Portfolio Managers Face New Challenges With Shoots Of Greenflation
Tighter environmental regulations, ranging from container ships to cardboard to price spikes, are creating shortages and price spikes. This is called “greenflation” and adds a new twist on corporate valuations.
For all the inflation-is-transitory messages from central banks, double or triple-digit cost increases have become common on company balance sheets, although the green variety has yet to show up in bond markets, the usual early warning system.
Although higher costs may be partly due to supply problems linked to the pandemic, fund managers believe that a strong impetus is being generated by strict new rules to guide the world’s transition towards a greener future.
These may outlast COVID-19’s inflation narrative.
The European Union will reduce greenhouse gas emissions by raising the cost of carbon for transport and factories, reducing gasoline-powered cars, and imposing carbon levies on trading partners.
Aluminium, electricity, and fertiliser are just a few of the sectors being targeted.
Investors generally agree that greenflation is a risk because of the fact that global warming is spiraling out of control and the United Nations stating that frequent floods, droughts, and forest fires are worse.
Fund managers must decide which companies will suffer a loss, which can absorb costs and which will thrive.
Peter Rutter, head equities at Royal London Asset Management believes that modeling how carbon dynamics might impact cash flow, revenues, and share prices is the key to finding the right solution.
“We believe in greenflation. There are situations that take assets out use, such as cars that cannot be driven or ships that aren’t allowed to enter certain ports.
“The second element is the infusion of additional costs. It’s inflationary if companies are able to pass on the costs. Rutter said that if it doesn’t, it adds inflation and hurts margins.”
Higher input costs are reflected in company earnings. It is difficult to determine which environmental factors are responsible for the higher company earnings.
The first quarter saw a 35 basis point drop in gross margins at Home Depot in the United States. This was due to a tripling in lumber prices and a 31% increase in same-store sales.
Conagra, a packaged food company, warned that raw material and packaging costs were affecting profit. This headwind would continue until late-2022.
BofA analysts noted references to inflation during the quarter’s earnings calls. They estimated that they rose 1000% year over year for companies in S&P 500 indexes and 400% for European STOXX 600 indexes.
Graphic: Inflation mentions
GROWING A TREE
Shipbuilding is one example. Officials attribute the drop in orders partly to uncertainty about which technology to use for alternative fuels.
Delivery of new vessels can take up to three years. They also typically operate for longer than 20 years. High-emission ships may not be economically viable by that time. Owners must purchase permits if shipping is added into carbon markets. Otherwise, they risk port bans.
Graphic: The ratio of dry bulk ship orders to fleet sizes has shrunk
This could support already high freight costs.
Geraldine Sundstrom, manager of PIMCO fund, noted that tighter forestry regulations as well as the closing of polluting Chinese foundries have an impact on timber and metal prices.
Sundstrom stated, “It takes time for a tree to grow.” “In a digital and green world, you must position yourself in the right place where there are no barriers to entry and thus pricing power.”
Sundstrom believes that sectors like integrated forestries or shipping could see significant price increases “as markets still bet on prices mean-reverting.”
There will be losers, too. According to Kempen Capital Management’s recent research, the world’s stock market could see a 20% drop if carbon prices, which is the price companies pay for polluting, rise by $75 per tonne.
Carbon-intensity varies by sector