slagnes
DESCRIPTION
TRANSCRIPT
1www.innovestgroup.com
Uncovering Hidden Value Potential - Electric Power Companies & The Climate Change Challenge
National Renewable Energy Laboratory, 2006
InnovestSTRATEGIC VALUE ADVISORS
New York . Toronto . London . Paris . San Francisco
2
Agenda
I. Innovest
II. Why Should We Care? Emerging Indicators of Competitive
Advantage - Key Drivers
III. Implications for Investors
IV. Innovest Rating Model-
V. Findings – The Electric Power Sector
VI. Climate Change – A Key Emerging and Financially-Relevant
Value Driver
VII.Conclusion- Q&A
3
Innovest Background
• Innovest is an international equity research firm focusing on non-traditional drivers of investment risk and return
• Specializes in analyzing companies’ performance on intangible values with a focus on their impact on share price performance and the bottom line
• Founded in 1995 and has grown to over 50 professionals• International presence with offices in San Francisco, New
York, London, Paris, Toronto and Melbourne
• Strategic investors include State Street Global Alliance and ABP, the largest European pension fund
4
What We Do
• Research coverage: reports on 2200 companies globally, 60+ sectors: North America, Europe, Asia-Pacific, global emerging markets
• Best-in-class rating: from AAA (top) to CCC (Bottom) within each industry sector
• Innovest’s perspective: AAA companies are those which supply the goods and services which we demand, with the lowest environmental impact relative to their peers and in a socially equitable manner
• Over $1 billion currently invested based on Innovest’s research platform (e.g. State Street Global Advisors, T.Rowe Price, Crédit Agricole AM (IDeAM) and ABP)
5
An increasing number of academic and business studies show a positive correlation between environmental and stock market performance
Correlation exists because environmental performance is an excellent proxy for superior management quality
Management quality is a leading determinate of stock market performance
Why Should We Care? Indicators of competitive advantage are changing…
6
Environmental issues represent one of the most complex challenges facing management
Why Should We Care? Indicators of competitive advantage are changing…
Many complex issues, stakeholders and non-financial measures to address
High level of technical, market and regulatory uncertainty
Success in this high complexity area implies ability to excel in other business areas, and thereby earn superior returns
7
What We Do
“…The bulk of the value (60%) of any company is determined by its long-run or sustainable returns, the next 20% by secular or cyclical change observed in the coming 12 months; and the remainder by longer term growth or other issues.”
Goldman Sachs, February 24, 2004
Innovest’s Intangible Value Assessment Model is designed to derive information on that 60%
8
Four Key Intangible Value Drivers
Financial Capital 30%
Sustainable Governance
• Strategy• Capability/
Adaptability• Traditional
governance practices
Stakeholder Capital• Regulators &
Policymakers• Local communities• NGOs• Customer
relationships• Alliance partners• Supply chain• Social benefits of
products & services
Human Capital• Recruitment retention
strategies• Employee motivation• Labor relations• Innovation capacity• Knowledge
Development & Dissemination
• Health & Safety• Progressive
workplace practices
Eco-Value• Quality of
environmental management
• Environmental risks & Eco-efficiency
• Strategic profit opportunities
The “Iceberg” balance sheet
Intangible Capital 60-70%
9
The Findings–Analysis of Stock Performance Based on Environmental Ratings (May 1997 – Nov. 2005)
TOP HALF
BOTTOM HALF
SPREAD
Top Half Outperforms by 76%
-50%
0%
50%
100%
150%
200%
250%
Ma
y19
97
No
v19
97
Ma
y19
98
No
v19
98
Ma
y19
99
No
v19
99
Ma
y20
00
No
v20
00
Ma
y20
01
No
v20
01
Ma
y20
02
No
v20
02
Ma
y20
03
No
v20
03
Ma
y20
04
No
v20
04
Ma
y20
05
No
v20
05
To
tal
Re
turn
DifferenceAbove Avg EV21 Rating - Electric Power Companies - N. AmericaBelow Avg EV21 Rating - Electric Power Companies - N. America
10
Superior Environmental Management –Benefits
Reduce regulatory risk and litigation exposure
Improve operations (reduced energy and materials costs)
Improve relations with regulators and other stakeholders
Enhance ability to attract, retain and motivate workforce
Increase competitive position
Enhance market access in difficult countries and regions
Lower cost of capital and insurance
i.e. Sustainable competitive advantage
11
• ABN-AMRO Bank• ABP Investments• Aeltus Investment Management
(ING)• Baillie Gifford• Bank Sarasin• Bank Julius Bear• BNP Paribas• BP Investments Management• Brown Brothers Harriman• CalPERS• Cazenove Fund Management• Collins Stewart (CI) Ltd• Contra Costa County Employees’
Retirement Association • Daiwa Securities• Dreyfus Investment Advisors• Friends, Ivory & Sime• Frontier Capital Management• Glenmede Trust• Henderson Global Investors• IDeAM (Crédit Agricole AM)
• Hermes • HSBC Asset Management• IBK Capital Corp.• Insight Investment• John A. Levin & Co.• Legg Mason Funds
Management• Lombard Odier & Cie• Mellon Capital Management• Mellon Equity• Morley Fund Management• Neuberger Berman• Rockefeller & Co.• Schroders Investment
Management• Société Générale AM• SNS Asset Management• Swiss RE Asset Management• State Street Global Advisors• Threadneedle Asset
Management• T. Rowe Price• UBS Investment Bank• Wellington Management• World Bank
Partial Client List
Financial Institutions
12
STRAT. PROFIT OPPORTUNITIES
+
MGT QUALITY
+
Past Present Past Present Future Future
RISKS FACTORS
• Historical Liabilities
• Operating Risks (Toxic Emissions, Haz. Waste Disposal, Waste Disch.)
• Product Risk Liabilities
• Market & Regulatory Risks
• Health and Safety
•Climate Change
• Social “License to Op.”
Multi-factor EcoValue’EcoValue’2121 algorithms integrate over 60 key data points, including:
• Policy & Strategy
• Governance Capability
• Environmental Mgt Systems
• Env. Auditing, Accounting and reporting
• Value Chain Mgt
• Stakeholder Capital
• Ability to profit from environmentally driven industry and market trends
• Sustainability of earnings
• Eco-compatibility of product portfolio and R&D initiatives
EcoValue’21=
Eco Value 21® Environmental Research
13
Products &Services
Intellectual CapitalProduct Safety
Stakeholder Capital
Labour relationsRegulators and PolicymakersLocal communities & NGOs
Customer relationshipsSupply Chain
Partnerships/alliances
Human CapitalRecruitment/retention strategies
Employee MotivationInnovation Capacity
Knowledge Development &Dissemination
Health & SafetyProgressive workplace
practices
Intangible Value AssessmentSocial Research
IVA™
Sustainable Governance
Strategic Scanning CapabilityAgility/Adaptability
Performance indicators/monitoring/reporting
International “best practice”
Emerging MarketsEconomic Development
Human RightsOppressive Regimes
14
Innovest Rating Model
A rating from AAA – CCC is assigned to company based on total
Analyst assesses company against 100+ factors by assigning a score of 0 – 10(10 = best in class)
Model computes all scores to generate a normalized figure for the company
Score Rating RankNovo Nordisk 1412 AAA 1
Bristol-Myers Squibb 1168 AA 2Pfizer Inc. 982 A 8
Abbott Laboratories 748 BBB 12Watson Pharmaceuticals Inc 514 BB 15
Forest Laboratories 100 CCC 18
Rating Matrix
Example: Pharmaceutical Sector
Note: Figures in table above are indicative and not actual.
15
Standard & Poors 500 Universe
Financial Screens• Valuation measures: P/E, Price/Free Cash Flow
• Momentum Factors: Earnings growth & consistency• Historical Returns: ROE etc
Intangible Value Overlay• EcoValue
• Human Capital• Corporate Governance
• Stakeholder Capital
Sustainability-Enhanced Portfolio
Innovest
Portfolio Construction: Integrating the Innovest Signal
( 150 Companies)
Sector Views
Portfolio Risk Control/ Optimization
(60-80 Companies)
16
Enhanced Fixed Income
Enhanced Index Equities, e.g. SSgA, ING Investments,
Active Plus Equities, e.g. ABP, Credit Lyonnais/ABF
Return
Risk
The Risk/Return Continuum
HIGH
HIGH
Private Equity Funds, e.g. Carbon, Renewables, Forestry
Theme Funds, e.g. T. Rowe Price “Clean Future Fund”
Long/Short Hedge Funds, eg. Green Cay
Enhanced Fixed Income
Enhanced Index Equities, e.g. SSgA, ING Investments,
Active Plus Equities, e.g. ABP, IDeAM (Crédit Agricole AM)
Return
Risk
The Risk/Return Continuum
HIGH
HIGH
Private Equity Funds, e.g. Carbon, Renewables, Forestry
Theme Funds, e.g. T. Rowe Price “Clean Future Fund”
Long/Short Hedge Funds, eg. Green Cay
Portfolio Construction: Integrating the Innovest Signal
17
Across a Number of Investment Styles. . .
-0.50
0.00
0.50
1.00
1.50
2.00
1Q - 4Q Tilt = 50 -0.04 0.23 0.08 0.51 -0.01 0.45 0.20
1Q - 4Q Tilt = 100 0.15 0.48 0.39 0.92 -0.04 0.65 0.43
1Q - 4Q Tilt = 200 0.76 1.07 0.47 1.58 -0.40 1.45 0.82
US Large Cap Growth
US Large Cap Value
Int'l Large Cap (EAFE)
US Mid/Small Cap Core
US "Diversity" Index
US Large Cap Core
AverageInnovest/ING
Aeltus
PRELIMINARY RESULTSReal Time Simulation of Innovest RatingsApplied to Actual Portfolios of a U.S. Pension FundFor the Year 2002Three Simulations per Portfolio1) at 50 basis point tracking error2) at 100 basis point tracking error3) at 200 basis point tracking errorwhere the benchmark is the actual portfolio and thetest portfolios are set to maximize the Innovest ratingsubject to the tracking error constraint (tilt)
Innovest Strategic Value Advisors, Inc.
1.30
18
The Green Planet Fund (IDEAM)
19
Focus: US Electric Power Sector and The Climate Change Challenge
20
Key Drivers
• Tightening global, regional, and domestic regulatory pressures
• Accounting-based numbers are telling less and less of the story
• Tougher requirements for disclosure of “non-financial” risks for both companies and institutional investors (e.g. Sarbanes-Oxley, SEC)
• Increasing market pressures -e.g. shareholder activism, institutional investors’ awareness on hidden environmental liabilities, public scrutiny
• Changing consumer demographics: Greater sensitivity to social/environmental issues in tandem with greater availability of information on corporate performance
• Broadening interpretation of fiduciary responsibility to include social, environmental and governance issues
21
Limited ability of companies to recover operating and compliance costs through regulated rates
The burden of environmental expenditures continues to
shift from customers to
investors Need to
differentiate their products (commodity) and diversify
revenue streams
Need to improve efficiency rates, retain customers
and attract investors
Increasing Pressures
Growing pressures to incorporate negative
externalities into market prices from
regulators, shareholders and
customers
Restructuring towards more competition
Some states move beyond federal rules
Evolving industry model
Electricity Industry - Key Drivers
22
Downside Issues – Risk Metrics
• Air Emissions Regulations: SO2, NOX, Hg and increasingly CO2
• Other Operating Risks associated with coal mining, water and waste management
• Resource Usage & Efficiency
• Site Remediation Liabilities
• Nuclear Management (long-term waste disposal, pot. radiation releases, decommissioning, public acceptance and security concerns)
• Other Sustainability Risk/Climate Change
$$
23
Projected changes in climates worldwide will affect the frequency and severity of extreme natural events with the potential of causing physical damage to power assets
Unpredictable weather patterns will impact the availability of water for power plant cooling and cause unpredictable variabilities in power consumption
Climate Change- Physical Impacts
24
Investors have been filing shareholder resolutions demanding disclosure of the climate change risks and opportunities with 20-30 percent of shareholders support
The potential influence of institutional investors over corporate boards and management is substantial controlling 60 percent of the shares in the 1,000 largest US companies
Signatories to the 2006 CDP, which has combined assets under management of $31 trillion, have demanded the chairmen of the 500 largest quoted companies in the world to mandate corporate disclosure of the risks posed by climate change
Climate Change- Financial Impacts
25
• Legislation to cap CO2 emissions is inevitable
• Question of “when and what form”, rather than “if”?
• What will be the impact on the Utility sector?
• Debate has moved from policy to technology - Global focus is on technology solutions
Potential Carbon Caps- The Electric Power Industry
26
Exposure to Carbon Regulations
Some States Are Moving Beyond Federal Standards
MA: Law requiring 10%cuts in CO2 emissionsfrom existing powerplants; sources may
purchase external CO2offsets
CA: GHG climateaction registry being
developed
NJ: StatewideGHG emissions
reduction target of3.5% below 1990levels by 2005;
voluntarygeneration of GHGcredits and bankingin NJ credit registry
TX developing GHG registry
WI developing GHG registry
Seattle, WA: Long-term goal of zeronet GHG emissions from Seattle City
Light, which has purchased reductionsfrom OR Climate Trust
Portland,OR: 20%
below 1988CO2
emissions by2010
NY: 3 pollutantbill passed, GHG
task forceestablished
OR: CO2standard for new
power plants -17% below mostefficient natural
gas plant;reductions can bepurchased fromOregon Climate
Trust or generatedfrom approved
projects
27
• Electric power plants account for 40 percent of U.S. CO2 emissions
Downside Issues – Potential Carbon Caps
• Current, proposed or impending CO2 caps will require substantial investments -50% of the 1000 US coal plants are older than 30 years and will be replaced in next 20 yrs
• The industry is likely to become a prime target under future GHG emissions regulations
• Even more so in a deregulated marketplace, in which cost recovery is uncertain
• Delayed climate change response may result in higher cost response actions including impairment of generating assets or early retirement
28
• Major C02 emitters may face higher debt charges from air quality conscious lenders
• Insurance premiums may be imposed on companies unprepared to take carbon risk management steps
• Credit risk ratings may become impaired due to exposure to weather changes and future regulations
Carbon Caps- Implications for Investors
• Ability to negotiate rates with regulators may be impaired
• Access to capital markets may be limited as institutional investors increasingly consider carbon profiles as part of their fiduciary obligation
29
Financial impacts are highly differentiated across companies, creating potential winners and losers:
• Prevailing power market dynamics and competitive environment in operating states
• Pace of carbon regulations in operating states
• Ownership of generating assets and geographic diversification
• Fuel mix of generating assets
Carbon Caps- Innovest Analytical Approach
30
Financial impacts are highly differentiated across companies, creating potential winners and losers:
• Flexibility to diversify the existing generation portfolio away from carbon- intense fuels
• Ability of passing on costs to consumers, and access to less-carbon-intensive technologies
• Strength of the corporate carbon governance, management systems and mitigation strategies
• Positioning to pursue and profit from emerging business opportunities in new less carbon-intense technologies
Carbon Caps- Innovest Analytical Approach
31
Develop GHG hedging strategy as critical component of risk management to anticipate mandatory GHG emission caps
Leading Carbon Management Practices
Set quantitative GHG reductions targets and monitoring
Follow third party GHG inventory and reporting protocols
Monetize external impact of fossil fuel generation
Incorporate risks in asset and investment planning decisions (better capital allocation)
Allocate formal management and board responsibility
Engage in carbonless business or products
Conduct sensitivity analysis and emissions trading simulations
32
Reduce GHG emissions through internal energy efficiency
Industry Carbon Mitigation Practices
Avoid GHG emissions by increasing operation of low carbon emitting generation
Offset GHG emissions through emission trading, i.e., offset purchases
Switch towards less CO2-intensive fuel
Engage in renewable power
Pursue “clean” coal technologies
Participate in efforts to sequester carbon
33
Allow companies to gain expertise and strategic positioning in a niche market
Benefits of Investments in Green Power and Distributed Power Generation
Protect companies from grid disruptions (on-site projects)
Reduce operating costs due to avoided potential carbon related charges
Create additional assets from tradable certificates generated during project
Align with potential national security energy goals to reduce fossil fuel dependency
Lower exposure to fluctuating fossil fuel prices
Enhance access to capital- About 66% of total investment in energy generation were in clean technology (Cleantech Venture)
Target of fast-growing clean technology funds
34
Carbon Is A New Asset Class
The EU’s Emissions Trading Scheme started in Jan 2005-Price of CO2 is €26.5 per ton (March 2006) from €7 in April 2004
The value of the EU carbon emissions trading market is about €58.3 billion per year (US$ 73.4 bn) based on March 2006 prices
Further standardization is expected to increase liquidity
Price drivers include policy events, fuel/other commodity prices, CDM/JI supply, and weather
Japan, Canada and New Zealand as well as some US states have considered similar trading schemes
The US Chicago Climate Exchange provides for a voluntary spot market platform.
Financial institutions increasingly engage in carbon trading-Bloomberg expands coverage
35
Identifies potential hidden risk and profit opportunity factors
Risk Control
Enhances reputation with internal (employees) and external stakeholders (regulators, suppliers, consumers)
Better access to capital markets as a growing number investors consider companies’ individual carbon risk exposure and management capabilities as part of their fiduciary obligation
Reputation
Funding
Source of differentiation and competitive advantage
Strategic Pos.
Benefits of Carbon Management Leadership-CONCLUSION
36
For Further information
Carla Tabossi
Senior Research Analyst
Innovest Strategic Value Advisors
675 Third Avenue, Suite 400
New York, NY 10017
Phone: 212-421-2000 x211
Fax: 212-421-9663
www.innovestgroup.com