What are we looking for?
Energy companies with relatively less climate-related risk.
The screen
The Globe and Mail reported last Wednesday that the Caisse de dépôt et placement du Québec, Canada's second-largest pension, wants climate-related factors to be at the core of all of its investment decisions. This is a growing trend across the entire industry and something investors need to be aware of. If large institutions are actively avoiding companies that are not being good corporate citizens with respect to the environment, this will hurt these companies stock prices, regardless of how profitable they are. Canada's economy is already poorly diversified, with more than half of the S&P/TSX composite index represented by financial and energy companies. Energy companies can't be excluded from investment, but it stands to reason that as institutional investors adopt more of a "green" focus, investment dollars will flow out of the worst offenders, and into those that are, relatively, more climate-friendly. For individual investors who themselves have sustainability values, this type of strategy can support these, as well as their bottom line.
Our universe is all Canadian companies in the Thomson Reuters Business Classification scheme's energy sector. First we consider ESG (environmental, social and governance) scores. SRI (socially responsible investing) is inherently difficult for many reasons, one being that ESG scores are based only on what companies claim they do, and these claims don't need to be audited. Thomson Reuters ESG combined score partially overcomes this limitation by also factoring in other sources – Reuters news, reports from non-governmental organizations, etc. We require at least 30 (out of 100) for an ESG combined score, and at least 50 for the company's emissions specific score (an underlying factor of ESG combined), to filter out the worst offenders.
Next, we look at actual emissions. Two more difficulties inherent in SRI are 1) companies don't actually have to disclose their carbon emissions, and 2) there is no standardized framework for how these emissions figures should be disclosed. Thomson Reuters uses past carbon emissions disclosures and applies a multiplier based on the company's growth to tackle the first issue. If even past carbon disclosures aren't available, we produce an estimate extrapolated based on the amount of energy the company uses. To address the second issue, the disclosures are standardized so that "apples-to-apples" comparisons are possible between companies, sectors and countries across the world. Rather than looking at absolute values, we will screen for companies that are trending in the right direction – by filtering for those who have reduced their carbon emissions over the last three years.
Finally, we look to the company's annual reports to make sure they have specific emissions policies in place. To be included in the screen a company must either have an explicit policy to improve emission reduction or have explicitly stated that climate change can present commercial risks (or opportunities).
More about Thomson Reuters
Thomson Reuters provides 400-plus ESG data points and 100-plus ESG analytics going back to 2002 for over 5,000 public companies. This content empowers investors to incorporate ESG issues into their financial analysis and identify companies that demonstrate an active, positive contribution to sustainable development.
What did we find?
The screen, ranked by market capitalization, yields seven companies, and although Husky has achieved the smallest reduction in its carbon emissions, it may be the most promising from an investment perspective. From a valuation standpoint, Husky is priced at 4.8 times cash flow and 0.9 times book value, compared with six and 1.2, respectively, for the energy sector as a whole.
Hugh Smith, CFA, MBA, works in the financial and risk unit of Thomson Reuters and specializes in wealth and asset management.