Generally speaking, we are used to things getting better. Obviously the current pandemic is a (hopefully) temporary break in that trend, but it does not alter the fact. Life expectancy, infant mortality, quality of life, access to communication and other services are all on a generally improving line. From a global perspective, in most measurable ways there has never been a better time to be alive. This is true for us humans, but almost completely untrue for every other species on the planet. Our trend of rising prosperity brings increased consumerism, which demands the production of ever greater quantities of goods. Not only do we want more but there are more of us to want it and as our population grows the sad corollary is that the population of every other living thing declines. As China’s failed one child policy has shown us there is no absolutist solution to population control so we must deal with this trend as effectively as we can by using innovation, improving education and applying common sense strategies in our own lives while encouraging others to do the same. Reuse, recycle, mend and maintain; think twice before buying that item wrapped in plastic; invest in ESG.
Invest in ESG – but what does that really mean? In a recent discussion with a young lady just beginning her working career we got onto the topic of ESG investing. Like most people of her generation she was (rightly) strongly supportive of the concept and made sure that her investments went into suitably labelled funds. However, beyond a broad wish to make a positive contribution with her money she was understandably vague about the sorts of companies that she would ultimately like to be invested in.
Somewhat mischievously I asked her ‘ how about an industrial heat treatment business?’ and she winced. This would be a common response I suspect yet highlights one of my concerns about the shallow thinking behind much of the investment into ESG in general.
The industrial heat treatment business in question is Bodycote Plc. This is an example of a high-quality UK based engineering company, founded between the wars in Leicestershire but which only entered the heat treatment business in the late 1970s. The company has a strong tradition of innovation and has grown organically and through acquisition to be a leading player in the industry. Unsurprisingly heat treatment is not something many people think about but is an essential process in many mechanised industries. The process dramatically improves hardness and thus durability. It significantly extends the life of mechanical components as well as allowing them to be smaller and lighter. Gears, bearings, cutting tools, fasteners and many other applications rely on this process. Without it, engines and turbines would be less efficient and require more maintenance, drive shafts and components would be heavier requiring more energy – more petrol or wiggly-amps in your car. So while the process of heat treatment is itself energy consumptive, it more than makes up for this in the energy it saves over the lifetimes of the components it creates. Wind turbines, for example, would not be viable without the process of heat treatment.
Bodycote is an example of a company whose operations are not obviously helping to reduce our environmental impact yet are clearly contributing behind the scenes. It is the contribution made by these somewhat hidden, second tier businesses which needs to be better understood by environmentally conscious investors. Like many industrial companies Bodycote has made mistakes which have led to brushes with environmental agencies and there is clearly room for improvement in their practices. But companies are ultimately beholden to their shareholders and active investors have a key role here to engage with the management and push them in a positive direction. “Responsible’ funds which avoid companies in essential industries like this and starve them of capital will not help in the joined-up process of reducing global emissions. There are many examples of industrial companies who devote enormous sums into research and development to drive efficiency gains such as better conductors for electricity distribution, improved lubricants to extend product lives and reduce energy loss, and new compound materials reducing weight without compromising strength. They play a vital role in helping to achieve the global CO2 emissions targets but get little public recognition.
Bodycote is a longer term holding for the Columbus Fund and is a great example of a well managed champion in its niche with considerable longer-term growth potential. They have consistently improved their internal carbon efficiency and water usage and are getting better at providing information across a number of environmental indicators. On top of this the stock offers an attractive and growing dividend sourced from consistent cash flow generation with a conservatively managed balance sheet and a mid-teens return on investment.
Investing wisely for a better environmental future is essential – but let’s remember to look beyond the headlines.
Photo – Bodycote Annual Report