Sustainability and the Investment Case: Heavy Industry

• Sustainability factors should reinforce a strong fundamental case for owning stocks, either as a source of alpha or a source of investment risk mitigation.
• The analysis of how sustainability supports an investment case is an under-researched and under-utilized part of the market that suggests an opportunity for active management.
• It is important to take ownership of both fundamentals and sustainability characteristics of an investment thesis with an integrated investment process, looking well beyond headline scores of third-party ESG research, which in our experience often do not prioritize investment value.

Thinking of sustainability and the fundamental investment process together makes sense, as sustainability factors should reinforce a strong fundamental case for owning equity securities, either as a source of alpha or a source of investment risk mitigation. This principle is at the heart of ClearBridge’s integrated approach to investing, which weighs sustainability factors as part and parcel of company fundamentals. We will explore how this principle plays out in different industries and investment themes here and in a series of posts to follow.

The analysis of how sustainability supports an investment case is an under-researched and under-utilized part of the market that suggests an opportunity for active management. While third-party ESG ratings providers aim to “measure a company’s resilience to long-term ESG risks,” as MSCI defines it, for example, this remit admittedly lacks an investment focus. Materials and industrials stocks in heavier industries might not screen well on traditional sustainability metrics, especially given their above-average carbon footprints, but it is certainly possible to find companies in these sectors where sustainability is a factor that supports and enhances their investment case.

Consider a company like Vulcan Materials, which produces construction aggregates like crushed stone, sand and gravel that make asphalt and concrete. Aggregates production extracts rock from quarries, and cement production (a component in concrete) is one of the most energy-intensive industrial activities. Yet sustainability is part of the investment case for Vulcan. Aggregates play an essential role in building infrastructure, and, in turn, infrastructure is a key foundation of economic and social development and a tenet of the U.N. Sustainable Development Goals. There is no commercial-scale substitute for aggregates, which are used in infrastructure of all kinds, from roads, to bridges, to buildings, as well as the foundations for wind turbines.

Vulcan has the lowest carbon emissions intensity among its peer group given its position as primarily an aggregates company, without a cement-making operation unlike many of its peers. Aggregates production is 150x less emissions-intensive than cement production, with emissions per ton sold 97% below the public peer average. Vulcan’s low carbon intensity means it faces lower carbon transition risk in the form of less regulatory risk, less carbon pricing risk and less competitive risk from low-carbon alternatives (Exhibit 1).

Meanwhile, Vulcan has a small concrete business, where the company has an innovative partnership with CarbonCure to permanently sequester carbon dioxide (CO2) by injecting it into concrete mixes during the production process. Not only does this remove the CO2 from the atmosphere, but it also has the added benefit of making the concrete stronger. Vulcan is sequestering over one million tons of CO2 into concrete via this partnership, with the technology having been installed in more than 20 sites across several U.S. states. For example, Vulcan’s CarbonCure concrete was used in the construction of Amazon’s HQ2 in Arlington, Virginia, saving approximately 1,000 tons of CO2. Vulcan has also been active in recycling its materials, recycling 1.7 million tons of asphalt and 2.1 million tons of concrete in 2022, for example. These initiatives are small relative to the size of Vulcan, but they should be watched.

Vulcan is positioning itself as key to sustainable infrastructure development, and this lends support to the company’s ability to sustain volume growth over the long term. Such growth is part of the investment case for Vulcan, combined with time-tested pricing power thanks to attractive market structure with high barriers to entry as new quarries are difficult to permit.

Exhibit 1: Carbon Intensity of Industries in the Materials Sector

Another example is Republic Services, the second-largest municipal solid waste company and recycler in the U.S. While the company has high carbon emissions, primarily due to methane produced by landfill waste as it decomposes, we see this as an opportunity. Specifically, Republic’s earnings through to at least 2027 are benefiting from sustainability investments such as landfill gas — investments with very attractive returns on capital and a notable earnings driver. It is involved in 65 landfill gas-to-energy projects that turn organic methane into renewable natural gas — some of which will create electricity, some of which will be sold into the market, displacing traditional natural gas demand.

Republic is also opening several polymer recycling plants in the U.S. in the next three to four years, which should each contribute $30 million annually to its EBITDA. These facilities produce nearly pure streams of polyethylene terephthalate (PET) and high density polyethylene (HDPE), which sell at a higher value than typical recycled plastics produced by standard materials recovery facilities. The end product can be further chemically recycled into food grade products. Republic here has an advantage in this business because it has differentiated access to feedstock (plastic waste streams) through its waste collection operations.

As demonstrated by these examples, investable stocks with strong fundamentals enhanced by sustainability factors are discoverable across the market. To identify them, it is important to take ownership of both fundamentals and sustainability characteristics with a robust and integrated process.