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Re-positioning business portfolios through an ESG lens to deliver competitive advantage

Market and social pressures to transition to a low-carbon future are driving sharp value declines in high-carbon components of the business portfolio – making it critical for companies in asset-intensive industries to rethink their portfolio of businesses. Additionally, growing indications that social outcomes and governance integrity will have similar impacts continue to materialise.

Companies have an opportunity to not only survive, but thrive, by strategically factoring in ESG as they reassess and rebuild portfolios.

Investors and debt markets are actively rewarding climate-friendly businesses, while shunning enterprises with high-carbon activity in their portfolios. Globally, almost US$700 bn of sustainability linked loans1,2 (SLLs) were issued in 2021 – an over tenfold increase from 2017 – accounting for 13% of global debt issuance. ESG refinancing is rapidly gaining prevalence, driven by an increasing need for banks to achieve their own sustainability goals. Further, lenders are actively tracking borrowing businesses’ progress against decarbonisation targets, with SLLs creating an opportunity for strong performance to be rewarded with interest rate reductions of as much as 5 basis points.  (This is currently done at the expense of their own margins – expect differences to increase should regulators get involved.)1

Debt markets are also punishing businesses lacking publicly stated reduction commitments with higher rates than financial metrics alone would imply.  Perhaps more critically, the funding landscape is sharply and rapidly changing: principal investors – with asset manager Blackrock publicly leading the charge - are oversubscribing to green opportunities and shunning high carbon businesses – materially impacting business asset valuations.  Looking ahead, leading indicators that social and governance factors will have similar impact1,3- in both investment decision criteria and the volume of SLL’s targeting ‘SG’ aligned businesses – are increasingly prevalent in the market.

These threats to business portfolios pose short-term challenges, but also represent a source of competitive advantage and a foundation for future growth if responded to proactively.

The key considerations to address while doing so are:

  • Significant portions of legacy portfolios are viewed as toxic and unaligned to a low-carbon future, driving sharp business asset value declines. Exiting these businesses is not as simple as straightforward divestiture; future liabilities and future stances on ESG - must be quantified and factored into decision making – not only financial and legal, but also ‘license to operate’ considerations due to social and reputational considerations.
  • Concurrently, companies need to replenish portfolios for future growth. This is a multi-speed challenge as there is the burden of competing for currently desired assets and executing at pace, but also a need to build resilience in portfolio planning. Understanding how the ESG landscape is likely to evolve, and anticipating needed action is imperative. (E.g., in the mid-term future, climate-aligned assets located in disadvantaged communities may face the financial headwinds legacy components face today – scenario impact assessment and risk-adjustment plans must factor into target portfolio construction.
  • As the stance on ESG evolves, consequences may extend beyond financial disadvantages imposed by securities markets (quantitatively driven decision-makers) to ‘license to operate’ considerations imposed by governments and communities (subjectively driven decision-makers). Addressing the perception gap inherent in asset-intensive industries is critical as companies reposition and protect their businesses.
  • A logical consequence of the preceding considerations is that acquirers need to quantify and project the ESG ‘state’ and future impact of their acquisition targets. This is self-evident, but given the added complexity, bears repeating.

Unsurprisingly, our 2022 M&A trends report4 found the following in alignment:

  • Companies are aiming for transformational change through their deals; further our 2021 CFO Signals survey indicates over 50% of CFOs expect M&A to drive as much as half their companies’ growth over the next three years
  • Over 70% of respondents expect both the average number of deals and the average deal size conducted by their own organization to increase over the next 12 months
  • Energy, Resources & Industrials respondents had a particularly keen interest (at 84% vs 75% for the overall panel) in re-evaluating portfolios to acquire or divest through an ESG lens
  • Critically in this environment, the report highlighted that executives view the integration of corporate strategy, M&A strategy, and operating models into a coherent approach as one of their greatest challenges.

We highlight the importance of re-aligning capital allocation through an ESG lens, revisiting our Sustainably Advantaged Portfolio approach which puts forward 4 sets of criteria. Recapping briefly, is the portfolio: strategically sound, value creating, resilient, and sustainable:

Most companies currently incorporate the strategically sound and value creating pillars into their portfolio planning, and from a business perspective address the resilient pillar or at least give it consideration. What is often lacking is the incorporation of an ESG lens into the portfolio building process, and as a lens for the resilience pillar. This in turn is the result of ESG not being integrated into the business’ strategy from the outset, but rather applied retroactively.

A winning approach requires that leadership first agrees on the company’s ESG positions, and then develops scenarios given that stance.  This then sets the basis for aligned portfolio re-positioning.

We recommend companies address the following questions:

Each question above merits careful, structured consideration to properly address, but done correctly will position your organisation to thrive through the changes ahead.

Given the competitive consequences of inaction, lagging companies will need to weigh options particularly carefully. The transition is already underway across asset-intensive industries:

The big 4 are pivoting away from coal, with Rio Tinto leading the exit, having completed the sale of its assets in late 2018.  Concurrently, companies are refocusing portfolios on green minerals - BHP and Glencore have signed deals to supply Tesla (nickel and cobalt respectively) for example.

Companies are variously engaging in: reducing operational GHG emissions, carbon sequestration efforts – as Occidental Petroleum is doing in partnership with Carbon Engineering – and repositioning portfolios to lower emissions energy sources – as Shell is doing via its Energy Solutions approach and as BP is transitioning to an integrated energy company.

While much of the chemicals industry is viewed as trailing in commitments, Solvay has committed to reduced operational emissions, and diversified into renewable energy via Solvay Energy Services.

Capital goods & heavy machinery are similarly viewed as trailing; however, Caterpillar has made significant commitments to reduce operational GHG emissions and is refocusing its offerings portfolio to feature more remanufactured products.

ESG is no longer an abstract, ‘stand-alone’ pillar for companies building an advantaged portfolio – rather it is essential to integrate across strategy development, market communication, target capital allocation, and execution.  Fortunately, given the tailwinds of the cycle, most firms start from a position of strength, with the traditional business strategy pillars addressed. Present challenges serve as a call to actionactively integrate ESG to unlock competitive advantage for your business.

Need help?

Deloitte Climate & Sustainability

Deloitte Climate & Sustainability is a dedicated team of 35 partners and over 150 staff from across our firm, offering end-to-end climate transformation solutions to Australia’s leading organisations. Backed by the collective power of Deloitte, we support our clients’ transition to net zero, integrating the best of our climate and sector expertise with our strategy and organisational transformation capability. 

Monitor Deloitte | Energy, Resources & Industrials Strategy Consulting

Monitor Deloitte supports asset-intensive businesses, service companies and equipment manufacturers in these industries, and suppliers, with their strategic and business transformation challenges. Our team is passionate about bringing the latest trends in strategy, technology and innovation from the resources, energy and heavy industry sectors to support clients to be ‘future fit’ in an increasingly complex, disrupted and competitive market.

Should you require any support to navigate these challenges, please feel free to reach out to either Struan Buchanan (Partner – Energy & Resources, Strategy & Business Design) or Senjit Sarkar (Director – Energy & Resources, Enterprise Strategy).