Investors Beware: Blackholes & Blacklists

By Debra Tan 8 November, 2012

Hi-street & hi-end fashion diversification may no longer make sense. Debra explains why investors are exposed

Impact of water caps, tariff rises and price of raw materials should be priced into projections & valuations
Rising NGO activity & protests = blacklists are key
Holdings of Fidelity, State Street, Vanguard, BNY Mellon, Capital Group, L&G, T Rowe Price and Govt Pension Fund of Norway in polluting brands reviewed

At last month’s Sustainable Textile Conference, I was listening to Reiner Hengstmann, Global Director of Puma.Safe talk on Puma’s Environmental P&L (EP&L), about quantifying the costs to the environment of doing business.
The argument is that if business is about money, then impact on the environment has to be measured in dollar terms in order for corporates to take the problem seriously … there is an excellent video featuring Stephen Fry on this – you can watch it here. Or you could read about why it’s time to redefine fiduciary duty beyond profit-making here.
An excellent initiative from PUMA and a good start but I would argue that in the case of water, (only one part of the environmental equation) it makes more sense to price it into the “real P&L” (budgeting and valuation models) and not a separate EP&L.
Here’s why: the waterscape has changed opening up some black holes… Water risks can no longer be ignored in the textiles sector – especially not when cotton represents a third of natural fibres used in the global textile industry and China owns a third of that market globally…

Pricing in physical & regulatory water risk

There are also new regulatory risks with central government imposing new central and provincial caps on water usage as well as new targets to tackle pollution –all set to address physical water scarcity. Needless to say, these caps and quotas are generally tougher for the Dry 11.
Analysts and corporates should at least be evaluating the impact on P&L of the exposure to physical water scarcity and impending water tariff hikes. We recommend:

  • Price in a 300% to 500% water tariff hike – read about these impending hikes in “Government Issues Stark Warning
  • Sensitivity analysis: water rationing scenarios to meet provincial government quotas for the 12FYP. A reduction of water allocation of X would mean factory operations at X capacity …Too far fetched? Not really, when one of the major textile manufacturing bases like Shanghai has to reduce its water by a compound annual rate of 6.5% for the duration of the 12FYP

  • Sensitivity analysis related to the price of raw material inputs: this would include exposure of cotton and synthetics to droughts. Drought caused the price of cotton to rise by more than 50% in 2010/2011 resulting in global textile companies like H&M seeing lower profits of 20% over the first 9 months of 2011 and GAP slashing its profit forecasts by 22% for the year. Naturally, manufacturers switched to synthetics, and the higher synthetic prices in turn pushed up the prices of many base chemicals – we covered this here.
In fact Shanghai is already responding to the tough targets … October 2012, Shanghai Water Authority announced the introduction of the “strictest water management system by 2014. The city is to invest up to RMB100 billion (US$16 billion) over the next five years to improve its water utilities. Cash spend will include water supply systems, an anti-flood system & riverbank administration. The new systems will include more scientific water resource allocation across the city and a central platform to monitor and control the water use efficiency of local companies. Major industries will be made to use 30% less water compared to 2010.


Pollution: not just new 12FYP targets but also reputation at risk

Pollution as it relates to reputational risk is harder to assess. One approach would be to avoid investing in brands/ manufacturers who pollute/ use polluting factories along their supply chain.
An eye on IPE’s database and following the report updates from the IPE/Green Choice Alliance of 49 Chinese NGOs (GCA) as well as Greenpeace is a good start  … you can read more about their work and who they have named and shamed… here and here.
Moreover, with six new central and provincial government pollution targets to meet, not only are there are now more yardsticks that local and foreign NGOs can hold companies accountable to, but provincial governments may also act to clamp down on certain industries. Textiles is a clear target as it is amongst the top five users of water and amongst the top five most-polluting industries.

Investors more exposed than not …diversification from hi-street to hi-end fashion doesn’t work

After reading reports from IPE/GCA: Sustainable Apparel’s Critical Blind Spot and Greenpeace’s Dirty Laundry I & II, you soon realize that that brands, whether high end or high street, use the same manufacturers. Greenpeace’s focus on just two factories impacted over 20 brands. These range from sports brands like Nike, Adidas and Puma to high-street H&M and C&A to high-end Ralph Lauren. Likewise, IPE/GCA’s report affected 49 brands from Zara to Armani.
A quick analysis of the top 10 institutional investors in some of the brands named in one or both the campaigns makes an interesting read:

Fidelity is a top 10 shareholder of 10 out of the 12 brands, owning from 0.4% of Li Ning, which has responded positively to both local Chinese NGOs & Greenpeace, to 10.7% of Abercrombie & Fitch and 11.8% of PVH Corp (Calvin Klein, Hilfiger & Van Huesen), which were marked with negative responses in both reports. State Street and Vanguard are similarly exposed.
Several questions arise from the table above:

  • Fidelity, State Street, Vanguard, BNY Mellon, Capital Group, L&G, T Rowe Price … perhaps you are more exposed to water risks in China than you think? Are any of you engaging with these companies on water risks?
  • The Government Pension Fund of Norway is supposed to be a “green” investor … really?
  • Surely a collaborative effort would push brands to tackle these issues? Especially since these eight funds collectively hold more than 10% of 7 out of 12 of these brands and up to 25.7% of Abercrombie and 25.5% of PVH?
  • Abercrombie, Calvin Klein, Hilfiger, Victoria Secret and Ralph Lauren spend millions of ad dollars to project a wholesome all-American image … but in reality it’s at China’s expense?
  • Of PPR’s stable of brands owned, only Puma is named by the campaigns and has committed to an EP&L and zero-discharge by 2020; what about other brands owned such as Gucci, YSL, Alexander McQueen, Stella McCartney … what are their water strategies/ philosophies?

All it takes is one pollution incident at a factory and a wide range of brands will be affected. Diversification from hi-street to hi-end fashion simply does not work in the case of water risk exposure in China. Let’s not forget that protests are also on the rise – currently 500 protests a day and growing (more about that here)
The nightmare scenario would obviously be a headline like “Louis Vuitton/ Prada/ Gucci poisons China’s precious water with heavy metals” – you could imagine that a well-run campaign would persuade the most hardcore supporter of these bags/ shoes/ clothes to give up buying their favourite brand (remember Nike and child labour). Too far-fetched? Well think about the amount of chromium that goes into making leather … you can read about that here.

A case of shooting yourself in the foot?

Brands ignoring water risk could shoot themselves in the foot with their single largest group of potential consumers – the Chinese market. There are already local NGOs educating school children and university students about the hidden value of water in their clothes and water (read about this here). Engaging with suppliers and ensuring a water-friendly supply chain does not just repair brand damage, it could also help position the brand amongst more water-aware consumers. So if you are buying into the China spending story … think water before you invest.
Brands and their investors in them should count their blessings that local NGOs are now just focused on clothing and not leather and use this time to get their houses in order. A perfect water storm is blowing in the textiles sector: know the black holes & blacklists.

Debra Tan
Author: Debra Tan
Debra heads the CWR team and has steered the CWR brand from idea to a leader in the water risk conversation globally. Reports she has written for and with financial institutions analyzing the impact of water risks on the Power, Mining, Agricultural and Textiles industries have been considered groundbreaking and instrumental in understanding not just China’s but future global water challenges. One of these led the fashion industry to nominate CWR as a finalist for the Global Leadership Awards in Sustainable Apparel; another is helping to build consensus toward water risk valuation. Debra is a prolific speaker on water risk delivering keynotes, participating in panel discussions at water prize seminars, numerous investor & industry conferences as well as G2G and academic forums. Before venturing into “water”, she worked in finance, spending over a decade as a chartered accountant and investment banker specializing in M&A and strategic advisory. Debra left banking to pursue her interest in photography and also ran and organized philanthropic and luxury holidays for a small but global private members travel network She has lived and worked in Beijing, HK, KL, London, New York and Singapore and spends her spare time exploring glaciers in Asia.
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