Why going carbon zero is a huge investment opportunity

Globally, governments are setting emission targets, some even with a 2050 deadline. This presents a colossal challenge for companies, particularly considering that the ASX-200 produces a combined 240 million tonnes of emissions. 

Whilst reducing this number may present challenges, Firetrail Investments' Portfolio Manager James Miller says it also presents large opportunities in the market. One common mistake investors are making is investing only in the companies that have already reduced their emissions. However, Miller says that there is a great opportunity in the companies working toward net-zero, as the companies who are eventually successful in lowering their emissions see earnings and valuation growth. He cites Danish electricity provider Ørsted whose sustainable shift took its forward PE from 11x to 35x earnings.

In this episode of the Firetrail Analyst Series, Miller clearly explains what net-zero emissions means, the impact this will have on markets, and why companies who embrace the green wave will benefit immensely in the long run.

Edited transcript

Hi there, and welcome back to the Firetrail Analyst Series. As you may know, the Firetrail Analyst Series involves taking a deep dive into a stock or sector with the help of a Firetrail analyst. Today, we're going to shift gears slightly and try and cut through some of the noise around sustainability, why you should care about it, and importantly, the investment opportunities. To help me with that, I'm joined by Firetrail portfolio manager, James Miller. James, thanks for joining me.

Let's get into it. Sustainability, it's permeating discussions, not only with our portfolio companies, but our clients, and even around the dinner table. A topic that we're hearing a lot is net-zero emissions targets. Could you start by taking us through what that actually means?

James Miller:

Sure. And you hear net-zero a lot now, and it's something you're not going to be able to avoid in the future. So, what's really important when we talk about net-zero is to understand what it means from an investing perspective. There are two things to think about. 

The first one is, what are we actually talking about? So, you hear net-zero, you're probably thinking net-zero carbon, but it's actually four gases, carbon dioxide, methane, nitrous oxide, and fluorocarbons as well. Those four, they're the main contributors to global warming. 

The second thing, and without going into too many accounting quirks here, is saying, "Well, what emissions is a company really responsible for?" And when a company talks about net-zero now, they're really talking about two things: scope one, or direct, and scope two, or indirect, emissions.

So, say you're a cement producer. Your scope one emissions are the carbon dioxide that comes up through the kiln as you make the cement and your scope two, or indirect emissions, that could be from the coal-fired, coal-generated electricity that you're sourcing there. Interestingly, say you're an oil producer, then that oil you're producing is used by end consumers and has emissions. That doesn't count in scope one or two. But even if you look at scope one and two, for the ASX200, that's 240 million tonnes. To put that in context, that weight is the same weight as the amount of iron ore that BHP ships out of Australia each year. So it's a big number.

Eliza Clarke:

All right, now carbon emissions, that sounds like a challenge, but also an opportunity for companies. What are they doing about it?

James Miller:

It's going to be a lot easier for some companies than others. So, think about people businesses, service companies, tech companies. For them, it's a lot easier. Look at our Commonwealth Bank, big market cap company, it has about 110,000 tonnes of emissions each year. The big reduction it can do is simply by shifting to renewable electricity sources. But then, on the other hand, take a company like Qantas. It's got 12 million tonnes of emissions in a normal year, and they're a world leader in terms of looking at ways to reduce those emissions. But it's going to be tough. Think about the technology, electric planes. They do exist, but they're not that good yet. Secondly, substitutes that Sydney and Melbourne and high-speed train, still talked about, still not on the ground yet, as well. So, Qantas will do what it can, but it's going to have to rely on things such as carbon offsets to get themselves to net-zero in the short to medium term.

Eliza Clarke:

You mentioned offsets there. Can we dig a bit deeper? What do they mean?

James Miller:

Offsets are like the Wild West, at the moment Eliza. We could go out and we could source offsets for a dollar. We could source offsets for $20 today. And this doesn't really make intuitive sense because there's one atmosphere. An emission's an emission and an offset should be an offset, but there's different rules, regulations, schemes. There are different qualities as well. If you think about the gold standard offset, would be planting a tree because that tree will be sucking out carbon dioxide from the atmosphere, into the tree as it grows. But say you build a solar farm, is that really going to displace some coal-fired electricity generation? It gets a bit murkier there as well.

So, there are those things. There are even some regimes, such as the EU, that don't actually allow you to use offsets. So if you emit there, you've got to pay $80, or the equivalent of 80 Australian dollars per tonne. So, it's really a bit odd at the moment. Overarching all of that is the bigger picture, which is that there aren't even enough offsets to go around. You could not plant enough trees to offset all of those emissions that are out there today.

Eliza Clarke:

All right. Final question for you, James. How is Firetrail thinking about it? What are the opportunities out there?

James Miller:

Well, from what I've said, the easy thing would be to just avoid these heavy emitting companies. That's what you might think. But in reality, those risks are being priced in very quickly today. So you've got to think about the forward-looking opportunity. And when you think about it, in terms of a positive change perspective, say there's a company today, which is a heavy emitter, but you can see that pathway to it reducing those emissions. Along that pathway, you'll probably see a valuation increase as those earnings risks reduce, and you're actually making that emissions difference as well.

The global poster child for this would be a Danish electricity utility company called Ørsted. They've shifted successfully from being a fossil fuel generator of electricity to now being the world's leading developer of offshore wind farms. And in that process over the past five years, its price to earnings ratio has gone from 11 times to 35 times earnings one year forward. Current opportunities are the ones where you haven't seen that journey yet. So, there are companies like Alstom out there, which is the world's, or the Western world's, largest train manufacturer. It is decarbonizing diesel fleets rapidly. And it's also providing that cleaner alternative to something such as air travel. So those are the opportunities we look for. It's that positive change opportunity. They're the investments that will make a difference in emissions reductions, but most importantly, they are the ones that will be the best investments for your returns from a financial perspective.

Eliza Clarke:

Great. Thanks a lot, James, for taking us through a bit more detail about how Firetrail is thinking about sustainability. And thank you for joining us for the Firetrail Analyst Series.

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We hope you enjoyed the second instalment of the Firetrail Analyst Series 2021 on Sustainability. We will be discussing a stock or sector on a monthly basis throughout 2021. If you'd like to receive our exclusive reports first, hit 'FOLLOW' below.