CASY - ClearBridge ESG Investment Strategy Q1 2023 Portfolio Manager Commentary

2023-04-22 22:30:00 ET

Summary

• ClearBridge is a leading global asset manager committed to active management. Research-based stock selection guides our investment approach, with our strategies reflecting the highest-conviction ideas of our portfolio managers.
• ClearBridge has designed our net-zero approach around high-touch engagement with portfolio companies on their decarbonization strategies.
• Recent net-zero engagements across ClearBridge help us get under the hood with company-specific nuances to setting or meeting science-based emissions reduction targets and highlight the value of lesser-known enablers of the energy transition.
• Industrial software enables the digitalization of capital-intensive industries such as utilities, energy and chemicals, and should see sustainability investments from many sectors drive growth as more companies seek to model emissions and increase operational efficiency.

By Brian Angerame, Dimitry Dayen, Mary Jane McQuillen, & Anuj Parikh

ClearBridge Engagements Zero In on Net Zero

Climate change, and its associated investment opportunities and risks, remains a priority for ClearBridge, both in our active stock selection across portfolios and in our engagements with C-suite leaders of the companies we invest in. Our interest in the topic across sectors and portfolios coincides with growing interest in climate mitigation across the country: as of December 2022, 33 U.S. states had released a climate action plan or were in the process of revising or developing one, according to the Center for Climate and Energy Solutions.

In 2021 we joined the Net Zero Asset Managers (NZAM) initiative — a group of more than 300 asset managers with nearly $60 trillion in assets under management committed to getting the world to net-zero carbon emissions by 2050 — and we have designed our net-zero approach around high-touch engagement with portfolio companies on their decarbonization strategies.

We are making progress on our goal of assessing each portfolio company’s emissions trajectory and determining its alignment with the pathway required to achieve global net-zero emissions by 2050 (Exhibit 1). We are ahead of schedule in confirming the net-zero alignment of our initial in-scope assets (43% we deem to be net-zero aligned versus a goal of 39% as of December 2022), and are conducting either in-depth or exploratory engagements with unaligned portfolio companies across the firm.

Exhibit 1: Tracking Progress Toward Targets for In-Scope Assets

Recent net-zero engagements across ClearBridge portfolio companies reveal how company- and sector-specific conditions shape decarbonization efforts, help us get under the hood with company-specific nuances to setting and meeting science-based emissions reduction targets and highlight the value of lesser-known enablers of the energy transition.

Semiconductor Growth Sets High Bar for Renewable Energy Capacity

ASML makes semiconductor manufacturing equipment and is a leading supplier of lithography systems to the semiconductor industry. It has set science-based targets to achieve net-zero Scope 1 (direct from sources controlled or owned by a company) and Scope 2 (indirect, through the purchase of power, heat, cooling, etc.) emissions by 2025, and zero emissions in the supply chain or Scope 3, by 2030. We consider ASML’s emissions reduction pathway to be net zero aligned.

While ASML seems on track to meet its net-zero goals, in January 2023 we met with its CEO to discuss, among other topics, potential hurdles it might encounter along the way. Among these might include ASML’s own success as it works to build a renewable energy grid for its Veldhoven headquarters in the Netherlands fast enough to keep up with its own growth. ASML is investing in solar and wind and working with energy generation companies to build its own renewable energy capacity in order to support its fast-growing production capacity. The company also cited a goal of 75% reduction in gas use as another key lever in meeting its Scope 1 and 2 goals, which we find credible.

While ASML works to lower its own emissions, it is also enabling its customers to lower theirs. As a semiconductor capital equipment provider, ASML directly improves the energy efficiency of semiconductor chip manufacturing. Its extreme ultraviolet (EUV) lithography systems, which took ASML more than two decades to develop, enable semiconductor manufacturers to make chips that use less energy and/or have higher performance. More power-efficient chips have an emissions reduction multiplier effect down the semiconductor supply chain. ASML directly enables chip manufacturers serving rapidly growing data center and AI businesses, as well as auto and industrial markets, and even smart phones to make more powerful chips using less energy.

Navigating Spotty EV Penetration

Casey’s General Stores ( CASY ) is one of the largest gas station and convenience store owners and operators in the U.S., with over 2,400 stores predominately in the Midwest. Most of Casey’s sales and profits come from the sale of gasoline, prepared foods (pizza, sandwiches and breakfast items) and grocery and other convenience items. Its stores are well-located and have significant brand recognition. Casey’s tends to have dominant market share in the states and the markets in which it operates. As such, its business is stable and cash generative. Also, its small market presence gives Casey’s pricing power and provides for a wide moat against would-be competitors.

One of the risks to Casey’s is the slow but accelerating shift from internal combustion engine cars to electric vehicles (EVs). This will slowly eat into the company’s sales of gasoline and some traffic into the stores. We have encouraged Casey’s to be a leader in the rollout of EV charging stations at its stores. To this end, currently Casey’s has installed EV charging stations at 29 of its 2,400+ gas station and convenience stores. Management has shared with us that the stores with EV chargers average roughly 390 fuel transactions per day but average only 12 EV charges per day. That equates to a 3% penetration rate for EV demand. That data may actually overstate demand somewhat because the stores with the EV charging stations were handpicked by their charging station vendor/partner as being the stores most likely to see charging demand. EV adoption across the U.S. remains concentrated in mostly coastal states (Exhibit 2); across Casey’s entire 16-state portfolio, we think EV charging demand is roughly 0.6%. We, and the company, recognize that EV acceptance is lower in Casey’s market than in other more urban and coastal markets.

Exhibit 2: EV Penetration Across the U.S. Is Uneven

Casey’s remains committed to offering EV charging as a service, just as it offers gasoline today, but will do so at a rate that more closely aligns with the rate of EV acceptance and demand for EV charging. As EV penetration continues to rise, Casey’s will install more charging stations. We also believe that the level of service and range of goods and prepared foods offered inside Casey’s stores will make Casey’s an attractive place to pass the time required to recharge electric vehicles.

Capital-Intensive Industries Going Digital

Part of our net-zero strategy entails recognizing climate solution enablers such as Aspen Technology ( AZPN ), a pure-play industrial software leader supporting complex operations across a wide range of industry verticals, including operations, maintenance and asset optimization. The company has limited carbon emissions itself, and our engagements with it focus on how it is benefiting from the growth in renewables and sustainability investments as Aspen helps the digitalization of capital-intensive industries. Broadly, Aspen’s products help organizations streamline engineering and maintenance processes to reduce downtime and increase operational efficiency, in part helping industry to limit emissions and pollution.

Recent engagements with the company’s CEO and CFO have focused on markets opened up by Aspen’s recent transaction with Emerson Electric to acquire Emerson’s Open Systems International ((OSI)) and Subsurface Science and Engineering ((SSE)) businesses in exchange for a majority share in the combined company. OSI helps global electrification through digitalizing and optimizing transmission and distribution systems for utility companies in the power industry. In particular OSI supports smart grid initiatives, processing and analyzing millions of data points in real time from all levels of the electrical power supply chain, helping to manage the complexity of integrating renewable energy into the grid.

Aspens’ SSE business supports efficiency in the oil and gas industries and aids the development of carbon sequestration, geothermal and hydro energy.

Sustainability investments and decarbonization spending across the product suite should act as strong growth drivers for Aspen. Its technologies are also being used by Google ( GOOG , GOOGL ) and META to model emissions and heat flows at data centers, and Tesla ( TSLA ) and Rivian ( RIVN ) are now customers on battery energy flow modeling. Biofuel and hydrogen investments are expected to be modeling intensive, too, providing Aspen several avenues to deliver for shareholders and help decarbonize the operations of equities across many sectors.

Climate Initiatives Raise Awareness and Improve Disclosures

ClearBridge’s involvement with several climate initiatives — such as the Task-Force for Climate-related Financial Disclosures (TCFD), which develops consistent metrics for companies to use in disclosing financial risks associated with climate change; Climate Action 100+, an investor-led initiative to engage high emitters on lowering emissions and better disclosure; and the CDP, or Carbon Disclosure Project, which collects climate and water data from companies worldwide — further supports more acute awareness of climate risk and attests to our commitment to moving the energy transition forward.

In the interest of transparency, we provide more information on our climate-focused investing in our 2022 Climate Report and outline our approach to meeting our NZAM commitment, both on our website and via the Principles for Responsible Investment .

Brian Angerame, Portfolio Manager

Dimitry Dayen CFA, Director, Senior Research Analyst for Renewables/Industrial Products and Services

Mary Jane McQuillen. Head of ESG, Portfolio Manager

Anuj Parikh, Vice President, Research Analyst for Technology Hardware

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