Carbon pricing and Danone: this might just be a game changer
By Andrew Hughes
It might be surprising to know that a company that produces plastic water bottles and plastic yoghurt containers, Danone, has long been considered a pioneer in its sustained push on achieving environmental, social and governance (ESG) goals.
More than 10 years ago Danone was setting carbon emission targets on its entire value chain including the farms producing its foodstuffs.
This year it pushed the bar even higher and published, for the first time, a financial statement that included a profit figure adjusted by the cost of its entire carbon emissions including supply chains.
It did this by allowing for a carbon cost of €35 per tonne and multiplying this by its total measured carbon emissions. This figure showed that the company’s headline 2019 earnings per share (EPS) would have fallen from €3.85 to €2.38, a decline of 38%.
Financial analysists, when trying to assess a company’s value, look most often at the EPS figure which is effectively an indicator of profitability. A track record of EPS growth is seen as a very positive sign.
The good news, however, is that Danone’s carbon-adjusted EPS growth in 2019 was faster than its headline growth (12% vs 8%), as a result of it having achieved a 9% decline in carbon emissions. Danone believes it has already reached its peak carbon emissions as a company and is confident each year will see successive declines in emissions.
What is exciting about this move is that it is a simple financial calculation in a profit and loss account that financial directors, senior managers, investors and the market can all understand.
It also means that senior management can be incentivised, at least partially, by their contribution to carbon-adjusted EPS. Suddenly management remuneration and a company’s sustainability goals become more aligned.
Danone has gone further and at its annual general meeting (AGM) in June there was 99% shareholder support for Danone’s proposal to become an “Entreprise à Mission”. This officially embeds, within its articles of association, “a purpose and social, societal and environmental objectives that reflect its conviction that the health of people and the preservation of the planet are interdependent”.
As far as we can see, Danone is the first large quoted company in Europe to make these moves and it will put pressure on others to follow suit.
Which got me thinking as to whether we could do the same maths for other large companies where we have specific data for their supply chain emissions (often called Scope 3 as defined by science based targets.
As Danone highlights, 95% of its reported emissions are Scope 3. Scope 1 (direct emissions) and Scope 2 (indirect emissions from purchased energy) may be more easily controllable, but are not significant overall and if we are to make any real headway on meeting 2030 carbon targets we have to focus on Scope 3.
Given the focus on apparel as one of the largest contributors to emissions, we conducted the same exercise for H&M and Inditex, two large and geographically diversified businesses.
For H&M, Scope 1 and 2 emissions in FY2019 were 61,462 tonnes. Scope 3 was 17.7m tonnes, or 99.7% of the total. For H&M, the supply chain is all-encompassing in terms of emissions. If we take the same cost per tonne as Danone (€35), then H&M carbon adjusted EPS would have been 37% lower than reported EPS, similar to the gap seen at Danone.
For Inditex, Scope 1 and 2 were 350,000 tonnes. This figure is much higher than H&M, with Inditex handling internally much of the cutting and finishing for Zara garments. Scope 3 emissions were 20.5m tonnes, or 98.3% of the total. Total emissions costs would have reduced EPS by 14.7%, a much lower proportion than our other examples as Inditex margins are starting from a much higher level. As a percentage of sales, Inditex emissions are also slightly lower than at H&M.
As a further example, we planned to use data from Gap Inc, however an assessment of the data on its website suggests the figures are non-comparable. The figures provided for Scope 3 appear to only include distribution, not the full production cost. This shows the importance of data standardisation and comparability.
This analysis is a good starting point to assess total emissions. Using carbon-adjusted performance measures and carbon pricing are increasingly being talked about in financial and investor circles as the most effective method to incentivise companies.
It’s worth noting though that there is still a long way to go before we can truly assess the cost of profits on the planet as this would need to include areas such as water use, pollution and nitrogen production.
Finding standard and validated measurements will be a key issue for all these areas, and the more progress we see here, the more accurate an adjusted EPS figure will be.
Andrew Hughes is a Managing Director for Bankers without Boundaries. A financial consultant specialising in retail analysis; he is a former Managing Director at UBS, analysing companies including fashion retailers.
 Danone’s underlying income before tax in 2019 was €2477m. The cost of carbon emissions was €952m, or 38% of the total. See link above.
 At €35 per tonne, H&M profits would have fallen by €620m, or SEK6510bn (assuming €1 = SEK10.5). PBT was SEK17391m in FY2019. See full year 2019 report https://hmgroup.com/investors/reports.html.
 Total cost of emissions @€35 per tonne is €719m. ITX FY20 PBT was €4880m (pre IFRS gain of €88m and inventory write-off of €287m). See https://www.inditex.com/en/investors/investor-relations/results-and-presentations?p_auth=WhAEmsMG&p_p_id=filters_WAR_filtersportlet_INSTANCE_Gf3hm8iNwIwb&p_p_lifecycle=1&p_p_state=normal&p_p_mode=view&p_p_col_id=column-4&p_p_col_count=2&_filters_WAR_filtersportlet_INSTANCE_Gf3hm8iNwIwb_javax.portlet.action=filterAction