Leading investors consider environmental, social, and governance (ESG) and sustainability as integrated parts of their portfolio strategies. As a result, more funds are being invested in sustainable assets. According to the Global Sustainable Investment Alliance and Bloomberg Intelligence, sustainable investing assets under management amounted to $23 trillion globally in 20161 and are poised to reach $41 trillion by the end of 2022—an approximately 10 percent CAGR.2
Industries across the oil and gas value chain have taken note, with ESG and sustainability emerging as top priorities for executives and boards alike. More specifically, chemical companies are investing in sustainability initiatives such as advanced recycling3 and hydrogen production.4 But although there is consistent attention across the industry on sustainability, there remains a lack of consensus on how investors can evaluate companies’ actions.
We conducted an analysis of the top 114 global public chemical companies, categorizing their end-market revenue into three segments (aligned to sustainability tailwinds, neutral, and sustainability headwinds) based on available investor information. We then calculated companies’ predicted enterprise-value-to-revenue valuations based on the weighted average of their end-market revenues. The results help illustrate how chemical companies can create value during the transition to increased sustainability.
ESG ratings and performance and valuations
Our research shows that 90 percent of the top 20 global chemical companies have public commitments to reach net-zero emissions, near-zero emissions, or carbon neutrality by 2050. Large institutional investors are also putting greater focus on ESG and sustainability. An example of this focus can be found in comments by BlackRock CEO Larry Fink in his annual letter to CEOs.5
Despite the increased attention to ESG and sustainability, there is uncertainty about how ESG ratings relate to TSR performance and valuations.6 Most chemical companies have mixed portfolios, with some business segments selling in end markets with sustainability tailwinds and others selling in neutral end markets or those experiencing headwinds.
With increased attention on ESG, the industry is looking for evidence of financial performance in relationship to ESG ratings. Due to the challenges of consistency in measuring ESG, there is still uncertainty in the relationship between ESG and financial performance. To illustrate, one challenge with considering ESG ratings is selecting which ESG scores and indexes to use. When evaluating across the major ratings agencies, such as Sustainalytics or MSCI, ESG ratings have poor correlation. A 2019 MIT study noted that the correlation among six prominent ESG ratings agencies was, on average, 0.61. Credit ratings from mainstream agencies Moody’s and S&P had a correlation of 0.99.7 Due to this inconsistency of ESG ratings across ratings agencies, it can be challenging to link ESG actions to higher ratings and their impact on financial performance.
This poses a riddle for chemical companies. If more funds are flowing into sustainable investing assets despite uncertainty with performance and ESG scores, is there another way to think about sustainability and value creation?
Exposure to sustainability tailwinds commands significant premiums from investors
When considering sustainability and valuation, it is important to consider what investors care about: that is, cash flows. In this sense, sustainability can drive cash flows through either higher ROIC or higher growth.
Our research shows that chemical companies with sales exposure to end markets aligned with sustainability growth trends have higher valuations. Looking at relative pure-play chemical companies, we observe that players aligned primarily to end markets with sustainability tailwinds achieve an enterprise-value-to-revenue valuation of approximately eight, compared with a valuation of two for companies exposed primarily to sustainability-neutral end markets (Exhibit 1). This indicates that investors are placing a premium on chemical products that enable sustainability-aligned end markets, such as electric vehicles (EVs), circular packaging, and natural ingredients.
The difference between lithium- and pine-based chemicals offers one helpful comparison. There are questions about the sustainability of mining and producing lithium and its derivatives. Yet lithium products are critical in enabling the transition to EVs, and therefore investors are rewarding companies with higher valuations because of the growth potential. In contrast, pine-based chemistries are produced from a sustainable resource (pine trees) and refined from a byproduct of timber and paper production. Yet pine-based chemistries are primarily sold as bio-based intermediates in end markets, such as adhesives or construction, where there is limited growth driven by sustainability trends. We note, however, that sustainability value may rapidly evolve as companies increasingly focus on carbon reduction, with a premium placed on biogenic carbon. Therefore, despite the sustainable production process, investors are not yet fully placing premium valuations on revenue from these chemistries.
Portfolios oriented to end markets with sustainability tailwinds are rewarded with higher TSR
We measured the correlation of predicted enterprise value to revenue based on sustainability orientation to valuation metrics. The findings show that there is some correlation when evaluating chemical companies along this dimension. While the correlation is not perfect—this method does not include other aspects driving valuation, such as exposure to growth regions—it provides a lens through which to categorize financial performance and sustainability.
Generally speaking, companies with a sustainability tailwind orientation correlate with higher enterprise-value-to-revenue multiples (Exhibit 2). As an example, companies that derive a substantial share of their revenue from natural ingredients and bio-based products are being rewarded with higher valuations based on expectations for growth and price premiums.
We also analyzed enterprise value to forward-looking EBITDA multiples to account for potential differences in EBITDA margins on enterprise-value-to-revenue valuations. The trend is consistent in this analysis as well, indicating that investors value higher-than-expected growth and cash flows above current margins for the chemicals industry, enabling end markets with sustainability tailwinds.
Taking a comprehensive approach to create value from sustainability
The industry shift to sustainability is an opportunity for chemical players to make proactive moves to pursue top-line growth from green sources of demand and value pools.
First, companies should focus on enabling the green economy by selling existing materials and solutions to end markets that are accelerating sustainability trends. Examples include players targeting end markets tied to EVs (such as battery catalysts and battery material separators) or energy efficiency (such as specialty insulation).
Second, companies should work to “greenify” their products and sell at a premium to markets that value sustainable solutions. This does not apply to all markets, so companies should consider this alignment before taking action. For example, sustainable ingredients already command premiums in personal-care applications (such as natural ingredients for beauty product formulations), while sustainable materials sold into infrastructure (such as bio-based asphalt binders) have seen limited premiums to date.
Companies can pursue the following methods to align with end markets that value green solutions:
- New functionalities. Invest in products that support sustainability-linked areas of the economy, such as EVs, the energy transition, and efficiency improvements.
- Green substitutes. Invest in products that improve the sustainability profile of existing applications, such as biodegradable polymers.
- Green feedstocks or processes. Improve the footprints of existing products with renewable inputs—bio-based or recycled—and reduce carbon footprints.
Chemical players can choose to participate across these vectors depending on their existing product portfolio, technologies, and core end markets. When players take action, they should consider how to leverage existing strengths and where products can achieve excess growth and pricing premiums.
The industry is shifting focus to sustainability, and chemical players have an opportunity to take advantage of it. By pursuing green growth opportunities aligned with sustainability trends, chemical companies can position themselves to generate shareholder value. Doing so will likely separate leaders from laggards as companies seek to match their portfolio strategies with ESG and sustainability targets.
