seb disruptions esg integration sitra_16012018

Disruptions and ESG integration January 16, 2018

Jukka Honkaniemi Julian Beer Anssi Kiviniemi

Disclaimer

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Contents

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1 Why are we here today ? 3

2 ESG integration in the investment process, and the concept of materiality 7

3 Company specific ESG valuation: SSAB example 16

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Regression of corporate market value on earnings and book (equity) value

Increased role of non-financial data in explaining value and risk

Source: End of Accounting and the Path Forward for Investors and Managers. 2016, Baruch Lev & Feng Gu

5

Disruptions

Source: Global Footprint Network

Environment

Photovoltaics cost curve

Source: Deutsche Welle

Source: Wikipedia

Cobalt

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Project: Framing Stranded Asset Risks in an Age of Disruption

• Framework for evaluation of disruptions in creating

stranded assets risks.

• Create non-linear future scenarios

• Test for spiralling negative dynamics

• Translate to asset-type implications

Conventional of Stranded Assets risk

Contents

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8

0

2

4

6

8

10

12

2006 2008 2010 2012 2014 2016

Europe (EUR tn1))

0

2

4

6

8

10

2006 2008 2010 2012 2014 2016

USA (USD tn1))

• Around 30% of all equities and bond funds now classified as “responsibly invested”

• Multiple strategies used:

- Exclusions, Norms-based screening, Engagement, ESG integration, Best-in-class, Sustainability Themed

Emergence of “responsible investment” commitment by asset managers To qualify as socially responsible investment funds, asset managers have to fulfill one or more defined criteria

Source: EUROSIF, USSIF 1) Assets under management at the beginning of the year

9

0,1 0,4

1,9

3,3 3,6

6,9

0,1 0,5

2,6

4,3 5,1

10,2

0

2

4

6

8

10

12

SustainabilityThemed

Best in Class ESG integration Engagement &Voting

Norms-based Exclusions

2014 2016

Source: EUROSIF 1) Assets under management at the beginning of the year

MAINLY RETURN DRIVEN MAINLY ETHICALLY DRIVEN (EUR tn1))

Responsible investment strategies Ethical strategies have led; return-based strategies becoming more common as correlation to ESG issues emerges

COMMON SECTOR EXCLUSIONS

(responsible and ethical funds)

COMMON SECTOR EXCLUSIONS (sustainability funds)

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controversial weapons

adult entertainment

COMMON SECTOR EXCLUSIONS

(most responsible funds)


adult entertainment

alcohol

tobacco

gambling


adult entertainment

alcohol

tobacco

gambling

coal mining/powergen

oil and oil products

oil production equipment

? next … GHG emitting product sectors

Exclusions: entire sectors excluded, varying according to type of fund For asset owners like pension funds, some are excluding these sectors based on stranded asset risks, not ethics

ESG: many complex issues, with varying relevance depending on sector ESG evaluation can be used both to examine responsibility of companies, and to improve quality of financial analyses

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• GHG emissions • Air quality • Energy management • Fuel management • Water and wastewater management • Waster and hazardous materials

management • Biodiversity impacts

• Human rights and community relations • Access and affordability • Customer welfare • Data security and customer privacy • Fair disclosure and labeling • Fair marketing and advertising

• Labour relations • Fair labour practices • Employee health, safety and wellbeing • Diversity and inclusion • Compensation and benefits • Recruitment, development and retention

• Lifecycle impacts of products and services • Environmental, social impacts on assets &

operations • Product packaging • Product quality and safety

• Systemic risk management • Accident and safety management • Business ethics and transparency of

payments • Competitive behaviour • Regulatory capture and political influence • Materials sourcing • Supply chain management • ESG integration into corporate strategy • Materiality of ESG targets / goals • Ability to adapt to disruptions / climate

transition

Environment

Social Capital

Human Capital

Business Model and Innovation

Leadership and Governance

Quantitative ESG analysis – value focussed A contemporary addition to the conventional suite of financial analysis considerations

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1. Independent of (but complementary to) ethical / responsibility screening

2. Focus only on issues that are most material from a value perspective

3. Forward looking, and considers megatrend, policy and customers driven disruptions

4. Cash flow based (and also cost of capital based for equity value assessment)

• Poor reputation, ethics or environmental impact leading to lender / investor aversion

• Lack of management engagement with ESG challenges, leading to lender / investor aversion

Examples of ESG issues that may impact value or valuation Could lead to positive or negative forecast adjustments, depending on company’s specific attributes and capabilities

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• Effect of customer focus on emissions or energy efficiency on demand and pricing of the company’s products

• Growing aversion of customers to buy from a company with poor environmental or other ethical track record

Revenue themes (Growth)

• Forecasting increases in carbon emissions costs and other emissions penalties

• Effect of climate or other megatrend disruptions on cost of raw materials

• Cost of transitioning to new products or revamped designs to remain compliant with policy

• Cost of fines and penalties relating to poor ethics and regulations (= governance)

Cost themes (Cost)

Cost of capital / RRR issues

(Control)

SEB Equity Research’s SAFE – SEB’s Adjustment for ESG Quantitative ESG analysis led to adjustments to fair value estimates; most material issues varied from sector to sector

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Source: SEB

Key materiality varies from sector to sector The MOST material issues (from a value perspective) vary from sector to sector

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Green House Gas Emissions

AUTO OEM

BRANDED CONSUMER

GOODS

STEEL

Toxic Emissions

Energy / Emissions Saving Products

Protectionism

Changing customer preferences

Product quality

Digitisation

Supply chain sustainability

Company specific ethics

Contents

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• Increasing direct carbon costs relating to policy actions

• Impact on valuations as carbon concerned investors migrate to low emission exposures

Green House Gas Emissions

• Fines, capital costs and charges from non-compliance with legislation

• Pressure on valuations as investors disinvest from companies with poor waste disposal policy Toxic Emissions

• Increasing market share or margins for light weight but strong innovative steel products Energy / Emissions

saving products

• Steel is a global industry, and new trade policies could substantially change sector profitability

Protectionism

• E.g. poor relations with labour leading to stoppages; history of corruption, market fixing Company specific

ESG issues

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Material issues for ESG analysis of steel sector companies Generated by SEB steel sector equity research analysts

In absolute terms, we argue ESG issue reduces SSAB’s value Based on our ESG analysis, we estimate there should be SEK 6.0bn negative adjustment for SSAB’s market value

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53

2 -1

-7

0 -1 1

47

40

42

44

46

48

50

52

54

56

58

60

Share pricebefore SAFEadjustment

(SEK)

PRO FADE COST LAW SIZE TIME Share price afterSAFE

adjustments(SEK)

SS

AB

sh

are

pri

ce (

A-c

lass

, SE

K)

Source: SEB

In relative terms, SSAB is a top quality steel company Both from an economic perspective (products, margins), and also from an emissions intensity perspective

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90

100

110

120

130

140

150

SSAB EU average NAFTA Russia China India

CO2 efficient steel production - indexed

+200,000 cars driven 20,000km each

Source: Stahl-Zentrum

CARBON EMISSIONS INTENSITY PER TONNE OF STEEL PRODUCED (INDEX, SSAB=100)

Does relative ESG score correlate with valuation? That correlation cannot be found among large steel companies currently

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Source: SEB, Thomson Reuters, MSCI

0.0

2.0

4.0

6.0

8.0

10.0

12.0

14.0

16.0

18.0

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

5.0

Company A Company B Company C Company D Company E Company F

ESG score (LHS) 2018E P/E valuation multiple (RHS)

Relative ESG SCORE, major listed steel companies

2018 PRICE/EARNINGS RATIO

Inflection points mean that there will be an absolute change We estimate there could be some SEK 650m extra costs coming from SSAB’s emission deficit in the future

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Source: SEB

0%

25%

0%

5%

10%

15%

20%

25%

30%

2017E 2030E

Yearly CO2 emission right costs for SSAB (% of 2017E pre-tax profit)

% o

f S

SA

B 's

201

7E p

re-t

axp

rofi

t (%

)

The future of steelmaking? “HYBRIT” – joint venture with LKAB and Vattenfall to solve steel industry’s carbon dioxide challenge

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Source: SSAB