Closing the sustainability valuation gap
David Willans, Director, Sustainability, at Bladonmore, explains why the value of sustainability isn’t properly reflected in valuations – and what to do about it.
With a myriad of regulations and standards, companies are focused on telling investors that they’ve ticked the boxes and done some good things that year. They haven’t yet taken it further to show how that’s made the business more valuable in the context within which it operates. As such, there’s a gap between the work they are doing and the valuations that they are getting.
Risks & opportunities
The way companies currently measure and report on their ESG performance is based on standards that only take one perspective – how a company is managing the risks and opportunities from ESG issues on its ability to do business. This is the definition of ESG, as coined by the Principles for Responsible Investment. From a buyer’s perspective, that sounds sensible at first glance. But it completely ignores the context, which is the source of the sustainability valuation gap.
Value is clearly a function of how fit for purpose something is for the context within which it is operating.
Would you invest in a brewery with great water management, but whose operations are in areas with extreme water scarcity predicted in coming years? Or one that’s less good at water management but in a country with no water issues? ESG ratings would score the business with better water management higher, but with the additional sustainability context, it looks far less rosy. Getting to grips with this broader context is how to show the value and, to make a massive understatement, it’s not always an easy task.
Getting the message
The Value Balancing Alliance, whose members include BMW, Bosch, Novartis, Kering, Holcim and others, aim to ‘create a way of measuring and comparing the value of contributions made by businesses to society, the economy, and the environment – a metric not previously reflected in a company’s balance sheet’.
Sounds a bit worthy, but it’s actually enlightened self-interest because a company’s profitability and value is at the mercy of regulators, suppliers, employees and customers. Regulators can change the rules and are increasingly doing so to internalise the externalities that are now so painfully clear that politics has taken note. Suppliers can suffer scandals or major disruptions. Quality employees can leave, new talent can refuse to apply. Customers can choose a competitor.
By understanding how business creates value for these stakeholders, and by how much, these businesses can make better decisions. If I was being cheeky, I could describe the narrow, ‘how ESG issues affects my business’ view as selfish, and the broader, ‘how is my business contributing to sustainability’ view as a more realistic picture of how the world works. This second view captures a truer picture of the value a company’s sustainability efforts create, which can then be used to close the valuation gap.
It needn’t be complicated
As much as the quants, rating agencies, stock exchanges and regulators try to objectify it, value is always going to be somewhat subjective. The main cause of the sustainability valuation gap is a lack of context. Recognising why this is the case, shows what can be done to close it.
Here are four quick fixes:
The work required to measure, assure and report in line with requirements is enormous. You can’t stop it, but you can remember it’s only part of the job. The other is working on understanding, capturing and communicating the context to better frame the performance.
Fortunately, gathering data on the context can happen outside of reporting season. Bring together sustainability, communications and IR teams to agree the story of context, so that you can weave it in to all your other communications to build a more valuable story.
Beef up governance
Investors want to know that their investments are well run, but sustainability governance is often neglected and left to the last minute because it’s, well, a bit dry. Even some private equity firms, whose business is inherently linked with good governance, often don’t make a thing of it, which is strange. Still, it shows you the state of play and size of the opportunity.
Sustainability communications aren’t just for disclosure deadlines. They are valuable all year round. This is especially true for internal communications, where making the context clear helps others, especially leaders, get their heads round, and voices behind, your more sophisticated and valuable story.
Closing the valuation gap is simply about bringing in the context that shows why your sustainability is more valuable than it first appears. That way you can reclaim the money that you may be currently leaving on the table. And for most businesses, that is surely no bad thing.
If you want help getting more value from your sustainability work, get in touch.