Head of Environmental, Social and Governance Investment Research
Opportunities to capitalise on a rising demand for food – driven by population and economic growth in Asia – coincides with opportunities and risks related to changing consumer trends. However, there is also currently an increasing obesity issue and the food and beverages sector is exposed to a number of other sustainability issues.
AMP Capital reviewed the food and beverage sector, exploring some of the key sustainability drivers from an investor’s perspective. This article presents these findings, as well as links between company management of environmental, social and governance (ESG) risks and investment returns.
The food and beverage sector is subject to sustainability drivers
Compared to other sectors, the food and beverage sector is subject to relatively strong sustainability drivers – some of these are long-term drivers and others may have a more immediate effect.
Some of the key drivers include:
- Demographic change – population growth and rising income levels in Asia.
- Changing consumer trends – increased focus on ‘healthy living’, demand for convenience and affordability.
- Regulatory change – increased attention to obesity issues as well as social and environmental effects and costs.
- Increased competition for constrained natural resources – lack of arable land and need for yield improvement, competition for water and other scarce resources and impacts on soft commodity prices.
- Increased consumer awareness of ethical and sustainability issues – globalised supply chains and increased complexity, coupled with greater consumer awareness, result in a greater need for strong supply chain management.
- Climate change – potential regulatory changes and impacts of physical climate change on assets and resources.
Looking through this sustainability lens provides some interesting investment insights on companies across the sector.
What does the obesity issue mean for investors?
How do you invest in a world that is constantly changing? The simple answer – invest in the companies that are changing the world. Generally, investors can buy into the solutions and avoid the culprits. However, obesity is a multi-faceted issue which includes consumer awareness levels, consumer choice and lifestyle, as well as corporate responses and regulation.
Obesity has been on the rise for decades and contributes significant costs to already over-burdened government budgets. Government responses to abate the costs to the public purse include stricter marketing rules and/or consumption taxes however, until recently few governments have taken any significant action. An exception to this is the Government in Mexico – a country with a significant obesity problem – which introduced an 8% tax on high-calorie food and a peso per litre tax on sugar-sweetened drinks in 2013. Additionally, the US city of Berkeley in California recently became the first in the country to pass a tax on sugary drinks. New measures are currently being discussed in the US and elsewhere in the world.
Empirically, there are few studies available on the long-term impacts of obesity-related taxes and consumption levels. This is ultimately a question about price elasticity, but in addition to raising prices, increased government regulation also results in greater consumer awareness.
As a result of growing consumer interest in personal health, some of the fastest growing segments in the food and beverage sector include organic and gluten-free food. In contrast to this, consumption of sugary soft drinks and beer may be on a slippery slope.
So, where does this leave investors?
Investors can reduce their exposure to companies and sub-segments at risk, although doing this reduces the breadth of their investments. Instead, by screening out companies with relatively poor ESG profiles, investors can generate a better pool of stocks to choose from.
Our review of the food and beverage sector shows that on average, companies with relatively better overall ESG profiles outperform those with relatively poor ESG profiles, in both the short and the long term.
Importantly, any exclusion needs to be dynamic as opposed to static. Evolution does not necessarily favour those that are the strongest, but those that are the most adaptable. In this vein, companies which are currently negatively exposed to obesity may change, with some responding with new products or by reducing the size of food or beverage products or fat and sugars included in their offerings.
However, given the slow-down in supermarket earnings growth there is a concern about what will happen to top-line growth and margins in the fast-food segment if and when supermarkets decide to target the take-away segment, similar to supermarket counterparts overseas, in the UK for example.
Health foods, although fast growing, still represent only a relatively small percentage of the total pie. As a result, the ASX200 index offers some interesting but limited opportunities to invest in the health food industry. Some of those that are on offer are also exposed to the risk of supermarket private label competition, as supermarkets come under pressure to find new growth areas. Investors can also turn their attention to the healthcare sector, where a number of companies are positively aligned with the obesity issue.
Asia’s food bowl or Asia’s ‘specialty food store’?
The world’s population is expected to increase by nearly one billion over the next decade with a major proportion of this growth expected to take place in Asia – this signals export opportunities for Australian companies. From an investor’s perspective, we believe the biggest opportunities exist in continued merger and acquisition activities by offshore investors and certain niche export areas.
When it comes to the latter, economic growth is typically coupled with increased consumption of protein. Interestingly however, in some emerging countries protein consumption per capita remains at subdued levels despite decades of economic growth, implying skewed wealth distribution. This, coupled with relative operational cost differences and logistics costs, leads us to believe that Australia’s greatest export opportunities will likely be in the premium space, i.e. premium products to premium markets, particularly in protein. This means opportunities in infant formula – for example UHT milk – for certain seafood categories and other areas where demand outstrips local supply, including certain nuts.
Another important component in the food exports equation is water, which is the key scarce resource in food production. Going forward, we expect water risk will be exacerbated by climate change and risks of shortages. Therefore, it makes sense to analyse forecast economic value per unit of water consumed in order to assess export opportunities in the future.
Other key ESG issues that may have a material impact on investments
We identified links between companies’ overall ESG profiles and total shareholder return; some of the key issues for investments in this sector are below:
- Corporate governance – a lack of independent directors and audit committees, combined with executive remuneration structures that may not be aligned with shareholders’ best interests.
- Supply chain management – globalisation means increasingly complex supply chains and exposure to a wide range of sustainability and ethical issues, including labour conditions, animal welfare, the environment and critical resource sustainability.
- Food safety and quality risk management – pressure to improve productivity and yields meets concerns about the impact on human health from growth hormones in beef production (illegal in the EU but legal in Australia and the US) and genetically modified crops.
- Workplace management – occupational health and safety risk is relatively high compared to other sectors and few companies have comprehensive external safety reporting.
- Environmental risk management – the sector is highly vulnerable to impacts from physical climate change, which is expected to lead to increased frequency and velocity of extreme weather events. This means risks of earnings volatility and supply chain issues.
The food and beverage sector is subject to relatively high sustainability risk compared to other sectors, due to drivers such as changing consumer behaviour, regulatory change, resource constraints, climate change, population growth and an increased demand for food. In our review of 37 listed companies we found that on average, those with relatively better ESG profiles outperform those with poorer profiles. This means investors need to understand the implications from sustainability drivers on investments as well as how companies are managing their ESG risks.
The increased regulatory focus on the obesity issue combined with increased consumer awareness about personal health means two things; there are structural challenges for companies that cannot adapt and investment opportunities within companies who make product part of the solution.
Important note: While every care has been taken in the preparation of this article, AMP Capital Investors Limited (ABN 59 001 777 591, AFSL 232497) and AMP Capital Funds Management Limited (ABN 15 159 557 721, AFSL 426455) makes no representations or warranties as to the accuracy or completeness of any statement in it including, without limitation, any forecasts. Past performance is not a reliable indicator of future performance. This article has been prepared for the purpose of providing general information, without taking account of any particular investor’s objectives, financial situation or needs. An investor should, before making any investment decisions, consider the appropriateness of the information in this article, and seek professional advice, having regard to the investor’s objectives, financial situation and needs. This article is solely for the use of the party to whom it is provided.