Three Sustainability Stocks with Low ESG Risk

Shaking off the slight slowdown in 2022, sustainable funds roared back in 2023, as investor interest drove up demand and popularity of companies with shiny ESG credentials.

Gathering steam this year, global sustainable fund assets racked up nearly US$2.8 trillion at the end of June this year, according to Morningstar’s latest Global Sustainable Fund Flows report. According to Morgan Stanley, this means these funds now make up a whopping 7% of assets under management, up from 4% around five years ago.

This explosive growth bears out that, far from being limited to doing good, ESG investing is a positive force to propel returns. Long-term investors may want to take a look at the following names with low ESG risk ratings, having successfully incorporated sustainability policies into their corporate structure.

Specialty retailer, Williams-Sonoma (WSM) dominates the US$300 billion domestic home category. The company offers high-end cooking essentials through its namesake Williams-Sonoma (175 stores), while Pottery Barn (189) provides casual home accessories. The firm’s portfolio of brands also includes Pottery Barn Kids (52 stores); West Elm (121), an emerging concept for young professionals; and Rejuvenation (nine), which offers lighting and house parts.

Williams-Sonoma boats an enviable ESG risk score of 11.80 (low), as of Oct 09, rated by Morningstar-owned ESG research firm Sustainalytics. The ESG risk score is a metric that represents a company’s exposure to material ESG issues. The lower the ESG risk score, the better.

Williams-Sonoma has established a strong presence in the global home sector worth US$750 billion and the U.S. B2B market valued at US$80 billion. “It has historically launched most of its brands organically in underserved segments and its brand intangible asset has been the key factor in its top- and bottom-line growth,” says a Morningstar equity report.

More recently, the firm has been growing its business beyond furniture and home goods, by focusing on B2B sales and marketplace initiatives. “These white-space business lines, along with faster growth from franchise and the e-commerce channels (66% of 2022 sales) should help the firm reach US$10 billion in sales in 2029,” says Morningstar sector director Brian Bernard, who recently lowered the stock’s fair value to US$202 from US$209 after incorporating second-quarter growth and an updated full-year outlook.

Leading U.S. pharmaceutical wholesalers, Cencora (COR) sources and distributes branded, generic, and specialty pharmaceutical products to pharmacies (retail chains, independent, and mail order), hospital networks, and healthcare providers.

The firm has an ESG risk score of 12.75 (low), as of Oct 09, rated by Morningstar-owned ESG research firm Sustainalytics.

Cencora is one of three leading domestic wholesalers of branded, generic, and specialty pharmaceutical products. These wholesalers play a pivotal role in the supply chain for prescription drugs with over 90% of all prescription drugs in the U.S. going through wholesalers. 

“With over US$197 billion in U.S. human healthcare solutions sales in fiscal 2022, the company supplies roughly one third of the domestic drug distribution market,” says a Morningstar equity report.

The three big wholesalers constitute over 90% of the overall U.S. drug distribution market, and they have done so for the past 20-plus years. “We anticipate most of the market to continue to be serviced by these three players over the next 10 years, with minor changes in market share among them,” says Morningstar equity analyst Keonhee Kim.

The U.S. distribution space is expected to continue to grow at a low- to mid-single-digit rate over the next five years, boosted by an aging population, new pharmaceuticals, and greater use of specialty medicines. “Cencora is well positioned to enjoy these dynamics and expect it to maintain its leading position over our forecast period,” says Kim, who pegs the stock’s fair value at US$162.

Athleisure giant, Lululemon (LULU) designs, distributes, and markets athletic apparel, footwear, and accessories for women, men, and girls. In addition to selling clothing fit for both leisure and athletic activities (yoga and running), the company’s product portfolio includes such fitness accessories as bags, yoga mats, and equipment.

The Vancouver, Canada-based retailer operates more than 670 company-owned stores in 19 countries, e-commerce, outlets, and wholesale accounts. Lulu has an ESG risk score of 16.94 (low), as of Oct 09, rated by Morningstar-owned ESG research firm Sustainalytics.

“Narrow-moat Lululemon has a solid plan to expand its product assortment and geographic reach while building its core business,” says a Morningstar equity report.

While the firm’s business categories are getting crowded, Lululemon benefits from the athleisure fashion trend and will continue to retain premium pricing, supported by the brand’s popularity and the styling and quality of its products, the report adds. 

Lululemon’s e-commerce efforts gained momentum during the pandemic and have since continued to grow its share (33% sales growth in 2022), outpacing store-based sales.

“Lululemon’s e-commerce should benefit from investments in digital capabilities (such as buy online, pick up in store), new product, and an expanding loyalty program,” says Morningstar equity analyst David Swartz, who recently raised the stock’s fair value to US$267 from US$259, prompted by 2023 second-quarter earnings report, showing 18% sales growth and a 21.7% operating margin.

Lululemon has been expanding outside of North America, particularly in China, the second-largest activewear market.