ENERGY security and workplace relations were among the big ESG themes to emerge from this year’s annual reporting season, says Pendal’s Rajinder Singh.
The volatility of energy supply amid disruption in energy markets has become abundantly clear in the last six months, leaving companies with real challenges on how to respond, says Singh, who manages sustainable Australian share funds for Pendal.
And the emerging theme of labour shortages and industrial action by workers is starting to show up as a key risk for Australian companies.
“This reporting season was quite interesting because we have this ongoing bounce-back out of Covid, while at the same time there are top-down geopolitical issues and the bogeyman of inflation and interest rates,” says Singh.
“And we’re seeing ESG perspectives play out as well.
“A lot of companies have momentum on planning for net zero and building out renewable energy targets. But at the same time they are getting hit by massive volatility in energy prices.”
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“My one-liner to clients has been this: there’s plenty we don’t know about the energy transition, but what we do know is that there’s going to be increased volatility.
“That is the real challenge for companies on how they respond to that.”
Energy is a material input for many companies, meaning the cost of electricity, gas and fuel can be important factors affecting profitability.
Singh says this reporting season saw companies weathering energy volatility on the back of fixed price energy contracts entered before price rises.
“The question will be what happens when those contracts reset.
“Perhaps ironically, the companies that signed power purchase agreements using renewables are beneficiaries of this environment.
“Even though they may have signed their agreements at a higher-than-prevailing electricity prices a year ago, that’s a fraction of what the spot prices are now so they’re effectively hedged.”
Energy security issues and supply chain problems are playing out against the backdrop of decarbonisation across industry.
“Companies are scrambling to solve today’s supply chain and energy problems, but they are also in the medium to long-term grappling with decarbonisation goals.
“Previously, signing up to renewable energy, putting solar panels in and making your vehicle fleet a bit more efficient by buying EVs was easy. Now there’s a problem.
“You can’t get EVs, electricity prices are moving all over the place, and you can’t back it up with gas.
“There’s a lot more considerations that companies need to make because of this energy volatility.”
Another ESG theme that emerged from reporting season related to labour supply, from COVID-related absenteeism to industrial action and wages.
“The federal government’s recent Jobs Summit elevated industrial relations back onto the national agenda, but it was already showing as an issue in reporting season,” says Singh.
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“What we’re seeing is the importance of how companies do their human capital management – labour was taken as given but that’s changed. Labour has become harder to find.”
What does it mean for investors?
For labour, Singh says investors should seek to understand the nature of companies’ agreements with workers.
“When strikes in Sydney mean the trains aren’t working every second day, it provides a precedent for how things will get resolved going forward.
“If you’ve got an agreement that’s due for renegotiation in the next 12 months versus one that was signed for five years, that could have a material impact on your forecast growth of your labour costs.”
For energy, security of supply is critical, says Singh.
Partly this can be solved simply through dealing with larger companies – “there’s security in size,” says Singh.
But it’s also important to seek security in geography, he says, using battery mineral lithium as an example.
“The two biggest sources of lithium are hard rock in WA and brine at altitude in the Andes in South America. The regulatory environment is a lot different.”
Singh says investors should seek out companies that are clearly facing up their energy problems no before the problems become more acute.
“That could be contingency plans in the short to medium term, but you also want to see evidence that the plans will enhance their transition in terms of energy efficiency, replacement of vehicles and investment in technology.
“The other thing that matters for investors is understanding the required capital expenditure.
“What’s the capital allocation to these initiatives? And is there an actual measurable benefit for the amount they are planning to spend?”
Rajinder is a portfolio manager with Pendal’s Australian equities team. He has more than 18 years of experience in Australian equities.
Rajinder manages Pendal sustainable and ethical funds including Pendal Sustainable Australian Share Fund.
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