Water is one of the most essential natural resources – recognised by the United Nations as a human right and a key input to the global economy. Today, water risks are becoming more apparent in companies’ supply chains. But as some struggle with the complexities of water stewardship, we explain how we assess it as an environmental, social and governance (ESG) concern in our investment decisions.
Despite their complexity and global reach, an increasing number of companies are embracing their responsibilities towards water risk in their supply chains. Last year, companies reported 3,770 water risks which threaten their license to operate, the security of their supply chains, and their ability to grow, according to CDP1. Moreover, companies committed $23.4bn to tackle water risk in 91 countries around the world in 20172.
This commitment to water stewardship is illustrated well by the water policy of current holding General Mills.
Approximately 99% of General Mills’ water use occurs upstream of its direct operations in agriculture, ingredient production and packaging3. Food production, in particular, relies heavily on an adequate supply of clean water, for growing crops and making products for consumers. Today, agriculture accounts for 70% of global water use. As such, companies sourcing agricultural commodities are exposed to physical, regulatory and reputational water risks, which can manifest as financial damage. It is therefore necessary for General Mills to manage its exposure to water as it is critical to its long-term success as a global food company.
Rough seas: analysing water risk
Investors are also recognising the value in water, and they seek to better account for this ESG risk in their investment decisions. According to the PRI, agricultural products, food retail, packaged foods and meats and soft drink companies were found to be the highest users of water-scarce regions4. Mitigating water risks and demonstrating good water stewardship will create value for investors.
At Hermes, ESG considerations are embedded in our investment approach. Through our proprietary QESG scoring system, which draws on the insights of Hermes EOS and a wide range of research from leading data providers, we capture a company’s ESG metrics compared to its peers and, crucially, how its ESG profile is changing. This produces a single rating for each company, the QESG Score. This score is used to systematically direct our research efforts towards companies with an attractive ESG profile. Any change in the company’s ESG profile is highlighted by a change in the QESG Score, thereby alerting portfolio managers to any red flags or issues warranting corporate engagement.
With a QESG Score of 875, General Mills ranks among the top decile of food product companies. Additionally, the food-products segment ranks better than others within the Consumer Staples sector on ESG measures, meaning that the business is a strong performer in a leading field.
To gauge a company’s exposure to a specific environmental risk, such as water, the extent of its operations in various sub-sectors need to be captured. In our analysis of General Mills, we split its revenue exposure into seven business areas.
Figure 1: General Mills’ revenue exposure by sector and sub-industry
Source: Factset as at February 2018
We then assessed potential ESG risks and metrics using our environmental framework. Again, General Mills ranked better than its peers across key risks and metrics, scoring 83 compared to the industry median of 506.
Figure 2: Assessing environmental risks and metrics
|Environmental risks||Environmental metrics|
|Sustainable products||Greenhouse gas footprint and energy use|
|Sustainable supply chain||Sourcing|
|Sustainability of operations||Waste|
|Management of risks associated with climate change (e.g. changes to water scarcity and effect on food sustainability)||Water|
Source: Hermes Investment Management as at February 2018
Engaging with General Mills
Successful engagement on water risk – by encouraging a company to disclose long-term water risk in its supply chain and to improve its water management – can boost profitability, reduce risks and create opportunities, according to the PRI7. (For further information, see: Growing water risk resilience: an investor guide on agricultural supply chains).
In April 2015, we met with Jerry Lynch, General Mills’ chief sustainability officer, to discuss the complexities of the company’s water strategy. Encouragingly, he revealed plans to reduce the risk that water stress presented to its business model. Notably, the food group outlined its strategy in El Bajío, Mexico – where many of the vegetables for its Green Giant brand are sourced. It worked with The Nature Conservancy (TNC), identifying opportunities to reduce water use and protect its future supply, including water conservation in the group’s facilities and growers’ fields and reforestation. The TNC and General Mills met with over 70 business, government and community leaders to share their learnings. Together with other stakeholders, including Mexican conglomerate FEMSA, they are conducting a feasibility study, which will help them understand the potential of conservation activities in the region8.
Moreover, General Mills has also adopted a four-phase risk-based approach to develop and implement stewardship strategies for its most material and at-risk watersheds, which are areas of land that drain rain water into one location such as a stream, lake or wetland. These water bodies supply drinking water, provide a habitat to plants and animals, and are used for agriculture and manufacturing purposes. The four-phase approach comprises:
To date, General Mills’ progress has been positive. In 2016, the company assessed 15 key ingredients in 36 sourcing regions and 66 facilities, covering 41 watersheds globally. In doing so, it identified eight priority watersheds to target across its worldwide operations, including watersheds in San Joaquin County, California, and the mouth of the Yangtze River in Shanghai.
In its 2017 Global Responsibility Report, General Mills outlined its goal to develop water stewardship plans for the company's most important and at-risk watersheds by 20259. Additionally, every General Mills production facility has a target to decrease water use by 1% annually10.
Leading water-risk oversight
Water governance should be practised in the boardroom of every major company in the world. Last year, 520 companies had board-level oversight of water issues, according to CDP11. Discussing this information at the highest corporate level means that water stewardship can improve accountability, spur action and ultimately, become part of a company’s DNA.
In recent years, General Mills has shown leadership in water governance through the following measures:
Swimming with the current
Although General Mills is recognised as a sector leader in sustainability and an AgWaterSteward13, its disclosure to CDP Water earned a ‘B’ rating – the third-highest – in 201614. CDP found that the company must improve on two areas – water discharge and its manufacturing supply chain. As such, it is important to monitor the company’s water stewardship progress in its operations and supply chain.
With a PE ratio of about 17x and a three-year dividend growth rate of 20.5%, we believe General Mills is attractive compared to its peers. While we are encouraged by its progress on water stewardship, General Mills must continue to manage water prudently in its supply chain to ensure supplies can sustainably meet demand, thereby contributing to its long-term business success. Otherwise, water risk will manifest as a financial drain for General Mills and other companies operating in water-scare regions.
1 “A Turning Tide: Tracking corporate action on water security” published by CDP in November 2017
2 “A Turning Tide: Tracking corporate action on water security” published by CDP in November 2017
3 “General Mills water policy,” published by Water Mills in April 2017
4 “Growing water risk resilience: an investor guide on agricultural supply chains” published by PRI in March 2018
5 Data source: Hermes Investment Management as at 30 November 2017
6 Data source: Hermes Investment Management as at 30 November 2017
7 “Growing water risk resilience: an investor guide on agricultural supply chains” published by PRI in March 2018
8 “General Mills is working towards freshwater sustainability,” published by The Nature Conservancy
9 “Global Responsibility 2017” published by General Mills in April 2017
10 “Global Responsibility 2017” published by General Mills in April 2017
11 “A Turning Tide: Tracking corporate action on water security” published by CDP in November 2017
12 “General Mills water policy,” published by General Mills in April 2017
13 “The AgWater Challenge”, published by WWF in October 2016. Note: The AgWater Challenge is a joint initiative by Ceres and WWF to help companies advance their sustainable sourcing strategies. Companies recognised as an AgWater Steward are deemed a leader in the food sector in responding to water challenges, through new actions and commitments
14 “Thirsty business: why water is vital to climate action,” published by CDP in November 2016. Note: scoring levels build consecutively from Disclosure (D-) To Leadership (A)