-line and earnings growth for these companies that are already well-positioned to benefit from secular tailwinds over the upcoming decades.
Alternatively, there are other companies too that are focused on climbing up the ESG ladder but might not be necessarily involved in developing sustainable solutions. For example, the top holdings of the iShares ESG Aware MSCI Canada Index ETF include Shopify, Royal Bank of Canada, Toronto-Dominion Bank, Bank of Nova Scotia, and Brookfield Asset Management.
Investors should also understand that there are certain risks associated with ESG investing. For instance, there is no agreed-upon standard that can evaluate a company’s ESG performance. It’s important to invest in stocks and exchange-traded funds that are in line with your values.
There is not enough data to indicate that companies with a high ESG involvement have consistently outperformed the broader markets. There is a good chance that investors looking for robust financial gains might shift their investment strategies towards stocks that have the potential to crush equity indexes without considering any relevant ESG metrics.
In case you strongly believe in financial inclusion, diversity and the importance of reducing carbon emissions, you can hold a bunch of ESG stocks in your portfolio.