Below is an executive summary of our in-depth report. Click here for an extract of that report. The full version is available to clients of Cornerstone Capital Group. 

Introduction

The extractive sector is vitally important to the global economy and will in fact be critical to a sustainable future. With a market cap of over US$6 trillion, the extractive sector encompasses over 5,000 companies. It provides raw materials for everything from energy creation to high-tech manufacturing to electronics. Even as the world starts to transition from greenhouse gas emitting commodities like oil and coal, natural resource extraction will remain essential. Smartphones and electric vehicles, for instance, require metals sourced from extractive operations around the world. Yet natural resource extraction is, by its very nature, environmentally destructive and socially disruptive — and managing the risks inherent in mining is of prime concern to extractive companies and the host countries in which they operate. Extractive companies’ success will be in part determined by their ability to position themselves for this future.

Risk Assessment in Context

The environmental and social (E&S) issues we address in this report highlight strategic concerns for any mining or extractive company. Tailings risk (tailings are the effluents generated in a mine processing plant, and require long-term, secure storage), community-company conflict, contract workers and labor disputes, and management of global reputational risk (using biodiversity impact as its proxy) create event risks such as mine failures, shutdowns or license denials. They also impact longer-term operational planning because they require proactive engagement with local, global and contextual stakeholders to assure passage. We assess selected companies’ corporate governance as it relates to actively managing E&S issues, identifying leaders and laggards based on relative “attentiveness” to material E&S concerns.

Detailed analysis of E&S issues provides predictive insight. We offer a proprietary framework to assess extractive companies’ underlying values, leadership, and culture based on a bottom-up analysis of material, yet underappreciated environmental and social (E&S) issues. We then explain how the issues impact specific items within a company’s financial statements.

Key observations. At a high level, we came away with these conclusions:

• Community influence increasingly impacting social license to operate. Concerns over erosion, loss of biodiversity, contamination of soil and groundwater, waste material management, and worker safety continue to threaten project timelines and economics.  Companies overall scored most positively in community conflict management and most negatively in managing global reputational risk from biodiversity impact. Four companies, including AngloGold Ashanti and Rio Tinto, address biodiversity using our best-in-class approach. But only two, Antofagasta and Randgold, were ranked as leaders on their management of tailings storage facilities.

• High CEO turnover impacts performance. A change in leadership followed by fresh initiatives reflect strategic decisions and operational priorities especially in regards to health and safety. AngloGold, for example, used external groups to create new performance metrics, broadening data collection and targets for accident tracking. Among the group, outsider CEOs were more likely to be associated with best-in-class initiatives on transparency. Formative training in engineering, however well-suited to the industry, may counterintuitively increase the risk of community-company tension.

• Employment. All else equal, an owner-operated mine is better-equipped to manage its relationship with the community than one that relies heavily on contract labor; five companies, including Tullow Oil and Anglo American Platinum, scored well on this issue while Philex and Buenaventura did not.

• Best / Worst performers. Cornerstone identified several markers of a company’s culture, values and leadership quality, which in turn speak to its willingness and ability to address emerging risks as it executes its strategy.
  • Leaders: Antofagasta, Newcrest, Randgold, Tullow Oil
  • Laggards: Buenaventura, Harmony, Philex, South32

Methodology

We evaluated companies according to seven metrics that together provide a clearer picture of their potential for long-term success in executing their strategies. These metrics are:

• CEO leadership and turnover;
• Management of tailings risk;
• Community relations
• Labor relations
• Approach to biodiversity issues
• Corporate reporting structure (i.e., reporting lines for environmental and safety executives)
• E&S incentives in management compensation.

We performed our assessment on a range of representative companies, shown below. We “score” the companies on each of the seven metrics, then roll those up into an overall “attentiveness” indicator.

Sebastian Vanderzeil is a Global Thematic Research Analyst with Cornerstone Capital Group. He holds an MBA from New York University’s Stern School of Business. Previously, Sebastian was an economic consultant with global technical services group AECOM, where he advised on the development and finance of major infrastructure across Asia and Australia. Sebastian also worked with the Queensland State Government on water and climate issues prior to establishing Australia’s first government-owned carbon broker, Ecofund Queensland.

Carolyn Trabuco is a Managing Director and Global Thematic Research Analyst at Cornerstone Capital Group. Carolyn has spent more than 25 years in the global equity investment space where she has identified dynamic secular changes, made investment decisions, developed business and industry models, valued companies, and assessed risk around global commodities, companies and industries. Previous firms include Pequot Capital, Phibro, Montgomery Securities and Fidelity Management and Research.  She is an independent member of the Board of Directors of Azul Brazilian Airlines.

Michael Shavel is a Global Thematic Research Analyst at Cornerstone Capital Group. Prior to joining the firm, Michael was a Research Analyst on the Global Growth and Thematic team at Alliance Bernstein. He holds a B.S. in Finance from Rutgers University and is a CFA Charterholder.

Emma Currier is a Research Associate at Cornerstone Capital Group. Emma graduated with a Bachelors of Arts degree in Economics from Brown University in May 2016. While at school, she worked with the Socially Responsible Investing Fund and as a teaching assistant for the Public Health and Economics departments. She spent her sophomore summer researching differences between American and Indian educational styles in Arunachal Pradesh, India, and completed a summer investment bank analyst position with Citi in the Media & Telecom group in 2015.

We extend our thanks to Fiona Ewing, Cornerstone Capital Group summer intern, for her contributions to the report.

Recent survey results indicate a move away from antibiotics in emerging market poultry production. WATT Global Media surveyed poultry feed producers and consumers globally (i.e., nutritionists, consultants, veterinarians, production managers) and 43% of respondents said that more than half of their feed production is now antibiotic-free. Based on the regional breakdown provided, we estimate that emerging markets accounted for 60-75% of survey participants.

Possible divergence from company views. In fiscal 4Q16, Phibro Animal Health (PAHC: $25.54) reported modest growth in sales of medicated feed additives (MFAs) containing antibiotics. Weakness in the US was offset by international growth from emerging markets such as Brazil and China. On the earnings call, Phibro cited emerging markets’ growing populations and need to improve productivity in food production as a long-term driver for their international MFA business. Our read of the survey results is that investors should be cautious assuming that growth in emerging market poultry production will translate into similar growth in MFAs.

Nutritional and specialty feed additive opportunities in EM. Our October 5, 2015 report Antibiotics and Animal Health: Value-Chain Implications in the US highlighted nutritional and specialty feed additives as having significant growth potential. We believe the survey implies a broader opportunity in EMs with two-thirds of survey respondents exploring, testing or using feed additives as antibiotic alternatives. Probiotics and prebiotics usage is also on the rise, supporting our previous view that growth these categories would outpace other additives.

Investment implications. For animal health companies, the survey signals possible checks to future growth in antibiotic use in EMs. Nutritional and specialty feed additives are generally produced by major chemical companies and represent a small portion of overall revenue, but opportunities in the EM appear to be growing. For companies with more concentrated exposure, probiotic and prebiotic feed additives offer the greatest growth potential.

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Michael Shavel is a Global Thematic Research Analyst at Cornerstone Capital Group. Prior to joining the firm, Michael was a Research Analyst on the Global Growth and Thematic team at Alliance Bernstein. He holds a B.S. in Finance from Rutgers University and is a CFA Charterholder.

Sebastian Vanderzeil is a Global Thematic Research Analyst with Cornerstone Capital Group. He holds an MBA from New York University’s Stern School of Business. Previously, Sebastian was an economic consultant with global technical services group AECOM, where he advised on the development and finance of major infrastructure across Asia and Australia. Sebastian also worked with the Queensland State Government on water and climate issues prior to establishing Australia’s first government-owned carbon broker, Ecofund Queensland.

Uncertainty Has Increased Materially in Key Regions of the World. In the U.K., Brexit uncertainty could drag on for a few years. Globally, the next big uncertainty surrounds the U.S. presidential election, although that issue will be clarified in a few months.

Major Corporate Decisions Likely on Hold. In the U.S., Europe and the U.K., uncertainty will likely mean that managements avoid making major decisions pertaining to hiring, expansion, capex, M&A, etc. This decision-making paralysis could ultimately weigh on global economic activity and corporate profits.

U.S. Stock Prices Flat, at Best, in 2016. In equity markets, uncertainty has already taken a toll on stock prices by way of P/E compression. It’s hard to construct a scenario where multiples in the U.S. expand, at least until a clear victor emerges in the U.S. presidential elections. The combination of compressed multiples, and earnings that are potentially under pressure, suggests that U.S. stock prices will be flat, at best, in 2016.

Some Grounds for Optimism. Lower interest rates could support an uptick in consumer spending and business investment. A new U.S. president could initiate significant fiscal stimulus. Alternatively, a populist president could introduce a minimum national wage, which could spark consumer spending. Finally, despite uncertainty, technological innovation will continue, supporting new business models as well as creating new jobs.

Please see report for important disclosures.

Michael Geraghty is the Global Markets Strategist for Cornerstone Capital Group. He has over three decades of experience in the financial services industry including working as an investment strategist at UBS and Citi.