Throwing Good Money After Good

By Nilanjan Roy, CFO, Infosys

Study after study by Environmental, Social and Governance (ESG) evangelists shows the high positive correlation between ESG scores and value creation for high-performing companies. In fact, financial return for ESG investments is demonstrable and what better way to make that case than have the CFO also take charge of the ESG agenda!

Most readers would no doubt be familiar with the fundamentals of discounted cash flow (the holy grail of financial value creation). Value creation is influenced and manifested through growth, profitability, terminal value rate and cost of capital – this is where ESG spends can play an integral role in increasing shareholder value.

Business Growth: A new report from the Economist Intelligence Unit commissioned by the Worldwide Fund for Nature said that Google searches for sustainable products shot up by about 70% between 2016 and 2020. It is a fact that customer preference for sustainable and ethical products can drive revenue, and even significant price premiums. A giant multinational consumer product company saw sales of its water-saving brands grow rapidly in markets facing water shortage.

By the same token consumers shun products from companies with questionable sustainability practices in their supply chains. From diamonds to cocoa in chocolates, we are all now familiar with the sustainable sourcing narrative for commodities.

Margins and Costs: Counterintuitive as it may seem, ESG practices can indeed trim operating expenses by reducing the cost of raw materials and resources.

Even businesses that are high on environment-related costs (e.g. oil companies, mining firms or the paper industry), can lower financial cost and risk by improving their environmental posture. For example, they can reduce greenhouse gas emissions as well as costs arising from transportation by vertically integrating operations or relocating close to supply bases. Socially responsible actions such as inclusive hiring also create value – both from expansion of the recruitment pool and from the consequent diversity of thought and ideas. Data from one source says that gender diversity increases the likelihood that a company will earn more than its peers, by 15%.

When manufacturers redesign their goods according to circular principles – promoting repair, reuse, and recycling – the products deliver value repeatedly to outweigh any increase in production cost. Sustainable buildings are also an enormous source of financial savings. At the Infosys Pune campus, a project to retrofit high efficiency LED lighting and motion sensors in place of 9,000 CFL-based light fixtures spanning a million square feet of space across four buildings is saving approximately ~0.8 mn kWh annually, at a payback of less than 42 months.

Terminal Value Rate – This encapsulates the long-term sustainability risk across to the business beyond 10-20 years. These may not be apparent or measurable but has a significant impact on value creation even in the short term. With the world committing to net zero targets by 2050, emitters from energy majors to automobile manufactures to consumer goods have to rapidly turning their portfolios and supply chains to become energy efficient. Regulators will commence imposing carbon taxes on energy produced from fossil fuels impacting cost structures. ‘Sin taxes’ are going to extend beyond tobacco and alcohol. Again, the consequence of not doing this can be heightened shareholder activism, government penalties and other consequences.

Cost of Capital: The GSIA’s biennial Global Sustainable Investment Review 2020 declared that sustainable assets under management grew 15% in two years to cross US$35 trillion. ESG investing’s upward trajectory may be fuelled by regulatory mandates and social leanings, but businesses and investors are also seeing its potential for financial performance. In sum, money is now chasing companies who are integrating sustainability into their end-to-end business models.

Companies with strong corporate governance and transparency avail of the benefit of governance premiums. Investors hate surprises and poorly governed companies are more prone to volatile share prices all of which reflect in their betas which increase their cost of capital.

This is but a peek into a vast landscape where ESG is inextricably linked with the value creation journey. So next time your colleague from Finance asks you why you need to spend those dollars on a sustainability initiative, take a shot at responding with how you have contributed to their beta!

All views expressed in this article are personal. They do not express the view(s) of Infosys.