Tim Gerrard, Portfolio Manager in Janus Henderson Investors’ Global Natural Resources Team, outlines BHP’s shift to ‘Social Value’ and the possible implications for the company amid growing demand for ESG leadership.
There are so many reasons why it makes commercial sense for resource companies to be leaders in environmental, social, and governance (ESG) factors, so BHP’s ‘Social Value’ needn’t be dismissed as an exercise in public relations.
In early October, BHP held its first ‘Social Value’ briefing, where BHP’s Chief External Affairs Officer, Geoff Healy, argued for BHP’s belief that its move from ‘Social Licence’ to ‘Social Value’ underpins the company’s strategy and performance outlook.
It was evident from the briefing that the world’s largest mining company recognises the challenges associated with bringing about much needed (and rapid) change to the way it delivers its ESG strategy. Rather than describe the why and how in detail, most of this article outlines the possible implications of BHP undertaking such a venture.
But first, what is ‘Social Value’? In essence, it is BHP’s recognition that, for the sake of its shareholders, it must build deep relationships to maintain access to capital markets and gain goodwill among communities and host governments in the countries in which it operates.
Why the change?
Despite paying US$70 billion in tax and spending some US$1.7 billion on social initiatives over the past decade, a 2017 survey in Australia found only 37% of respondents viewed BHP favourably. With around 80% of BHP’s earnings before interest, taxes, depreciation, and amortisation (EBITDA) sourced from The Pilbara, Queensland’s coking coal basin and Chile’s Atacama Desert, good relationships in those regions are obviously critical.
More broadly, a lack of deep relationships with communities and society at large isn’t sustainable given BHP’s challenges – competing for talent, increased tax, climate change, timing of development and access to resources. BHP realises it must change – and quickly – to lead the sector, maintain the strength of its existing business and attract new opportunities.
How might it work?
I think internal rate of return measures will no longer be maximised, but optimised to allow for the cost of Social Value initiatives. BHP will start recognising the benefits that come from working more closely with communities by addressing their concerns quickly and effectively.
In each region, the general manager of operations will be making key decisions based on their understanding of local conditions and expectations. They are tasked with building and deepening relationships. Plans will be drawn up and implemented on an asset by asset basis.
Five potential implications
- The more that BHP’s leaders and peers collaborate and share best practices on environmental and other critical industry issues, the more insights they will have into each other’s businesses. They may even find common approaches to the importance of the value-add created by ESG. Areas of commonality and technical skills may become more apparent. Interestingly, both developments could provide additional rationale for M&A activity. For example, insight into a peer’s operation mired by a particular issue may result in an even more compelling acquisition opportunity should the acquirer possess the knowledge and expertise to efficiently turn it around. Conversely, knowledge and expertise could also be the focus of an acquisition.
- That leads to the question of how ESG leadership can add value. Increases in recycling, water quality and availability, energy efficiency, local employment and carbon abatement; conservation of resources and the implementation of new technologies that improve the economics of existing and future deposits could bring both financial and reputational benefits. M&A may give increased exposure to ‘green metals’ or see a low-rated ESG target re-rated based on the acquirer’s ESG capabilities, or vice versa, for that matter.
- Clear equity market valuation differentials may emerge reasonably quickly. ESG laggards could be marginalised as markets price in potential policy changes. Companies only paying lip service to ESG issues could even be excluded from the indices that are the benchmarks for passive funds. On the other hand, it’s not just about exclusion. Investors may also increase pressure on ESG underperformers to help influence positive change within their portfolios.
- Predicting the timing of ESG-based pricing differentials is also difficult. Already coal stocks have lost favour. But given how rapidly society’s expectations are evolving, strong ESG credentials could quickly win a ‘stamp of approval’ and attract a premium. Majors like BHP, Rio Tinto and Anglo American are well positioned to launch initiatives that may resonate with investors – and society – reasonably quickly. BHP seems well aware that ignoring ESG will likely lead to a ‘death by a thousand cuts’.
- According to BHP, offshore investors have moved their focus beyond climate change to requiring the organisation to better explain the nature and relevance of its business. Demand for ESG leaders will be high, but those in second place will likely be a long way down investors’ lists.
No passing fad
BHP is in a race to demonstrate true ESG leadership and gain the associated competitive advantages when seeking capital, along with local and national approval for projects.
Arguably, a simplified BHP, with a flatter structure and newly embedded processes, is well placed to collaborate with all its stakeholders, adding and protecting value for shareholders.
ESG: Environmental, social and governance are three key criteria used to evaluate a company’s ethical impact and sustainable practices.