4 ESG stocks for sustainable investing

This article is part of our Earth Week special report

Environmental, Social, and Governance (ESG) factors are rapidly gaining investor favour worldwide. As more myths around sustainable investing get busted, savvy investors are starting to look for businesses that embrace sustainability as part of their corporate strategy.

The ongoing boom in sustainable investing, also known as responsible investing, is proof that ESG issues are now key economic determinants with significant bearing on businesses and investors. “One need look no further than the nearly fourfold increase in assets that flowed into sustainable funds in the United States last year,” says Jon Hale, Morningstar’s  global head of sustainability research, adding that sustainable funds “attracted more assets in just the fourth quarter of 2019 than in all of 2018.”

The most recent data from the Global Sustainable Investment Alliance (GSIA) show that global sustainable investment assets reached US$30.7 trillion at the start of 2018, a 34% jump from 2016. In Canada, sustainable investing assets, for the same period, swelled by 42% and now account for over half of professionally managed assets in the country.

Investors looking to access sustainable investing may want to consider the following companies whose policies for environment, gender equality, diversity and sustainability have earned them many accolades. That they are still running successful businesses is a testament to the fact that far from being a headwind for performance, sustainability is a driver of growth, profitability, and higher returns.

The soda and snack maker, PepsiCo (PEP) is one of the largest food and beverage companies globally. Its portfolio includes many household brands including Pepsi, Mountain Dew, Gatorade, Doritos, Lays, and Ruffles. In addition to company-owned trademarks, Pepsi manufactures and distributes other products through partnerships and joint ventures with companies such as Starbucks. North America accounts for more than 60% of consolidated revenue.

The cola giant has been recognized among the top global companies leading on climate action for ten years in a row. With sustainability at the core of its business strategy, Pepsi’s other sustainability awards include America’s Most Just Companies, 100 Best Corporate Citizens, climate leadership awards, and other accomplishments.

“While PepsiCo is still a beverage behemoth, its exploits now extend beyond this industry, with Frito-Lay and Quaker products accounting for roughly half of sales and over 65% of profits,” says a Morningstar equity report.

In addition to a diversified portfolio across snacks and beverages, PepsiCo’s wide moat, or sustainable competitive advantage, are underpinned by several structural dynamics, supported by cost advantages and intangible assets. “At a high level, we see characteristics of the snack and beverage categories where Pepsi competes, and its positioning within these categories, that should allow the company to continue to glean economic profits,” says Morningstar equity analyst, Nicholas Johnson, who puts the stock’s fair value at US$140.

Canadian energy heavyweight, Enbridge (ENB) generates, distributes, and transports energy in the U.S. and Canada. It owns and operates a vast network of oil and natural gas pipelines, including the flagship Canadian Mainline system. Additionally, it generates renewable and alternative energy.

A long list of awards and recognitions demonstrate the company’s commitment to sustainability. Some of these awards include gender equality, Canada’s Top 100 Employers, Canada’s Best Diversity Employers, and a spot on the Dow Jones Sustainability Indexes.

“Wide-moat and 4-star-rated Enbridge remains one of our top picks in the energy sector,” says a Morningstar equity report, adding that the “bullish thesis is driven by our long-term forecasts for production growth and pipeline utilization.”

While it could take years for the “market to come around to our way of thinking,” the report says, “the long and winding road brings significant upside potential for long-term investors.”

Almost 75% of Enbridge’s 2019 adjusted EBITDA was generated from assets that are underpinned by secured contracts. “Because of this, the dividend looks safe even when the [Canadian] Mainline pipeline system is operating at lower utilization levels,” says Morningstar equity analyst, Joe Gemino, who pegs the stock’s fair value at $57.

Calling the stock “deeply undervalued,” Gemino contends “investors are mistakenly worried about underutilization of the Mainline pipeline system due to production cuts” and competing pipelines.

Canada’s flag carrier, Air Canada (AC) serves nearly 50 million passengers annually together with its regional partners, operating 1,500 daily flights to around 200 destinations. In 2019, the company generated $19 billion in revenue.

Canada’s largest airline has won many accolades and awards for its commitment to sustainability. Some of its key achievements include awards for Best Sustainability Contribution, Best Corporate Sustainability Report in the Canadian Transport Sector, 2018 Eco-Airline of the Year, among others.

The ongoing coronavirus pandemic has brought global travel to a grinding halt. Like its peers, Air Canada is expected to have an unprofitable year in 2020, driven by almost a 40% revenue decline and negative operating leverage owing to high fixed costs. “However, we still expect the firm’s fundamentals to bounce back in 2021 as the impact of the virus fades, and we continue to believe that air traffic could overshoot normalized demand for a period as pent-up demand (postponed family vacations or business conferences) is released,” says a Morningstar equity report.

The airline has been cutting costs to improve operational efficiency. Additionally, “Air Canada has embarked on global expansion strategies, ordering widebody aircraft and capitalizing on sixth freedom traffic (flying U.S. passengers from Canadian airports),” says Morningstar equity analyst, Brian Bernard, who recently lowered the stock’s fair value from $53 to $30, prompted by the slowdown in air traffic.

One of Canada’s two largest banks by assets, Royal Bank of Canada (RY) is a diversified financial services company, offering personal and commercial banking, wealth-management services, insurance, corporate banking, and capital markets services. The bank derives two thirds of its revenue from Canada, with the U.S. and the Caribbean accounting for most of the rest.

Royal Bank is a member of the Responsible Investment Association (RIA), an organization committed to responsible investment through the incorporation of ESG factors into investing. The lender was recognized as one of Canada's Greenest Employers (2019) and was also adjudged one of Canada’s Best Diversity Employers (2020)

RBC is one of Canada’s six banks that collectively hold nearly 90% of the nation's banking deposits. “It has done an admirable job of expanding its nonbank lines of business, running efficient banking operations, and generating some of the best returns for shareholders in the industry,” says a Morningstar equity report, adding the bank would continue to enjoy a dominant position for years.

However, the financial institution, like its peers, isn’t immune from the overall uncertainty surrounding the global financial system resulting from COVID-19 outbreak. Canada is in a potentially precarious position as consumer debt levels and elevated property markets could strain the financial system, warns Morningstar equity analyst, Eric Compton, who puts the stock’s fair value at $111.