Aiming to forestall the worst effects of global warming, companies, countries, and even cities are rallying around net-zero carbon emissions to fight climate change. Getting to net-zero emissions—in which one takes as much carbon out of the atmosphere as one puts in—implies an accelerated reduction in greenhouse gas emissions, with those emissions that cannot be reduced further being eliminated through any available technology. Governments have determined that achieving net zero by 2050 is critical to containing some of the worst effects of global warming. With time of the essence and globally coordinated action required, many questions remain around the likelihood of reaching this goal and what role companies should play in the transition.
Surprisingly, some of the largest net-zero commitments have been made by consumer goods companies, such as PepsiCo (PEP), L’Oréal (LRLCF), and General Mills (GIS). According to data collated by the Net Zero Tracker—a global initiative to increase the transparency and accountability around net-zero targets—around half of the top 2,000 companies in the world by revenue have committed to a science-based long-term goal to reduce their carbon emissions to net zero. The sectors making the greatest commitments are utilities and energy, with an average of 70% of companies across these industries adopting net-zero targets.
Interestingly, consumer defensive companies come in third, followed closely by the consumer cyclical sector. These companies are positioned further along the value chain—users and not producers of energy. Why are they declaring ambitious emissions-reduction targets in such large numbers?
We think this proliferation of net-zero emissions commitments from consumer goods companies stems in part from the growing scrutiny of both investors and consumers, with the latter being increasingly informed and preoccupied by the environmental impact of their daily choices. As Morningstar’s consumer sector director Erin Lash said at the 2022 Morningstar Investment Conference: “Consumers have a penchant for environmentally friendly fare, and so firms that aren’t delivering products that align with this trend are bound to be left out.”
Indeed, a 2021 study conducted by Procter & Gamble (PG) showed that 76% of consumers expect the brands they buy to help them minimize their negative impact on the environment. There is a high expectation for consumer goods companies to be at the forefront of changing consumer habits and for their investment and innovation to be aligned with broader sustainability efforts.
Achieving Net-Zero Emissions
However, not all targets are equal. There is high variability in the types of emissions across sectors. There are three categories of emissions: scope 1 covers emissions that a company generates directly, scope 2 accounts for electricity purchased by a company for its operations, and scope 3 covers emissions not directly controlled by the company, generated both upstream and downstream.
A whopping 85% to 95% of consumer goods companies’ emissions are classified as scope 3, whose reduction is contingent on the actions of suppliers and consumers. Therefore, consumer goods companies will need to direct their efforts toward engaging with suppliers and ensuring they uphold the same high environmental standards, as well as helping consumers lower the emissions associated with the use and disposal of products. Given the magnitude of the task, individual action is almost certainly not enough. Industrywide collaboration and broader climate policy engagement are required.
From an investor’s point of view, a transition to net zero presents both opportunities and risks when considering the merits of a consumer goods stock. Opportunities stem from the increased demand for products with high sustainability credentials, which could boost the top lines of companies delivering meaningful innovation. Furthermore, efforts taken by companies to decrease their resource use, minimize waste, and optimize delivery routes, among other efficiency measures, have the potential to deliver initial savings on the path to lower scope 1 and scope 2 emissions.
Scope 3: A Risk in the Race to Net Zero
The risk stems from consumer goods companies’ large scope 3 emissions and the roadblocks they are likely to face in addressing them. Not least, an important consideration is likely to be the significant cost that a drastic reduction of all their addressable emissions will entail, with companies required to perform a careful balancing act between their sustainability initiatives and the other investments needed to support their competitive position (such as marketing or research and development).
3 Consumer Goods Companies With Excellent Sustainability Initiatives
In our research, we have identified three companies—PepsiCo, L’Oréal, and General Mills—that we believe have some of the strongest sustainability programs across their subindustries, with net-zero targets approved by the Science Based Targets initiative as consistent with limiting global warming to 1.5 degrees Celsius, the goal of the Paris Agreement. These companies’ plans place a strong emphasis on addressing scope 3 emissions, with actions that include supplier engagement and involvement in industrywide initiatives, as well as a focus on regenerative agriculture or curbing use-phase emissions, as applicable. Furthermore, Morningstar Sustainalytics has assessed these companies’ carbon management as strong, translating into a low carbon risk in regard to their own operations.
Overall, we believe PepsiCo, L’Oréal, and General Mills’ initiatives stand to limit the transitional disruption caused by climate change, and although these stocks are largely fairly valued, we think they are worth keeping on your watchlist for future buying opportunities.
Although the race to zero emissions is fraught with uncertainty, given disparate targets and the colossal effort required, progress is possible with continued engagement from all market participants. For investors, the best tools are likely to remain proxy voting and diligently lowering portfolio risk by considering the preparedness of companies in the face of an accelerated transition to a lower-carbon economy.
