Profitability Screens and Competitive Advantage Assessment
To qualify for the Jensen Quality Value Universe™ a business must produce 10 consecutive years of high profitability, as measured by a return on equity of 15% or greater. Companies must also demonstrate durable competitive advantages, growth in operating cash flows, and the ability to reinvest these cash flows to support margins and protect market share from competitors.
In most cases, highly cyclical business models, such as fossil fuel companies, or regulated industries, such as U.S. electric utilities, are unable to sustain the high profitability levels required through different economic environments. In the last five years, only one energy company has qualified, Core Laboratories N.V., a small-cap company offering petroleum services and reservoir diagnostic tools. However, as Core Laboratories relies on backlog growth and its business model is hyper-dependent on the price of oil for new exploration and production, it lacks competitive advantages and fails our preliminary fundamental analysis screen.
Why Does it Matter?
Many Jensen Quality Value companies are leaders in environmental risk mitigation. Our Strategy companies play a prominent role in reducing or minimizing the amount of greenhouse gas (GHG) emissions caused by manufacturing and distribution, as well as the amount of energy required to run their businesses.
For example, as of December 31, 2020, 23 companies1 that comprise 59.02% of the Strategy support the Climate Disclosure Project (CDP) and/or science-based targets for Scope 1 and 2 emissions, which aim to keep global temperature increases either at or below 1.5° or below 2°C through 2030.
According to the data from ISS in Table 1 (as of December 31, 2020), the Jensen Quality Value Strategy has 35% less carbon risk and 74% less carbon intensity than the benchmark Russell 2500 Index.
Among the 37 companies that comprise the Strategy, 92 have a meaningful carbon exposure (above the average of all holdings) under industries such as aluminum cans, automotive parts/supply, consumer electronics, food products/grocery, and semiconductor manufacturing. Many of these companies have developed programs to limit the growth of their Scope 1 and 2 emissions by implementing energy efficiency measures, adopting lower impact technologies, and introducing more renewable resources into their energy mix.
For example, Microchip Technology and ON Semiconductor are limiting their air emissions, recycling wastewater, and reducing chemical usage in their manufacturing processes to lower the carbon intensity produced per chip and chipset. Similarly, Crown Holdings is focused on improving its metal and glass packaging. The company notes a recent assessment by Metal Packaging Europe that showed the production of aluminum had a 31% reduction in carbon emissions between 2006-2016. These improvements can be attributed to the development of lighter weight cans and an increase in recycling rates, among other factors.3
Carbon Risk Examples
Kellogg has taken on a leadership role within the food products industry by developing a proprietary model that has measured key carbon-emitting activities across its value chain since 2009. Kellogg’s global business comprises over 60 facilities in four geographies: North America, Latin America, Europe and the Middle East, and Asia Pacific. The model includes actual or estimated data for ingredients, inbound transport, manufacturing, packaging, and distribution for all of its locations.
This tool helps Kellogg focus on ingredients (50%) and manufacturing (15%) as the two primary components in achieving its science-based targets. Although the company is generally classified with the food products industry, for purposes of the proprietary model, they are classified as “Other Industry” and face a tougher benchmark. As a result, the company’s carbon reduction targets are more aggressive than if using other available methodologies.
Kellogg’s long-term commitment is to deliver 65% combined Scope 1 and 2 target reductions by 2050.4 Management has implemented energy efficiency techniques across manufacturing and distribution over the past five years to help reach this goal. However, Kellogg will rely on improvements in grid technology to expand use of onsite and off-site, low-carbon energy generation in future periods.
Real estate is at the center of many of the important environmental and social issues of our time. As buildings and construction increasingly contribute to global carbon emissions (up to 40% according to the International Energy Agency5), CBRE Group recognizes the importance of driving sustainable real estate practices. The IEA estimates that over the next decade direct building emissions need to fall by 50% and indirect building emissions by 60% in order to stay on track for its 2050 net-zero carbon building stock target.6
As the world’s largest commercial real estate services ﬁrm, with a portfolio of 6.8 billion sq. ft. under management, CBRE fulfills a dual role in minimizing negative environmental impacts in the building environment through both the services it provides to clients and its own global operations. Despite a year-over-year increase in total emissions for 2019 due to increases in the number of offices and portfolio floor area, the company reduced overall Scope 2 emissions by 17% from its 2015 target baseline. These Scope 2 reductions were primarily achieved through efficiencies gained from a Workplace360 initiative, as well as the greening of electricity across its operations, including 100% renewable electricity for some offices across Europe. By the end of 2019, the company opened 81 Workplace360 offices worldwide, representing 35% of its global occupied space. Each Workplace360 office is a “free address” and has a paperless environment, supported by leading-edge technology tools and platforms. Assigned offices and workstations have been eliminated. Instead, up to 15 different types of workspaces are offered based on carefully calculated employee usage patterns.7
We believe that the Jensen Quality Value Strategy is suitable for U.S. Mid Cap Investors who are looking for fossil fuel-free and low carbon solutions. Since relaunching the Strategy in 2017, the Strategy has had zero fossil fuel exposure, it maintains a below-average carbon footprint, and it demonstrates an even lower carbon intensity8 score than the Russell 2500 Index.
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Jensen News & Insights
1 Best Buy Co Inc (2.83%), Broadridge Financial Solutions Inc (4.20%), Campbell Soup Co (2.53%), CBRE Group Inc (2.99%), Crown Holdings Inc (4.10%), Expeditors International of Washington Inc (4.04%), F5 Networks Inc (2.68%), General Mills Inc (3.03%), Hasbro Inc (3.20%), Herman Miller (1.16%), Kellogg Co (2.39%), Kroger Co (2.99%), Laboratory Corporation of America Holdings (4.03%), Lennox International Inc (3.03%), Levi Strauss & Co (2.71%), Microchip Technology Inc (3.57%), NetApp Inc (1.34%), Omnicom Group Inc (1.39%), ON Semiconductor Corp (2.44%), Teradata Corp (1.02%), Verisk Analytics Inc (0.99%), Waters Corp (0.59%), and W. W. Grainger Inc (1.76%).
2 Campbell Soup, Crown Holdings, General Mills, Genuine Parts, Kellogg, Kroger, Microchip Technology, ON Semiconductor, and Scotts Miracle-Gro.
3 2019 Sustainability Report: Building a Sustainable Roadmap,” Crown Holdings, 36.
4 “Better Days,” 2019/2020 Corporate Responsibility Report: Executive Summary, Kellogg Company, 11.
5 “Buildings-Related Carbon Dioxide Emissions Hit Record High: UN,“ UN Environment Programme, Energy and Climate Branch, December 16, 2020, https://phys.org/news/2020-12-buildings-related-carbon-dioxide-emissions-high.html.
7 “Our Values in Action,” 2019 Corporate Sustainability Report, CBRE Group Inc, 51-53.
8 41.2 tCO2e/Mil USD vs. 153.0 tCO2e/Mil USDT
Jensen Investment Management, Inc. is an investment adviser registered under the Investment Advisers Act of 1940. Registration with the SEC does not imply any level of skill or training. The discussion herein is intended as an illustration of the investment process for the Jensen Quality Value Strategy. Our views expressed herein are subject to change and should not be construed as a recommendation or offer to buy or sell any security or invest in any sector, and are not designed or intended as basis or determination for making any investment decision for any security or sector. Our discussions should not be construed as an indication that an investment in a security has been or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of any security discussed herein. Any holdings discussed herein do not represent an account’s entire portfolio, and represent only a small percentage of, or may not be included in, any account’s portfolio holdings. There is no guarantee that the objectives stated herein will be achieved. Graphs, charts, and/or diagrams cannot, by themselves, be used to make investment decisions.