The risks of climate change took center stage during 2021, as UN scientists linked global warming directly to human activities. With global attention focused on mitigation, adaptation and resilience, how are retailers managing related risks and considering possible business opportunities?
In 2021, Breckinridge Capital Advisors completed a program of engaging with retail sector issuers in the dollar store/general merchandise and aftermarket auto parts subsegments to learn about how they are responding to the threat of climate change while balancing their competitive strategies.
We explored the ways in which these retailers are measuring and managing climate risks, such as energy efficiency of the store footprint and the environmental impacts of company supply chain and transportation networks. These engagement meetings revealed a range of sustainability efforts, some perfunctory and others proactive.
For context, we believe investment grade analysis must have a view of the total picture, including fundamental financial position and environmental, social and governance (ESG) practices. ESG analysis could indicate that management is focused on long-term competitive market advantages that also may help it meet future bondholder obligations.
Conversely, a lack of attention to ESG considerations could leave a company vulnerable to risks ranging from litigation to reputational risks; these can have both a top-line and a bottom-line impact that may ultimately affect the issuer’s ability to repay bondholders.
Divergence in Practices Among Retail Subsegments
The subcategories of retail companies that we engaged with — aftermarket auto parts retailers and dollar stores — tend to have their business model centered around a brick-and-mortar store presence, in contrast to omnichannel retailers such as big box stores or apparel manufacturers.
We found that generally these two subsegments tend to lag their broader retail peers when it comes to tackling climate change challenges. This is likely a reflection of heightened consumer price sensitivity in these subsegments.
When price is a key driver for a business’ revenues, it may be most inclined to pursue sustainability initiatives as a means of cost savings. Cost saving initiatives may serve to support low prices for consumers and bolster margins to the corporate parent, but they can sometimes miss the bigger picture when it comes to more comprehensive, long-term strategy changes. In the most extreme case, dollar store customers are focused almost exclusively on price and convenience, allowing little room for retailers to consider environmentally beneficial trade-offs.
Energy Efficiency in Stores is a Key Driver
A key driver of a retailer’s carbon usage is energy in its brick-and-mortar stores. Generally speaking, adopting energy efficiency measures can be viewed as a favorable step to demonstrate a commitment to sustainability and achieve environmental goals, while also reducing operating costs in-stores.
Of the companies we engaged with, in some cases companies reported reducing their energy use and greenhouse gas emissions by converting to interior LED lighting and more efficient heating, ventilation and air conditioning systems, while committing to setting science-based targets for Scope 1 and 2 emissions (their own direct and indirect emissions).
In one case, the company’s Chief Sustainability Officer is working with a consultant that recommends strategies to achieve energy efficiency.
In contrast to these earnest efforts, we spoke with another retailer that has yet to appoint a sustainability leader. It has no stated target for reducing greenhouse gas emissions and it is not systematically measuring energy consumption price and supply risks.
Engaging the Supply Chain
Outside of the immediate store footprint, retailers see supply chain engagement as an opportunity to reduce Scope 3 greenhouse gas emissions (all other indirect emissions). They are doing this by favoring suppliers that seek greenhouse gas emissions reductions, or by encouraging existing suppliers to make measurable improvements.
One retailer is working to source products from cargo carriers that are certified by the Environmental Protection Agency’s SmartWay program. That program helps companies advance supply chain sustainability by measuring, benchmarking and improving freight transportation efficiency.
Selectively, aftermarket auto parts retailers have an opportunity to drive revenues while embracing environmental responsibility. Selling products made with recycled materials repurposed from take-back programs can help to keep costs down while embracing a principle of circularity. In this sweet spot, interests align at the crossroads of environmental sustainability and an opportunity to build customer loyalty, whether those customers are motivated by price, concern about the environment or a combination of both.
Discretionary Goods Demand Higher Environmental Scrutiny
One thing we have observed is that the degree to which a business, industry or market niche will be rewarded for environmental consciousness correlates in part to how discretionary the goods sold are.
On one hand, take a gallon of milk or a set of vehicle tires. Most consumers, especially in a pinch, are going to buy those goods based on necessity, with a consideration for price and convenience and minimal consideration of environmental factors.
In contrast, a pair of fashionable shoes or home goods might invite a variety of considerations. How carbon-intensive was the supply chain involved in their creation and transportation? How sustainable are the raw materials used in production? Discretionary purchases are increasingly subject to a higher bar of consumer decision-making.
COVID Rear-View Mirror
Looking back at differences among types of retailers during the early 2020 COVID shutdown is revealing; it became very clear which retailers were “essential” and which were not. Groceries, personal care items, auto parts, home maintenance products — these were items consumers needed without interruption.
Again, at the extreme end of the spectrum, dollar stores saw increased sales from pantry-stuffing behavior coupled with higher traffic from price-sensitive consumers driven by large-scale job losses/furloughs. Consumers were more motivated than ever to pursue the lowest-cost goods.
The takeaway is clear: discretionary purchases have more elasticity of demand relative to non-cyclical consumer goods. As a result, discretionary items are subject to consumer considerations beyond price and convenience, including ESG concerns. Certain retailers are especially sensitive to this trend based on who their consumers are and their willingness to pay a premium in pursuit of sustainability principles.
Turning Isolated Instances into Consistent Commitment
Something to strive for is the ability to turn isolated cases of cost-competitive environmental support into consistent programs. Imagine embracing the principles of environmental circularity across a wide variety of products, implementing energy efficiency programs in stores and engaging supply chain management in a concerted fashion. Together, these actions establish the importance of retailers as a linchpin in connecting consumers to principles of environmental sustainability.
When it comes to engaging with investors, retail management teams face a wide range of disclosure requests. We have found that businesses committed to leadership in reporting consistently disclose information according to at least one recognized framework while exploring the pros and cons of others. These efforts demonstrate a genuine commitment to communication and an earnestness and openness to achieve progress.
Ultimately, it is incumbent upon retailers to consistently drive top-line revenues through price competitiveness and customer loyalty while maintaining strong cost discipline. Over time, all consumers will benefit rather than those with income levels who can afford them the luxury of choice. Our base case continues to expect that consumers will increasingly reward retailers that demonstrate genuine commitment to environmental responsibility. In these cases, trade-offs become win-wins for cost-conscious consumers, competitively driven retailers, long-term investors and the sustainability of the planet.
Abigail Ingalls is a Senior Research Analyst at Breckinridge. She performs corporate credit analysis and contributes to the ongoing development of Breckinridge’s environmental, social and governance (ESG) frameworks. Ingalls joined the firm in 2009. Sheis a member of Women Investing for a Sustainable Economy (WISE), the Boston Area Sustainability Group (BASG) and Building A Sustainable Investment Community (BASIC). Ingalls holds a B.S. in psychology from Tufts University and an MBA in finance from the Boston University School of Management, and currently holds a Series 65 license and is an FSA Credential holder.