Case study by Ownership Capital
Through its internal screening process, our investment team identified a US industrial measurement tools manufacturer as an attractive investment opportunity, based on its strong market position in a competitive and fragmented market, a culture focused on continuous improvement and a high-quality management team. However, the company had a very basic approach to energy efficiency, and no comprehensive longer-term sustainability strategy.
Our fundamental analysis revealed that one of the longterm structural drivers for the company’s growth was its customers’ desire to measure and manage their environmental footprint, an effort which required the products and instruments sold by the target company. Adopting a sustainability strategy would, therefore, be crucial in developing the company’s commercial credibility and brand. It would also improve the company’s ability to recruit young engineers who prefer working for sustainability leaders.
During our initial due diligence meeting with the CEO and wider management team, we shared our analysis and presented a roadmap to a sustainability strategy that would enable the company to improve its sustainability efforts and communicate progress to stakeholders. The company subsequently committed itself to the roadmap, and as a result we took an initial stake, as well as offering the prospect of a stake increase, subject to the company making measureable progress on its roadmap towards sustainability.
Within a couple months of our initial meeting with the company, the management team hired a manager to centralise the existing sustainability efforts, build an internal platform for sharing best practices and start measuring critical components of the company’s carbon footprint and energy usage. After receiving a detailed presentation by the CEO on these efforts, we further engaged on expanding the scope of the initiative to include social parameters such as employee retention rates and training.
In the following months, the company released an inaugural sustainability report in which it published a number of environmental and social policies as well as the baseline measurement for its carbon footprint. Simultaneously, the company renewed its car fleet and optimised its sales and service technicians’ routes, resulting in an 11% decrease in carbon emissions, roughly the equivalent of 1,850 mid-sized cars.
In the following year, the company published a second sustainability report that further expanded the scope of its disclosure, and detailed substantial energy and carbon emissions reductions.
Results and lessons learned
Catalysed by the engagement programme, the company reduced its energy consumption by 30% and its carbon emissions by 20%, and announced clear plans to reduce them by a further 10% by 2020.
Our incentive-based approach of offering to increase our stake on the back of improvement played an important role in continuing the company’s sustainability improvements. The improvements the company has made in sharing its sustainability efforts, while continuing to deliver strong financial performance (including growth rates exceeding market growth and expanding its profitability by over 500bps), are pleasing, but there remains ample room for additional improvement. Our continuous engagement cycle will focus on expanding the scope of the analysis to include further improvements on water consumption and waste management.
We estimate that the direct measurable savings and pricing benefits from adopting a sustainability programme in this case currently amount to over US$12.3 million in pre-tax annual operating savings. At the company’s current PE multiple, this translates into an incremental US$243 million in total market cap after a five-year holding period, and an additional 60 basis points in annual return to us. While it has been possible to identify direct engagement benefits, we believe there are also substantial unquantifiable benefits arising from better long-term business strategies through improvements in employee morale, brand value for clients, etc., which can yield even greater long-term financial benefits than these directly attributable/measurable benefits.
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A practical guide to ESG integration for equity investing