Putting a bandaid on a bullet wound

British American Tobacco's ESG score is yet the latest example of the misalignment between financial and sustainability outcomes.

Last week, leading UK retail investment platform Hargreaves Lansdown published a list of the five “most highly ESG rated companies in the FTSE 100”. The catalogue of UK stocks, informed by Refinitiv data, included British American Tobacco and Glencore.

Why, or how, were a tobacco and mining company included in the shortlist?

Hargreaves explains that ESG ratings evaluate more than just how ‘green’ a company is. Social issues, such as diversity and human rights, also count. As do governance issues, including executive remuneration and supply chain management.

Focusing on these areas, writes the curator, makes good business sense – it’s not all about conscience.

Leaving aside the fact that the tobacco industry has devastating social ramifications, the argument is consistent with the state of the ESG market. In the world of sustainability ratings, extra-financial issues matter to the extent to which they engender financial risk. And doing badly on one metric can supposedly be offset by doing well on another.

That means a company that contributes to the 78,000 UK smoking-related deaths a year (and 7 million globally) can achieve stellar ESG marks.

Industry-leading carbon neutrality and human-rights initiatives proved enough to push BAT’s ESG score to the top of the heap. Refinitiv’s methodology is not unique: BAT’s investment into initiatives has been so well received that the company was just included in the Dow Jones Sustainability Index for the 19th consecutive year.

Of course, it’s important to protect your suppliers and environment. But doing so does not eradicate the impact of your products.

Our analytics bring that impact to light. BAT -- or rather, tobacco-related products, the only item for which BAT accounts -- have a detrimental effect on 12 of the 17 SDGs. That includes those on both the social (poverty, hunger, health, gender equality, clean water, industry and innovation, equality, justice) and the environmental (sustainable cities, responsible consumption, climate action, life on land) ends of the spectrum.

We can show, scientifically, that BAT does not have a positive impact on a single SDG.

No number of initiatives can negate the real-world effects of a toxic product. We know that. We keep saying that. But there’s another, unaddressed, issue with BAT being at the top of the sustainable stock pile.

As Hargreaves points out, in 2021, ESG risk matters inasmuch as it’s material. Thinking about material risk, whatever it is, makes good business sense. So while a focus on the real impact of a company’s products is noble, it might not be pertinent to business performance.

According to that argument, BAT has effectively managed its ESG risk: which is to say, the company minimised the possibility of ESG issues having a negative bearing on its share price. It might not be a win for the societies and environments in which it operates, but BAT’s ESG score is a win for management and a win for investors.

Except it absolutely is not a win for investors.

What the ESG market is still catching up to is the fact we live in an age of unprecedented transparency and consumer activism. A bad product is bad for reputation. And a bad reputation is bad for business.

Tobacco, more easily circumvented by the consumer than other ‘sin stocks’ such as fossil fuels, is in steep decline.

BAT, writes Hargreaves, is faced with the uphill battle of assuming demand will fall every year. That’s led the group to explore the e-cigarette market. But that’s still a small part of the whole, and a bushel of new regulatory pressures is likely to accompany its growth.

For now, the group has enough cash to comfortably cover dividend payments. Management will be keen to keep its 20-year dividend record intact. But dividends aren’t guaranteed, and yields aren’t a reliable indicator of future income.

Understanding real-world impact is not just a case of feel-good factor investing. BAT faces an existential crisis precisely because it has such damaging real-world outcomes.

Perhaps it's time for the market to, once again, broaden definitions of ‘materiality’.

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