Smithfield Foods is owned by WH Group, a Chinese food group. A recent Rolling Stone magazine article pointed out that in China, the WH Group uses bio-gas digesters and a dry-manure process, rather than wet lagoons. The magazine quoted a former Smithfield director of corporate communications as saying, “lagoons work better for North Carolina’s warm climate… I’ve seen growers go bankrupt trying to use alternative systems.”
The apparent ability to control the environmental pollution, albeit at higher cost, appears to make this more of a margin issue than an existential issue for Smithfield. The cost of risk mitigation may delay an upgrade at Moody’s.
Not In My Back Yard
Even though many of the best examples of environmental risk arise from the natural resources sectors, investors should also keep in mind the vulnerability of consumer brands in the age of social media. A seemingly small environmental issue, even in a company’s supply chain, can turn into higher costs and a flurry of negative publicity.
NIMBY-ism (“Not in My Back Yard”) is a reflection of the fact that sometimes social costs are concentrated on relatively few community members, rather than spread across society. If this risk concentration has fallen on the powerless and voiceless, investors should consider whether the rise of social media and the evolution of legal systems has increased the voice and power of these few.
General Risk Types: Accidents And Societal Change
Fixed income investors assessing environmental risk will find it useful to segment two general types of risk when assessing different bond maturities from the same issuer.
1. The risk of accidents affects all of an issuer’s bonds from very short maturities to long maturities. It is not difficult to imagine unfortunate circumstances that would send an issuer’s management running into bankruptcy court right after an accident.
2. The risk of societal change in the acceptance of social costs is more likely to affect an issuer’s medium term and long-term maturities.
We believe that fixed income analysts must consider the possibility of changes in societal attitudes, particularly when considering longer term bond maturities. Changes in societal attitudes about the environment are often championed first by thought leaders in academia, government agencies and Non-Governmental Organizations (NGOs). As these groups spread information and data on previously ignored social costs, the possibility of changes in societal attitudes increases.
To properly assess the environmental risks facing an issuer, analysts must be aware of the relevant issues being raised by thought leaders and consider how those issues impact the environmental risk facing a company.
Societies have largely decided to no longer tolerate the social costs of environmental pollution. With this in mind, investors must factor in environmental risks when assessing fixed income investments. The genie has left the bottle, likely to never be put back.
Patrick Faul is director of research at LM Capital Group.