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Top 5 ESG-tailored industrial companies

Looking for industrial firms that also check the ESG boxes? With major economies re-opening, cyclical industrial firms have been on investors’ radar lately, so why not pepper in some ESG winners, too? You won’t believe how clean industrials can be until you’ve read our list.

From an investment standpoint, ESG stocks will tend to do better for a variety of long-term and quality-related factors. Take for example companies that pay high wages, like Microsoft, in an inflationary setting. Because they already pay employees well, a wage hike is less likely to occur given a rise in inflation thus, their profitability would remain somewhat the same.

On the topic of inflation, such companies with relative pricing power advantages tend to be better off. High commodity prices are a hallmark of inflation which can squeeze profits and lower stock returns for those with little pricing power. ESG stocks on the other hand tend to offer quality in both their products and production methods, mitigating such risks, granting them extra trust from customers and longer-term turnover.

The next five stocks are taken from the MSCI ESG ratings filter, and a Bank of America investment shortlist. Each one is a leader in its business segment, and have outstanding ESG grades relative to their peers. While industrials may not seem as hot as technology, sometimes, your meat and potato stocks can go a long way, and sometimes, as we see below, industrials go techy.

 

Figure showcasing the top 5 ESG industrial companies


 

Johnson Controls International (JCI) green building products

JCI makes products for buildings, things like smart lighting, and HVAC systems. An ESG standout, JCI seeks to achieve net zero carbon emissions before 2040. This could be likely—in 2019, its greenhouse gas intensity dropped by 42%... This reduction has been attributed to renewable energy investments, fuel-efficiency transportation techniques, and disposition of its power solutions business.

The firm has come under the spotlight during the pandemic because of its artificial intelligence-driven OpenBlue system which offers automated contract tracing, social distancing monitoring and face mask detection. As a secular growth in smart buildings and smart cities is unfolding, this segment of the business could offset some of its other more cyclical products.

The bulls suggest that its strong backlog supports underlying recovery in commercial markets in 2021 and that the firm is in a good position to address indoor quality and security solutions as buildings reopen.

The bears speak of risk in the prolonged pressure in commercial construction holdbacks from covid-19, higher than expected raw material costs due to inflation, an unanticipated US dollar strength and a smart building demand potentially slowing down.

 

XYLEM (XYL) makes industrial water machinery

After spinning off from ITT in 2011, XYL has become a leading global provider of equipment to efficiently use water in public utilities. Their expertise is in the art of tackling hard water and wastewater engineering problems. They brand themselves as a water technology company, but their ESG status in the industrial management of water infrastructure more than qualifies them for this list.

Their ESG moat is clear: Xylem promotes a strong culture of transparency and ethics and they maintain rigorous environmental and safety goals. After all, they are the force behind bringing water to remote underprivileged regions and they live by those values. The company continues to meet or exceed its water, waste and greenhouse gas emission goals in 2020.

The bulls believe that a growing demand for fresh water infrastructure in developing countries and the need to renew infrastructure in the US are the long-term rationales for buying Xylem. Xylem also just acquired smart meter and leak detection companies which means their product offering is widening in 2021. Lastly, Xylem still has room to grow in cost-savings which could suggest rising margins later.

The bears point to significant inflation and a growing US dollar as an impairment to the company’s profitability, and while the company has actually successfully passed costs down to customers, rising commodity prices threatens to erode its margins nonetheless.

CNH Industrials N.V. (CNHI) construction machinery

CNHI is an Italian owned, Amsterdam based worldwide provider of industrial products. Listed on both the NYSE and in Milan, it is the only stock on this list with the word ‘’industrials’’ tied to its name. CNHI, is the world’s second largest farm equipment company after Deere & Co. It also happens to be a relatively cheap stock and a ESG powerhouse according to its top quartile MSCI index ESG ratings.  

The firm’s engagement practices include collecting bargaining agreements with unionized workers, covering 80% of its workforce. Its farm machinery and trucks business faces low risks of liabilities linked to workplace accidents and research suggests the company has certified its operations to high health and safety management standards.

The company also develops renewable fuel systems for vehicle products, which could help it capitalize on opportunities in clean tech. Its R&D investment to sales ratio has also been one of the highest in the industry which could suggest more innovation to come.

The bulls say higher crop prices increase farmers’ profitability allowing them to purchase new agriculture equipment which would substantially boosts CNHI’s revenue growth. Secondly, higher fiscal spending and the Biden infrastructure plan could further boost construction and infrastructure markets.

Bears see current vaccine rollout disruptions holding back sales. Secondly, further management disruption could lengthen the restructuring and transformation to drive the improvement in performance and a risk around weather and crop yields could be ahead.

Boise Cascade company (BCC) top wood distributor

BCC operates in two segments, wood products, and building materials distribution. Their commitment to sustainably-sourced materials through strong wood procurement and rigorous auditing policies makes it a standout ESG player. This stock is highly correlated with lumber prices, shown below, and also housing starts. With great housing starts figures for 2020, and more spending ahead, we can imagine a good scenario for this stock. However, the current fact is that lumber prices are crashing.

The bulls say BCC has tailwinds in pent-up demand and an incoming home buying recovery ahead. 2020 was a great year and the firm is sitting on profits that could be used for further growth. Net income grew in 2020 to $198.1M, but the trend was already an upward curve since 2018.

This indicates that BCC was able to pass the rising cost of lumber down to consumers instead of shedding off EPS—this is a great sign of inelastic demand, something to look for in an inflationary environment. Bears point to the obvious, the graph below, that until lumber prices stabilize, the share price will follow a downward trend. But a falling rice could also invite a buying opportunity.

Figure showing Boise Cascade Co’s correlation with lumber prices

Herman Miller (MLHR) recycled furnishing products

MLHR is a manufacturer of interior furnishing products used in a variety of environments ranging from offices to schools to healthcare facilities. The firm has received some high marks for its outstanding ESG practices around recycling—its repurpose program has diverted 27,000 tons of product away from landfill and back into production. The firm is gunning to produce no waste with their landfill initiative by 2023 and so far, they have been able to improve their processes in waste management.

Today, Herman Miller sees a pickup in demand for office furniture as employees move back to offices. For fiscal 4Q, Herman Miller expects sales orders to be better than the previous quarter. The Michigan-based company generated about $591M in sales during its 3Q and $566M in orders, down 11% and 13% year over year.

From a performance standpoint, the reopening trade is not fully priced in, with brokerage players pointing to a 20% upside from its current price. During the pandemic the company has migrated to a redesigned retail website, and began tapping into a variety of online revenue streams.

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