How Water Will Define The Future of Asia’s Beverage Industry

By Lindsay Cooper 21 July, 2010

Arisaig Partners (USD1.7bn AUM), has a consumer staples bias. Lindsay Cooper shares his views on risks in the beverage sector brought about by water.

In 1996 Lindsay Cooper, James Alexandroff and Torquil McAlpine co-founded Arisaig Partners, a fund management company headquartered in Singapore with USD1.7 billion of funds under management.  The firm manages three long-only equities funds covering Asia (ex-Japan), Africa and Latin America, which are all focused on investments in listed dominant consumer companies.  As at the end of June 2010 approximately 40% of the Fund’s net asset value was in China-related holdings – c.22% in dominant F&B producers and c.18% in supermarket companies.

Arisaig Partners was the first fund management company to join the United Nations PRI initiative and has subsequently begun working with ESG specialists such as Singapore-based Responsible Research to help develop its knowledge of ESG issues and raise awareness of the challenges that these issues face with the management teams of the companies in which it invests. China Water Risk interviews Lindsay Cooper on Arisaig’s exposure and management of water risks.

CWR:  What is the rationale behind focusing your investment strategy on dominant consumer companies?

Lindsay:  When we started Arisaig Partners we had a consumer staples bias to our investment strategy but we also invested in discretionary consumer companies providing education or healthcare services, as well as consumer related manufacturing businesses, finance businesses and property companies.  Through our years of experience and extensive back testing we believe that the companies best placed to deliver superior returns to investors are the dominant consumer staples companies – businesses with leading market positions, strong brands, and excellent distribution networks which all lead to strong cash generation to fuel organic growth or M&A expansion.  It’s taken twelve years to get here but these days only if a company (a) provides something that the emerging markets consumer can eat, drink, clean with, wear or shop in and (b) dominates that market, are we interested.

CWR:  What are the opportunities for the beverage industry in Asia?

Lindsay:  The opportunities for the leading players are huge.  Driven by favourable demographics and broad social tailwinds including urbanisation and increasing affluence, consumers in Asia’s developing markets are purchasing alcoholic and soft drinks at rates far exceeding developed markets.

An extract from Coca Cola’s 2008 annual report noted the scale of such social tailwinds in emerging markets: “Estimates show that over the next 12 years the worldwide population will grow by more than 800 million people. In addition, 1 billion new people will have entered the middle class, and nearly 900 million people will have migrated to urban centres.  That means more consumers with more money, who have the ability to purchase more ready-to-drink beverages.”  As far as branded beverage consumption is concerned, Asia is just getting started.

CWR:  How serious are the water risks facing the beverage industry in Asia?

Lindsay:  As highlighted in the Beverages in Asia report we commissioned Responsible Research to write, we believe water scarcity is the issue that will define the future of Asia’s beverage industry.  However, while most of the consumer companies in Asia are alive to the issue of water quality, it is generally only the multi-national companies that are acutely aware of the likelihood for water prices in regions such as China to rise and are hence focused on improving water usage efficiency.

CWR:  What are the key challenges/risks facing water intensive companies?

Lindsay:  Broadly speaking we believe that the beverage sector needs to mitigate water risks in five areas so that business performance and hence returns to investors are not negatively impacted:

1. Physical Risk:  Ability to secure a stable supply of good quality water to meet production needs would be foremost here.
2. Business Risk:  Many consumer companies should be factoring in higher water supply and treatment costs into their business models – particularly with respect to projections for cost of goods sold and capex requirements.
3. Regulatory Risk:  Companies should be alive to the potential for water consumption to be rationed in future and minimum efficiency standards increased with penalties for failing to do so.
4. Reputational Risk:  We recognise that companies who reduce water tables through over usage or whose waste pollutes water courses are increasingly likely to face severe negative reactions which could have a very damaging impact on consumer demand; this is particularly critical given that the products made by our portfolio companies are all sold in the same markets in which they are produced.
5. Litigation Risk:  It is in all our interests that judicial systems across Asia ensure that heavy environmental abusers are brought to task; given the growing pressure on current water supply across the region we would hope that there will be increased enforcement of environmental protection.

CWR:  How do you measure Arisaig’s vulnerability to water risks?

Lindsay:  Following on from the Beverages in Asia report we will be working to produce a checklist of questions which are investment research team can use when engaging with our holdings companies to examine the extent to which the risks outlined above – particularly with respect to water sourcing, water efficiency and wastage management – are being addressed.

CWR:  In your understanding, what are the key solutions that need to be taken on board by government and business to address the water problems?

Lindsay: We would advocate that governments force both stock exchanges and lenders to companies of a certain scale to ensure that such companies produce, together with their ESG policies and goals, key metrics with respect to a company’s water footprint which have to be included within the audited financial statements.  Maybe it’s because I used to be one but perhaps accountants can actually play a positive role in saving the planet here!  Hopefully the leading companies will get well ahead of the regulatory curve and potential laggards will be forced to stay on it.

CWR:  If you have engaged companies in dialogue regarding water, how open have they been to discussing water concerns?

Lindsay: The Beverages in Asia report was published in June and we have subsequently written letters highlighting issues raised by the report to the senior management teams of our holdings companies.  It will be interesting to see the reaction – particularly from those classified as laggards as a result of the benchmarking exercise.  Hopefully by pointing such companies towards peers who have taken a lead in these matters and by introducing third party ESG specialists to the more receptive management teams we will see improvements.  Already at least two companies in our universe have taken their low scores to heart and are in discussions with a third party to help them address issues raised.

CWR:  How does Arisaig plan to incorporate consideration of ESG issues into its investment research in the future?

Lindsay:  Following on from the Beverages in Asia report, we have commissioned Responsible Research to produce a report exploring ESG disclosure amongst our universe of food producers in Asia, which we hope will be completed in September.  We also intend re-do the ESG benchmarking exercise for our portfolio companies on an annual basis to determine if positive developments are happening.  Finally, we are in discussions to add a new member to the research team who will be responsible for assessing ESG considerations across our Asia, Africa and Latam funds.

CWR:  To what extent have your investors commented on Arisaig’s increased emphasis on ESG considerations within its investment research?

Lindsay:  Interestingly, although ESG issues were never raised by investors prior to us disclosing that we had joined the UN’s PRI initiative, since we have done so, the reaction has been extremely positive and supportive.  I get the sense that investors are increasingly keen for their fund managers to factor ESG considerations into their investment analysis because we have started to see this becoming an area of meaningful due diligence for potential clients.  I think that many of the larger, more sophisticated, publicly accountable sources of capital (e.g. sovereign wealth funds, superannuation funds, endowment funds etc.) increasingly recognise that ESG issues are genuine investment risks and therefore they would like to see their fund managers at least having an appreciation of them, and perhaps, for firms like Arisaig who have long-term holding periods, see those managers quantifying the risks and pointing company management teams towards best practices, thereby de-risking the portfolios.