Sustainability Insight
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August 28, 2019
Tackling Plastics
 

Sustainability Insight

Tackling Plastics

Tackling Plastics

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August 28, 2019

 
 

Taking plastic seriously

Plastic is high on the corporate agenda. We looked at the companies within our portfolios to assess how this topical issue might influence their sustainability of returns on capital. We believe that by addressing their plastic consumption, companies not only benefit the environment, but also create opportunities to differentiate themselves.

The world is drowning in plastic. A 2016 report (The New Plastics Economy: Rethinking the future of plastics) by the Ellen MacArthur Foundation predicts that, based on current trends, there will be more plastic in the oceans than fish come 2050.

Around half the total plastic produced is used for consumer goods packaging, usually single use, and very little is recycled, whether due to economic or technical reasons.

We believe taxes on plastic packaging, including outright taxes on virgin plastic, higher waste processing fees, and the introduction of deposit return fees, may all have a material effect on consumer staples companies in the future, unless they manage to adapt.

In terms of cost, we have identified two main ways in which plastic may impact fast-moving consumer goods (FMCG) companies, in addition to reputation or brand damage.

Plastic Taxes and Regulation

The aim of a plastic tax is not to raise revenues or reduce plastic use, but to encourage an increase in recycled content, e.g., a tax is levied on any packaging with less than 30% recycled content. We would anticipate any such tax being large enough to be noticed by packaging manufacturers (with their low margins) and their FMCG clients, but not so large that it would hurt final consumer demand if passed on.

The tightening of extended producer responsibility (EPR) rules would have a similar impact to the introduction of a tax. EPR means that companies producing any kind of waste have to pay the costs of dealing with it. The most comprehensive scheme is in Germany where brand owners are compelled by law to pay 100% of the net cost.[1] Meanwhile, in the U.K., the system only covers about 10% of the cost, although this is currently being reformed.[2] The EU, too, is reviewing EPR requirements across the bloc. To quantify the effect, we calculated the potential cost impact of such a scheme on an American beverage company we own. Should the whole world move to the German model, it would cost this company 4% of sales, while a move to the average EU cost would have an impact of 1% of sales.

Strong consumer brands have significant pricing power and have historically managed to pass a substantial proportion of their input cost inflation to their customers. We believe this would also apply to plastic. Similar to raw material inflation, if regulation increases companies’ costs, every company in a given country will be impacted similarly and will likely try to pass cost increases onto consumers. Given low price elasticity in consumer staples, we believe the volume impact of such industry-wide price increases would be limited.

Increased Cost of Recycled Material

There are over 350 signatories to the Ellen MacArthur Foundation’s New Plastics Economy Global Commitment, representing around 20% of global plastic packaging use. Their aggregate commitments to increase recycled content amount to five million tonnes of additional demand for recyclate by 2025-2030, compared to current market demand of what we calculate to be around three and a half million tonnes. Such a significant increase in demand may, in the medium term, push the premium up until enough capacity comes on stream.

With consumers ever savvier about responsible corporate behavior, our engagements with the FMCG companies we invest in show they are taking plastic waste seriously and, in preparation for the upcoming impact of stricter regulation and plastic taxes, have dramatically increased their commitments to virgin plastic reduction. Plastic may not currently represent a material risk to the sustainability of returns of consumer staples companies, but the potential of it doing so in the future, not to mention reputational damage, is too high to dismiss.

In April 2019, Morgan Stanley launched its Plastic Waste Resolution, committing to facilitate the prevention, reduction and removal of 50 million metric tonnes of plastic waste from rivers, oceans, landscapes and landfills by 2030.

 
 

RISK CONSIDERATIONS

There is no assurance that a portfolio will achieve its investment objective. Portfolios are subject to market risk, which is the possibility that the market value of securities owned by the portfolio will decline. Accordingly, you can lose money investing in this strategy. Please be aware that this strategy may be subject to certain additional risks. Changes in the worldwide economy, consumer spending, competition, demographics and consumer preferences, government regulation and economic conditions may adversely affect global franchise companies and may negatively impact the strategy to a greater extent than if the strategy's assets were invested in a wider variety of companies. In general, equity securities' values also fluctuate in response to activities specific to a company. Investments in foreign markets entail special risks such as currency, political, economic, and market risks. Stocks of small-capitalization companies carry special risks, such as limited product lines, markets and financial resources, and greater market volatility than securities of larger, more established companies. The risks of investing in emerging market countries are greater than risks associated with investments in foreign developed markets. Non-diversified portfolios often invest in a more limited number of issuers. As such, changes in the financial condition or market value of a single issuer may cause greater volatility. Option writing strategy. Writing call options involves the risk that the Portfolio may be required to sell the underlying security or instrument (or settle in cash an amount of equal value) at a disadvantageous price or below the market price of such underlying security or instrument, at the time the option is exercised. As the writer of a call option, the Portfolio forgoes, during the option's life, the opportunity to profit from increases in the market value of the underlying security or instrument covering the option above the sum of the premium and the exercise price, but retains the risk of loss should the price of the underlying security or instrument decline. Additionally, the Portfolio's call option writing strategy may not fully protect it against declines in the value of the market. There are special risks associated with uncovered option writing which expose the Portfolio to potentially significant loss.

 

1 Source: LSE Research Online: “Packaging waste recycling in Europe: is the industry paying for it”, Ferreira da Cruz et al.

2 Consultation on reforming the UK packaging producer responsibility system, Department for Environment, Food and Rural Affairs.

vladimir.demine
 
Executive Director
 
 

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