Why does sustainability matter to investors?

Why does sustainability matter to investors? Robert Dornau AIAG 2016 Corporate Sustainability Conference 27 April 2016

The next 30 min I. Corporate Sustainability - Investor view on sustainability II. Impact of sustainability data in a company evaluation 2

RobecoSAM Investment specialist focused exclusively on Sustainability Investing since 1995 Powering the Dow Jones Sustainability Indices since 1999 Approximately 110 employees headquartered in Zurich, Switzerland Part of Dutch asset manager Robeco over 220 billion Euros of AuM across the globe Dow Jones Sustainability Indices (DJSI) Cooperation with S&P Dow Jones Indices for the publication and licensing of the DJSI, launched in 1999. Annual sustainability assessment of 3400 largets companies globall Integrated assessment of economic, environmental and social criteria with a strong focus on long-term shareholder value. Rules-based methodology and use of primary research. Assurance of the assessment process by Deloitte. 3

Integration What Is Sustainable Investment? Source: RobecoSAM 4

Integration What Is Sustainable Investment? The Elephant in the Room Source: RobecoSAM 5

Megatrends are Shaping the World Demographics & Shifting Consumer Behavior Humanity is Exceeding Earth`s Carrying Capacity Acceleration of Global Change Changed Healthcare Patterns Changes in Consumer Behaviour Changes in Demographics Labor Market Urbanization Climate Change & Energy Efficiency Ecosystems & Pollution Resource Scarcity Globalization Increased access to Information / Online Society Innovation Politics and Policy Competitive advantage for companies with better management of risks and opportunities 6

RobecoSAM CSA What Is Corporate Sustainability? A company s capacity to prosper in a competitive and changing global business environment by Anticipating and managing current and future economic, environmental and social opportunities and risks and Focusing on quality, innovation and productivity to create competitive advantage and long-term value 7

The Questions we Seek to Answer 1. How is value created in this industry? What are the sources of value creation? Industry value drivers 2. What long-term trends could impact these sources of long-term value creation? Megatrends 3. What are the intangible aspects that need to be managed by companies to continue to create value? Long-term intangible factors 4. WHY?? How do these intangibles aspects related to long-term competitiveness and value creation? Link / Rationale 5. What KPIs can be used to assess the relative performance of companies in the industry? KPIs 6. Which companies stand out as high quality companies? Opinion 8

The Corporate Sustainability Assessment RobecoSAM s Corporate Sustainability Assessment uses a consistent, rule based methodology to convert an average of 600 data points per industry into one overall score. 1 Final Score 3 Dimension Scores 20 Criteria Scores 120 Questions 600 Datapoints Working backwards, our sustainability services enable you to benchmark your company in detail across the economic, social and environmental dimensions, all the way to individual data points. 9

RobecoSAM CSA Overview of Scoring Types Scoring Type Description Sample Questions Public Disclosure Codes of conduct Transparency Availability of qualitative or quantitative information Tax Strategy Disclosure of Median Compensation of All Employees & CEO Compensation Scoring of qualitative or quantitative data based on pre-defined thresholds or expectations Reporting Materiality Board Structure Performance Trend scoring on company s own performance over time Operational Eco-Efficiency Scoring of data compared to other companies within industry Lost Time Injury Frequency Rate Employee Turnover Rate GHG targets 10

Company Assessment - Scorecard Source: RobecoSAM 11

RobecoSAM CSA The benchmarking process Competitive benchmarking typically involves the following repetitive steps: Step 1: Measure your performance Establish your sustainability baseline and quantify your progess. Step 4: Take action Set or adjust your strategy to close the identified gaps. Step 2: Benchmark against your peergroup Different options from detailed analysis to a question level deep dive Source: RobecoSAM Step 3: Learn from data Discuss the results with management and operational functions 12

Evolution of Sustainability Integration Compliance Reputation Risk Mitigation Integration into Business TIME & COMPETITIVE ADVANTAGE Regulatory compliance, legal license to operate Societal license to operate, recognition by regulators Identifying and avoiding risk, identifying opportunities, providing societal value Brand differentiation, new markets, products & services, outperforming competitors, maximizing societal and shareholder value Source: Adapted from Holcim Group Support, 2012 13

The next 30 min I. Corporate Sustainability - Investor view on sustainability II. Impact of sustainability data in a company evaluation 14

RobecoSAM CSA The Value of Intangibles Components of S&P 500 Market Value 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 32% 20% 16% 83% 68% 17% 32% 68% 80% 84% 1975 1985 1995 2005 2015* Intangible Assets Tangible Assets Source: Ocean Tomo, LLC (*January 1, 2015) The graph depicts percentage of market value represented by physical and financial assets versus intangible factors, some of which are explained within financial statements, but many of which are not. In 1975, more than 80% of corporate value reflected in the S&P 500 in tangible assets while intangible assets accounted for less than 20% of the value. By 2015, these values have witnessed an inversion with intangible assets now accounting for 84% and tangible assets accounting for the remaining 16% of the corporate value. 15

Axis Signatories Title US$ Trillion UN Principles for Responsible Investment (PRI) Growth in PRI Signatories and Assets Under Management 1600 1400 1200 1000 800 600 400 200 70 60 50 40 30 20 10 0 Apr-06 Apr-07 Apr-08 Apr-09 Apr-10 Apr-11 Apr-12 Apr-13 Apr-14 Apr-15 0 Number of Signatories Assets under management Source: PRI Secretariat (2015) 16

Using ESG in investment decisions Different Approaches ESG data is used for investment decisions at different level Exclusion Sustainability score based selection or weightings Impact Integration in valuation models 17

Example of score based integration Historical returns: LTVC vs. S&P Global Large Mid-Ca Index 340 280 2.8% annual outperformance 220 160 100 40 Jan-04 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 Jan-10 Jan-11 Jan-12 Jan-13 Jan-14 Jan-15 LTVC S&P Global BMI LargeMid Source: S&P Dow Jones Indices. Total Returns from 12/31/2003-11/30/2015. All information presented is back-tested. Charts are provided for illustrative purposes. Please see the Performance Disclosure at the end of this paper for more information on the inherent limitations associated with back-tested performance. 18

Integration of Sustainability into Financial Valuation Economic Criteria Corporate governance Risk & crisis management Brand management etc. Environmental Criteria Operational eco-efficiency Climate strategy Environmental reporting etc. Social Criteria Human capital development Stakeholder engagement Supply chain management etc. Revenues Costs Investments Capital Structure Cost of Capital Earnings Invested Capital Return on Invested Capital Weighted Avg. Cost of Capital RobecoSAM Intrinsic Value 19

Integration Robeco and RobecoSAM s approach to integration: Integration of sustainability into financial valuation RobecoSAM approach: True sustainability integration. Sustainability and financial data are fully integrated into financial model to arrive at fair value Source: RobecoSAM 20

Materiality Matrix: Automotive Components Industry Likelihood 1 0.75 Business Ethics / Code of Conduct Liability Management; especially pension and health care reserves Human Capital Management Innovation Management Supply Chain / Risk Management 0.5 Capital Goods Management Corporate Governance 0.25 Tax Strategy Distribution Management 0 0 0.5 1 1.5 2 2.5 3 3.5 4 Business Value Drivers 21

Methodology for most material factors Corporate Governance Board Quality Experience Independence Diversity Compensation Structure CEO Pay Innovation Open Innovation Score (proxy for efficiency) Focus (correlation of r&d + capex vs. Income per segment) Innovation Awards Past impact from r&d Human Capital Human Captal Development and Talent Attraction and Retention Employee Turnover and Satisfaction Training, Injuries GlassDoor-Ratings Supply Chain / Risk Management MSA / Incident Score Supply Chain Management Score Risk Management Score 22

COMPANY B Mkt Cap: USD XX bln Sustainability Rating Corp. Governance Innovation Human Capital Supply Chain / Risk Brand MSA Conclusion 4 2 4 3 4 4 5 Company B receives a NEGATIVE sustainability rating owed to its poor innovation profile and a number of recent corruption cases in the company. We see the risk that the company may have to cut prices on certain products or increase r&d-expenses further. Business Value Driver Impact Comments Growth Profitability Negative Negative Customer satisfaction has already suffered and the company is loosing market share. In order to defend its market share, the Company may have to increase r&d-expenses again and/or reduce certain product prices. Both would create pressure on the gross margin. Poor disclosure of supply chain management practices indicates a risk that supply chain management itself is poor. Since suppliers of high quality rubber may become scarcer in the future and important competitors are trying to establish stronger bonds with their rubber suppliers, we see a potential risk to future profitability. Risk Profile Negative We observe a number of corruption cases (for instance misrepresentation of information to the Authority A and corruption in Country A and Country B) in 2015, implying a certain tolerance towards unethical business practices in the company. Robeco 23

COMPANY A Mkt Cap: USD XX bln Sustainability Rating Corp. Governance Innovation Human Capital Customer Satisfaction MSA Conclusion 2 3 2 3 2 1 Company receives a POSITIVE sustainability rating versus automobile seat manufacturing competitors. The Company earns a good innovation management score because it is comparatively active in engaging with external r&d-partners, which tends to make a company s innovation more cost-efficient. Company s innovation projects (as published) seem to be focused on product innovations in its core business in the short term, which corresponds with the improving trend in customer satisfaction. There is room for improvement in the company s human capital management, since it invests the least hours per employee in training compared to the total ATX-peer group. Business Value Driver Growth Profitability Risk Profile Impact Positive Neutral Neutral Comments With the its good overall innovation performance and customer satisfaction, Company should be able to slightly increase its market share going forward. While the Company s cost efficient innovation management supports a good cost control regime, the average human capital profile suggests to us that there is room to enhance labor productivity (note that, value added per employee has been stagnant from 2011 to 2014), for which we don t see any indication yet. Company is exposed to emerging market risks (assets in EM) and environmental risks from the past (soil contamination at ist former factories). These risks seem to be well managed. 24

COMPANY C Mkt Cap: USD XX bln Conclusion Sustainability Rating Corp. Governance Innovation Human Capital Supply Chain / Risk Brand MSA 2 3 2 2 1 2 2 Company A receives a POSITIVE sustainability rating compared to its tire peers. We acknowledge the company s focus on innovation in tires, the tight control of its supply chain and its continuous investment in employee training. Employees assess its management positively, in spite of the past restructurings. Company s products score good in test results and are mostly well reputed by customers. We have identified two areas where we would like to see improvements: Firstly, the number of former politicians/public employees on the board could be lower, and secondly, injuries per mio hours worked are on the high end of the spectrum. Business Value Driver Growth Profitability Risk Profile Impact Positive Positive Neutral Comments Referring to good customer satisfaction data and the Company s focussed innovation management we assume that Company should be able to gain market share in the future. Company s relatively high investments in training employees and close co-operation with suppliers of rubber have helped to control cost in the past and should do so in the future. Besides, the company has started initiatives for more flexibility in its local labor force. This should help, together with rising production volumes from market share gains, to increase capacity utilization and profitability, especially in the local manufacturing facilities. We don t regard the low industry experience in the board as a potential risk, as long as the company remains focused on its existing business. Robeco 25

Translating competitive (dis)advantages into value driver impacts Value driver Sales growth Margins Cost of capital Target price Benchmark Global Sector: 4% 15% EBITDA margin in 2013 8% Company adjustment ex ESG Exposure to low-growth segments: -50bps EU recovery: >+200bp Na $124 ESG adjustment Innovation management: +100bps Innovation management, Environmental management & Product stewardship: >+100bps Na $19 (+15%) Total 4.5% >18% by 2017 8% $143 Source: RobecoSAM 26

Top 10 material factors Factor Used in % of cases Innovation Management 39% Corporate governance 27% Environmental management 20% Supply chain management 17% Energy efficiency 16% High growth market 16% Human capital management 15% Brand management 14% Occupational health & safety 12% Network quality 12% Source: RobecoSAM 27

Valuation adjustments Source: Robeco 28

Summary Sustainability has three dimensions Economic, Environmental, Social Sustainability matters to all your stakeholders Investors Business partners Customers Regulators The public Leading companies understand that corporate sustainability simply makes business sense 29

Contact us in case of questions Robert Dornau Senior Manager Sustainability Services +41 (0)44 653 1239 robert.dornau@robecosam.com www.sustainability-benchmarking.com www.sustainability-indices.com www.robecosam.com/yearbook RobecoSAM Headquarters: Josefstrasse 218 CH-8005 Zürich Switzerland 30

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