European Equities

Sustainability: the fabric of good business

As consumers, we are becoming increasingly aware of the production process of our goods
July 2017

Sacha El Khoury

Vice President, Portfolio Manager, European Equities

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Risk Disclaimer 

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

As consumers, we are becoming increasingly aware of the production process of our goods, as well as what happens to those products when we have finished using them.

This heightened consumer awareness is a positive step from the consumer side, but what are the ramifications on entire industries’ supply chains, from suppliers to manufacturers and retailers to distributors? And what does it mean for investors?

We have always said that quality companies will have meaningful sustainable business practices, which will enable them to spot trends early and nurture innovation leadership. None exemplifies this better than Lenzing, the manufacturer of sustainable fibres.

As a consumer, have you ever stopped to consider what resources are required for the production of cotton? Cotton may be a natural fibre, but it is far from “green”.

Synthetic materials don’t fare any better and are, in general, poor substitutes as they don’t have the same characteristics of moisture absorption and breathability. Polyester, for instance, is five times more energy intensive to produce than cotton.

Enter: Lenzing, with its cellulose fibres, such as viscose, which are made from Dissolving Wood Pulp (DWP). While it might not sound particularly “green”, the pulp is derived from low-energy, fast-growing, and sustainably-sourced trees. Lenzing is over 50% vertically integrated, and is aiming to increase this to 75% by 2020. In controlling the pulp and fibre production, they have better visibility over processes and can operate a closed loop production process in parts of the production by recovering and reusing waste.

Risk Disclaimer 

The value of investments and any income derived from them can go down as well as up as a result of market or currency movements and investors may not get back the original amount invested.

Views and opinions have been arrived at by BMO Global Asset Management and should not be considered to be a recommendation or solicitation to buy or sell any companies that may be mentioned.

Source: Lenzing, 14 March 2018

 
 
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So, viscose, the cellulose-based fibre, is not only more sustainably sourced and has a lower overall strain on the environment, but also has better properties than cotton or polyester.

Lenzing didn’t stop there. They have spotted a trend and an opportunity, and are on a mission to bring sustainable solutions to their customers. The company has spent hundreds of millions of euros in research & development, more than all their competitors combined, to develop specialty fibres Modal® and Tencel™ (Lenzing’s brand name for lyocell), where they have built an effective monopoly with 65% and 99% market share respectively.

These specialty fibres have important properties, which allow their customers to differentiate themselves, and which allow Lenzing to charge a premium.

Their drive to come up with sustainable solutions has also resulted in Lenzing developing a revolutionary technology they call Refibra™, which essentially allows the recycling of cotton and scraps into specialty fibres, closing the loop and creating a circular economy model.

Lenzing are taking a proactive approach with customers, having developed solutions which address real sustainability problems in one of the most water intensive and polluting industries. A direct sales force has been put in place to establish relationships with the manufacturers and retailers, to educate them on the options, and most importantly, how that can help them differentiate themselves in a competitive market.

And they are listening:
 

M&S has nominated Lenzing Modal® and TencelTM as “Plan A” fibres along with organic cotton and recycled polyester and are aiming to increase their use.

H&M uses recycled polyester, organic cotton and TencelTM in their “Conscious” collection.

Inditex’s “Join Life” uses TencelTM, organic and recycled cotton and other recycled fibres like polyester and polyamide.

IKEA aims to switch 30% of their cotton fibre usage into more sustainable fibres, and TencelTM is their preferred fibre.

Source: Logos, Wikimedia Commons

Retailers are also stepping up their recycling initiatives, which allow customers to drop off unwanted items in fashion “bins” in high street shops. Many high street names, such as Zara and H&M, have moved their image towards being environment-conscious retailers, and the consumer is lapping it up.

Whilst all this is going on it is important to remember that Lenzing is not doing this out of the kindness of its heart. It, in fact, makes good business sense to be sustainable. The vertical integration in DWP gives the company an important cost advantage, boosting margins going forward, and it is an important component of their ‘moat’ as the production sites and pulp quality are hard to replicate.

Lenzing can charge a premium for their specialty fibres, but more importantly, the price of these specialty fibres doesn’t swing around with the price of cotton, unlike the more commoditised viscose. This means that as the contribution of specialty fibres increases as a proportion of the overall business, the return profile of the company will not only improve, but be more stable and predictable. In short, the quality of returns will continue to improve, and Lenzing should compound growing returns, which will be well protected by the moat it has built
around its business.

This is exactly what we look for in a company.

Meanwhile, the market continues to value Lenzing like a commodity viscose player. It is up to us, like Lenzing has done, to spot the trend and take advantage of the investment opportunity this presents us with.

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