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:

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:

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.

mining-fig2

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.

Click here to access the full note.

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.

People joke that Brazil is the country of the future … and always will be.

Brazil is the 5th largest country in the world. It has 7% of the world’s fresh water, is one of the world’s most biodiverse nations with more than four million plant and animal species, and has more available farmland than any other nation. And … its climate is largely free of natural disasters.

But Brazil is suffering a disaster that is entirely manmade. This 30-year-old democracy is presently roiled by a political corruption crisis with far-reaching consequences, including the potential impeachment or indictment of President Dilma Rousseff and the alienation of her and former President Lula da Silva’s Workers’ Party, the Partido dos Trabalhadores (PT).  Like pulling on a string that unravels the whole sweater, the now two-year-old Lava Jato (Car Wash) investigation into corruption at state-owned oil company Petroleo Brasileiro (Petrobras), led by Federal Judge Sergio Moro, has revealed endemic corruption on a massive scale. Corruption at the political level, board level and business levels across multiple states and industries. The people of Brazil themselves have taken to the streets to protest this corruption. They bang pots and pans in the street in a uniquely Latin American style of mass protest called ‘panelaço’ whenever the President or former president speaks on TV.  The people and the media encourage Judge Moro to press onward with his investigation.

Meanwhile an economic recession continues to deepen, unemployment rises and inflation spikes.

Brazil is entirely capable of righting its wrongs and setting itself down a new path of political accountability, and the reward for doing so would be significant.  But Old Brazil isn’t giving up easily. Here are some examples of the battle between Old Brazil and New Brazil.

Protection for the Political Class

A watchdog group called Congresso em Foco highlighted in a report that 40% of Brazil’s 594 members of Congress are facing charges for various crimes. The Supreme Court is the only court allowed to try members of the political elite.  In the last 27 years the Supreme Court has investigated 500 congressional members – 16 of whom were ever sentenced.

Many in Brazil believe that President Rousseff offered former President Lula a ministerial post in her cabinet last month as a means to shield him from the Petrobras investigation. That appointment is awaiting a verdict from the Supreme Court.

Federal Judge Sergio Moro, on the other hand, has become deft at using newly passed anti-corruption laws that offer reduced sentences in exchange for information.  Every day it seems there is more information, so much that a key party in the ruling coalition, the PMDB, voted on March 29th to withdraw support from President Rousseff entirely — potentially making way for impeachment proceedings. Should President Rousseff be impeached in 2016, the presidential election will be recast across the country. If the event were to happen in 2017 then the Brazilian Congress will select the new president.

Petrobras Tug-of-War

Created in 1953 as Brazil’s National Oil Company, Petrobras established world-class expertise in deep water oil exploration and development.  The centrist government of President Fernando Henrique Cardoso partly privatized the company in the 1990s. Petrobras was considered the crowning jewel of Brazil.

In 2007, President Lula’s Workers’ Party government created a new set of regulations and controls designed to keep the promising and massive “pre-salt” oil fields out of private and foreign hands while also reasserting state control of the oil company. Much of the Lava Jato investigations center around the alleged fraudulent use of funds from the company to pay off the political party’s leadership and to fund election campaigns. Recent reports suggest over R$6B in bribes were paid and over R$30B in state revenue was lost. Between 150 and 200 people have been arrested so far with nearly 100 convictions and 40 sent to jail, including construction magnate Marcelo Odebrecht. Lava Jato is now in its 27th phase and reaches the office of President Dilma Rousseff herself (who was Chairman of the Board at Petrobras during those years but has not been implicated in the investigation).

Novo Mercado (New Market)

In 2000, a group of leaders within Brazil’s leading stock exchange recognized that investors were shunning domestic equities in favor of fixed income or Brazilian company ADRs listed on foreign exchanges.  One-third of the volume traded in that year was from ADRs in companies such as Ambev, Vale and Petrobras. Lack of accountability and transparency, fears of fraud and unfair treatment for common shareholders kept investors away.

The Novo Mercado listing – and its Level 1 and Level 2 counterparts – was created to encourage companies to adopt strong governance standards such as equitable treatment of shareholders, high standards for corporate boards and comprehensive disclosure rules.  These were (and remain today) voluntary. Early adoption was hindered by fears over the incoming left-leaning administration of President Lula and the ongoing devaluation of the Brazilian Real. It was only once the commodity boom took hold and global investors desired Brazil exposure that Novo Mercado behaved as envisioned.  In 2004, Natura listed its IPO, followed by nine others in 2005 and 11 in 2006; by 2007 over 150 companies were participants in Novo Mercado, Level 1 and Level 2.  More than half of these IPOs were from industries not previously represented on the BOVESPA.  Families and private equity firms found the ability to divest, diversify and recycle their capital. Demand for these equities was so strong that their PE multiple was twice as high as those not participating. While there hasn’t been an IPO in Brazil since 2013 due to the political crisis, corruption scandals and deep economic recession, 130 companies remain members of the Novo Mercado. These companies are likely to be the first basket investors revisit once investor appetite returns.

Brazil’s currency rallied 15% from its lows earlier this year as Lava Jato appeared to have reached a turning point.  The world is now watching. Once the lengthy investigation process concludes, investors can focus again on all that Novo Brazil offers.

 

Carolyn Trabuco has over twenty years of global equity investment experience. She is an Independent board member of Azul Linhas Aereas, a commercial airline in Brazil, which she co-founded in 2007.