Target Rock Advisors, LLC
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Research Note
MAY 23, 2012
By Richard Rudden and Kyle Rudden
The Value of Sustainability:
At Least $20-25 Billion for Utility Investors
What is the value of sustainability to utility shareholders? A fair amount of academic and
industry research has been performed in an attempt to answer these and similar questions.i
However, little analysis has been done specifically for the U.S. energy utilities sector.
This analysis comprises a first-of-a-kind, best-efforts analysis, and is subject to further
refinement, but the preliminary results appear quite compelling to us.
INTRODUCTION
It would be virtually impossible to track all sustainability related efforts directly to shareholder returns. Some
lend themselves more readily to quantification and are perhaps even reasonably traceable to financial
statements, such as capital expenditures avoided through demand side management and energy efficiency
programs. The shareholder benefits of others are far less tangible; how does one quantify, for example, the
net shareholder benefits of enhanced CSR reporting, more operational transparency or greater customer
engagement and satisfaction?
A fair amount of academic and industry research has been performed in an attempt to answer these and
similar questions. However, little analysis has been done specifically for the U.S. energy utilities sector.
In earlier work, Target Rock demonstrated that, as a group, the equity securities of utility industry
ii
sustainability leaders have significantly outperformed other utilities with lower sustainability scores.
In this Research Note, we provide estimates of incremental shareholder value attributable to good
sustainability policies and practices, as measured by differentials in the market capitalizations of Target
Rock’s three overall sustainability indexes.
SUMMARY OF RESULTS
Comparative analysis of the ten year total returns for the 49 utilities included in Target Rock’s 2012
sustainability rankings and indexes along with several “what-if” scenario tests suggest that the value of good
sustainability policies and practices could be worth between $20-25 billion to utility investors.
The $20-25 billion estimate reflects the incremental market value realized by the Target Rock High
Sustainability Index plus the opportunity cost associated with being less sustainable for the Medium and
Low Sustainability Indexes.
These numbers are not insignificant. The $20-25 billion range represents 8-10% of the total starting market
capitalization of the 49 utilities covered by the Target Rock indexes and an additional 1.0% of relatively low-
risk compound annual return over ten years. With the three major utility indexes (S&P Utilities, Dow Jones
Utility Average and Philadelphia Utility Index) posting an average compound annual growth rate of 3.6%
over that period, another 1.0% is quite material.
The numbers could be larger going forward. This analysis includes a period of time, particularly the earlier
years, when only a handful of the most progressive utilities had sustainability plans in place. The impact of
sustainability practices on shareholder returns could be more substantial over the next decade now that
more utilities are taking the issues seriously and socially responsible investors are paying more attention.
Moreover, it is important to remember that the $20-25 billion estimate, while a relevant indicator of
shareholder value, grossly understates the true economic value of sustainability since market capitalization
metrics do not capture socio-economic benefits – including but not limited to reductions in pollution and
water use all along the consumption and carbon chain and contributions to local economic health and
development – created by utilities but accrued to others and society as a whole.
APPROACH
The basis of this analysis is Target Rock’s utility industry sustainability scoring and benchmarking system,
iii
the 2012 results of which were announced February 14, 2012. In summary, 49 utilities were analyzed,
scored and ranked on over 200 measure of sustainability related performance which are broadly classified
into the twelve high level dimensions listed in Figure X along with their weightings.
A detailed description of the process can be found at http://www.targetrockadvisors.com/sustainabilityscoring-indexing-processes/. The results are listed at http://www.targetrockadvisors.com/scores-indexeslisted/.
Figure 1: Triple Bottom Line (TBL) Elements and Dimensions
Next, we tracked the relative total return performance of each of our three flagship utility sustainability
indexes – High, Medium, and Low Sustainability – independently over ten years. This provided three
baselines for measuring the relative performance of the three sustainability groups. In calculating total return
dividends were assumed to have been taken as cash and not re-invested.
Over the ten year period 12/31/01-12/31/11 there is a strong positive relationship between sustainability
performance and stock market performance. The high performers clearly outperformed the lower
sustainability utilities. Our analysis focuses on that period but it is important to note that this relationship
iv
continues to date in 2012.
Chart 1: 10-Year Relative Total Return Performance by Sustainability Group
It is impossible to say just how much causality is implicit in this relationship between strong sustainability
practices and higher market returns – and there are certainly other factors in play – but we believe there is
enough of a connection to use these relative performance baselines as a reasonable foundation for a “whatif” analysis in estimating the value of overall sustainable practices in the U.S. utility sector. As we discuss
below, to the extent possible we have controlled for the “other factors” in our analysis to ensure that the
relationships we analyze are driven largely – if not mostly - by sustainable performance differentials.
Our what-if analysis estimated what the total return indexes would have been if each sustainability group
scored, and thus performed in the market, like the next higher group over the ten year period. Specifically,
we assumed the Low and Medium sustainability companies upped their sustainability profiles and
performed in line with the actual performance of the Medium and Low groups respectively. The High
Sustainability group’s what-if scenario considers the outcome if it had not been as sustainable, and instead
resembled the Medium group.
We went one step further and did a second analysis, this time controlling for size. For example, we assumed
the small cap companies in the Low Sustainability group performed, as a group, like the small cap
companies in the Medium group, the mid cap companies in the Low group performed in line with the mid
cap companies in the Medium group, and so on.
As mentioned earlier, when contemplating relative market performance, there are a variety of factors that
come into play ranging from micro to macro, from company-specific events to interest rates and market
sentiment. Many, if not most, of these other factors usually impact all companies in a particular sector
similarly.
Since our analysis is intra-sector and focuses on groups of companies rather than individuals, we made the
reasonable and practical assumption that all companies in our analysis would be similarly affected by these
non-size factors and would effectively wash out of the differential analysis that we performed. We therefore
felt that controlling for market capitalization would be sufficient.
RESULTS
Both approaches – size-controlled and not size-controlled – produced roughly the same net result range:
Sustainably business practices in the U.S. utility sector contributed to $20-25 billion in market capitalization
over the ten year period 12/31/01-12/31/11.
That reflects the aggregate market capitalization that would have been lost by the High Sustainability group
had it performed like the Medium group, and the total incremental market capitalization that would have
been realized for the Medium and Low groups had they performed in line with the High and Medium groups
respectively over the ten year period. Though both approaches produced similar industry wide results, there
were slight differences at the sustainability group level.
Not controlling for market capitalization, the High Sustainability group produced excess market capitalization
of about $10 billion for the period while the Medium and Low groups theoretically left $11 billion and $3
billion on the table. Under the size-controlled analysis, the comparable numbers for the High, Medium and
Low groups were $12 billion, $8 billion and $4 billion respectively.
Chart 2: Theoretical Market Capitalization Gained or Lost
The precision of these estimates is necessarily limited by the universal complexity of sustainability
assessment, but it does provide an informed effort to place boundaries around the potential industry-wide
shareholder value of sustainability as measured by market capitalization metrics.
CONCLUSION
The analysis above is Target Rock's contribution to the debate over how much sustainability is worth based
on stock valuations. We've tried to place some boundaries on the question as it applies to the U.S. utility
sector, although our estimates are more directional and order-of-magnitude in nature. Nevertheless, Target
Rock feels the results are compelling and could be a bit conservative.
Our work in this area continues and we will further refine our analysis in the future. In the meantime, we are
confident that this study - the only one of its kind to the best of our knowledge - represents an important
contribution to the field of sustainable and socially responsible investing.
To reiterate, this analysis does not attempt to estimate the value of sustainability in terms of any metric other
than market capitalization value. While good sustainability practices have been shown in the academic and
industry literature to provide many benefits, such as improvements in operating efficiencies, emission levels,
employee engagement, brand image, local economies, innovation and new product development, none of
these has been considered in this analysis.
About Target Rock Advisors, LLC
Target Rock is dedicated to the rigorous study and implementation of sustainability policies and practices
within the utility and financial industries. The Company’s mission is to provide data, information, analytical
systems and deep sector-specific technical expertise that identifies areas for improved performance and
helps utility companies achieve their sustainability objectives with favorable social and economic
outcomes. Through its partners and associates, Target Rock has over 250 years of combined experience
in sustainability and executive leadership, equities and fixed income analysis, financial management,
statistics and econometrics, regulatory policy analysis and management consulting. More information on
Target Rock can be found at www.targetrockadvisors.com.
RICHARD J. RUDDEN
KYLE P. RUDDEN
CEO, Co-founder, Partner
Co-founder, Partner
Richard Rudden has served in analytical, consulting,
management and executive positions within the
utility, financial and energy industries for over 35
years. As a senior vice president for a multi-billion
dollar global consulting and engineering firm, he
lead the company’s energy sector management and
strategy consulting practice, chaired its climate
change working group, and was a member of both
the Advisory Board and Sustainability Steering
Committee.
Kyle Rudden has 15 years of experience in equity
and fixed income analysis, with an emphasis on
finance and capital markets. Most recently, he was
president of R. J. Rudden Financial, LLC, a
registered broker-dealer and energy industry
advisory boutique.
Richard has published and spoken widely and has
testified before state, federal, and provincial
regulatory bodies, as well as in bankruptcy and civil
court proceedings, on natural gas and electric
economic, financial and policy issues. Previously he
was the founding CEO of R.J. Rudden Associates,
Inc., a strategy and economics consulting firm, and
R.J. Rudden Financial, LLC, a FINRA-licensed
broker-dealer providing services to the energy
industry; R.J. Rudden was acquired by Black &
Veatch in 2005.
Richard’s career includes management and
executive positions at Con Edison, Stone & Webster
(now Shaw) and Black & Veatch. He has also
served on the Boards of Directors of the North
American Energy Standards Board, a non-regulated
retail energy marketer and the Cornell Cooperative
Extension, where he is a member of the executive
committee. He has also been involved in Cornell’s
Marine and related environmental programs.
Before co-founding Rudden Financial, Kyle spent
nearly a decade at J.P. Morgan Securities as vice
president and head of the firm’s U.S. Energy and
Utilities Equity Research team covering electric
and natural gas utilities, pipelines, independent
power and new energy technology. Prior to J.P.
Morgan, he was a fixed income analyst at Fitch
Ratings, also covering the U.S. electric and
natural gas utility industries.
At J.P. Morgan, Kyle was named in both
Institutional Investor and the Wall Street Journal
annual lists of top analysts and participated in a
number of large domestic and international equity
and equity derivative underwritings, including
initial public offerings, public secondary offerings
and private placements.
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© Copyright 2012, Target Rock Advisors, LLC. All rights reserved. Target Rock Advisors, LLC Research Notes
are written for informational purposes only and neither constitute recommendations to purchase or sell any
security or group of securities nor do they constitute investment advice. Our reports do not provide all
information material to making an informed investment decision. Information about past performance of a
security or group of securities is not necessarily a guide to, indicator of, or assurance of, future performance. All
information in this report is provided “as is” without warranties, expressed or implied, or representation of any
kind to the fullest extent permissible under applicable law. Target Rock Advisors, LLC will not be liable to any
person or entity for the quality, accuracy, completeness, reliability or timeliness of information contained herein.
ENDNOTES
i
See Target Rock’s white paper entitled “The Case for Sustainable Utility Investing” and “Suggested
Readings in Sustainability and Socially Responsible Investing” at www.targetrockadvisors.com/researchreports/
ii
Ibid (www.targetrockadvisors.com/research-reports/)
iii
www.targetrockadvisors.com/press-releases/
iv
See current Total Return charts at www.targetrockadvisors.com/go-interactive/index-charts/