Has peak ESG hit the market? It may have, which makes you wonder why Teck Resources TECK-B-T, Canada’s premier diversified mining company, is selling its cash-cow coal division. Other resources giants and the funds that invest in befouled industries seem to be reversing course on ESG; they, quietly so, are painting themselves a lighter shade of green and are not getting punished for doing so.
ESG stands for environmental, social and governance. Investing on ESG principles became a phenomenon in recent years, with investors everywhere gravitating toward businesses that were trying to reduce their destructive impact on the planet. The reward, in theory, was sustainability, reflected through higher valuation measures.
The trend saw resources companies in particular overhaul themselves. Two decades ago, the former British Petroleum reinvented itself as “Beyond Petroleum.” It would become a broad-based energy company, stuffed with wind and solar farms, as opposed to merely an oil and natural gas producer. Years later, to a somewhat lesser degree, Shell embraced the same idea. Its plan, cheered on by environmentalists and ESG diehards, would see it reduce oil production every year while it doled out fortunes to build electricity businesses.
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More than a few big mining companies essentially gutted themselves, selling or spinning off the coal divisions that had made fortunes for them at the expense of the planet’s health. First to push its black assets out the door was Rio Tinto. By 2018, after a series of coal-business sales, it was entirely out of the fossil fuels game. Another ESG champion was Anglo American, which in 2021 spun off its South African thermal coal business into a new company called Thungela Resources.
The idea was to transform DirtyCo into CleanCo by bringing down hydrocarbon emissions. The companies’ transitions were cheered on by the likes of former New York mayor Michael Bloomberg, former Bank of England and Bank of Canada governor Mark Carney and BlackRock chairman Larry Fink, all of whom had warned for years that climate change was a risk to financial stability as well as an existential threat to Earth itself.
Some time in the past couple of years, the sheen came off the ESG movement. Numerous companies were accused, justifiably so, of “greenwashing” – investing in carbon-reduction or carbon-offset projects that were less clean than advertised. About the same time, investors, environmentalists and environment ministers everywhere realized that the fossil fuel spin-offs and sales did absolutely nothing to clean up the planet. Those deals still meant that endless amounts of coal would be fed to electricity plants and blast furnaces by new, private owners, many of whom faced little ESG pressure and adopted a burn-baby-burn approach.
At the same time, it dawned on fund managers that ditching coal sometimes meant ditching the cash machines that pleased investors and could help finance the transition to cleaner operations.
Recently, several big resources companies have gone back to basics. BP, for the second time, unravelled its clean-energy focus and embraced oil again. Ditto Shell. Meanwhile, financial giants BlackRock and Vanguard Group increasingly rejected shareholder proposals that focused on environmental and social issues. A few months ago, Vanguard said it had approved only 2 per cent of environmental and social issues bought by shareholders in 2023, down from 12 per cent last year.
Investors who endorsed ditching their companies’ hydrocarbon assets often watched those same assets turn into stock market darlings. Thungela soared more than 1,300 per cent on the Johannesburg exchange in the year after Anglo American spun it off and generated enormous amounts of cash to finance fat dividend payments. While the shares have come down since then, they have still performed far better than those of coal-free Anglo.
Which brings us to Teck. The sale of its coal business to Glencore (77 per cent), Nippon Steel (20 per cent) and South Korea’s POSCO (3 per cent) for US$8.9-billion shrinks Teck drastically, eliminating 60 per cent of the Vancouver company’s revenue and 75 per cent of its profit. And it gets rid of metallurgical coal, not thermal coal. The former is considered more ESG friendly because it is used to make steel, an essential component for the energy transition.
Teck argues that the bucket of cash will be reinvested in copper, a critical metal that is essential to underwrite the electrical revolution. As a purer critical metals company, Teck fully expects its shares to benefit from a lavish value bump. The company argues that while coal generates a lot of cash, it does not necessarily generate shareholder value.
Could Teck be wrong as the sheen comes off ESG investing? Mining companies that are reducing or eliminating their fossil fuel assets trade at higher multiples than those stuffed with the grubby bits. But the value spread has narrowed recently and is nowhere near as wide as you might suspect.
On an enterprise value (debt and equity) to EBITDA (earnings before interest, tax, depreciation and amortization), based on spot commodity prices, coal-laden Glencore trades at 4.6 times, which is almost the same as Rio Tinto and Anglo American and better than Brazil’s Vale – all of them coal-free companies – and only slightly lower than BHP, which produces metallurgical coal. On an enterprise value to cash flow basis, Glencore trades at 10.1 times, about the same as that of Rio Tinto and Vale, though somewhat less than that of BHP.
The multiples suggest that ditching coal, as Teck is doing, may not send valuations to the moon. Glencore itself may come to that realization soon. Glencore plans to spin off its entire coal unit after it buys Teck’s coal, creating stand-alone coal and metals companies. But why bother if coal is not a great valuation drag? Here’s betting that Glencore sticks with coal and that Teck’s dreams of lavish multiples when it sheds its coal business don’t come to pass.
Eric Reguly