ESG is another upcoming three-letter abbreviation that will impact the trucking industry, according to a recent report from Morgan Stanley (NYSE: MS).
ESG may sort of rhyme with ELD, but it stands for environmental, social and governance. It is a growing but still somewhat vague standard that judges companies on how well their operating practices and principles align with ESG guidelines. ESG ratings might ultimately be viewed as something akin to a credit rating, but against other nonfinancial performance metrics.
"We believe the freight transportation sector is exposed to these key ESG themes," Morgan's transportation team led by Ravi Shanker said in the report. Those themes:
- "Increasingly high regulatory and social scrutiny of carbon emissions."
- "A high degree of regulatory oversight for labor, safety and competition."
- "Varied levels of board independence but low board diversity."
Each of those three align, in order, with ESG.
Whether ESG principles have any real-life impact on a company's operations has been a subject of significant debate among analysts. In a 2018 piece for Forbes, the writer George Kell argued that it does matter to investors. "Many investors recognize that ESG information about corporations is vital to understand corporate purpose, strategy and management quality of companies," Kell wrote. "It is now, quite literally, big business."
In other words, it is not just an award for doing good things. It is a standard that investors, particularly institutional investors, are looking at when choosing where to put their dollars. A company on the wrong side of changing standards on the treatment of employees or environmental practices can find itself shunned by investors trying to avoid the risks inherent in a company like that. A company on the right side of those trends can be looked upon favorably.
One takeaway from the Morgan Stanley report, beyond its company-by-company commentary on how various trucking and transportation companies might be judged, is that in a highly fragmented industry with small companies sometimes competing for the same freight against publicly traded behemoths, regulation is good for the big guys.
For example, the report says, "as emissions regulations step up over time, the costs of running older trucks will increase and fees for noncompliance will be lofty, putting smaller carriers who can't afford to upgrade at a cost disadvantage."
Having a strong capital structure will aid in those efforts. "While the upfront costs are set to increase, well-capitalized companies who can make the investment likely will see future costs savings from reduced fuel purchases and we believe payback periods for these technologies could be a matter of months," the report said.
That is an economic scenario, one which would exist regardless of ESG standards being enforced by the investment community. But if the regulations on truck emissions join with fleet programs to improve fuel efficiency for cost savings, the E prong of ESG — environmental — might concurrently be accomplished sufficiently to meet the standards of investors.
Or as Morgan Stanley put it, "We believe tougher fuel-efficiency standards are a net positive to the trucking stocks."
The report goes through companies truckload by truckload, reviewing the fuel efficiency of eight of them. The companies almost uniformly get high reviews on the E prong. Werner's (NASDAQ: WERN) "fleet age of 1.7 years is impressive and means they benefit from the latest in fuel-efficiency technology." U.S. Xpress (NYSE: USX) "has adopted a variety of solutions to tackle greenhouse gas emissions." And so on.
The S prong has always been a bit tougher to define — and not just for trucking companies. The Morgan Stanley report mostly focuses on employee relations and turnover. As expected, all of the truckload companies it reviews are cited for high employee turnover, but it isn't clear what precisely would be a good social structure in an industry in which high turnover is a permanent part of the landscape.
Some of the kudos offered by Morgan Stanley for employee relations go to U.S. Xpress, praising its "position to attract and retain drivers … given benefits like a 401K match program," and Heartland (NASDAQ: HTLD), which it said is like most of the publicly traded truckload companies in that it can offer "relatively high driver pay."
The S scenario for LTL carriers in the report is complicated by the fact that so many of them have union workforces. And given that so many LTL drivers get home each night, turnover is a fraction of what it is at the truckload companies. The Morgan Stanley report notes that the lower turnover is a plus for its social grade. But it also says that in the case of ArcBest (NASDAQ: ARCB), the fact that about 65% of its employees are union "may put them at a disadvantage to other LTL players if new regulation tightens up driver capacity."
The G prong is a lot easier to define. The focus is on a company's board of directors and its level of independence, defined as the number of directors who are truly independent. When bad governance is looking for an example, the Uber board under founder and ousted CEO Travis Kalanick is often cited as exhibit A.
Governance also focuses on the diversity of board members. For example, the report lists Schneider as having just 60% of board members that could be described as independent, but 20% female board members, which is relatively high compared to other trucking companies. Knight-Swift (NYSE: KNX) has 72.7% directors who are independent. Heartland has 28.6% female board members; Werner has 11%.
The report also focuses on rail and parcel. Even though the environmental impact of moving a ton of freight by rail is significantly better than moving it by truck, the Morgan Stanley report sees risks and opportunities in the E prong for railroads.
For example, various regulations or market shifts already have impacted the railroads' coal business; coal is a negative in railroads' ESG scenario. But activism against the construction of new pipelines could result in greater opportunities to move crude by rail. That's a place where in an unusual way, environmental activism is boosting railroads so their financial performance can benefit.
That juxtaposition of how an environmental movement to fight coal might be bad for railroads at the same time that an environmental movement to fight pipelines might be good for the railroads is a perfect example of how ESG benchmarking is designed not just to praise companies for their efforts. It's also to identify risks and opportunities created by regulation and societal shifts.
S&P Global, with its debt ratings that are key industry benchmarks for companies, governments and countries, is making a major push into providing ESG ratings. That they are not just a blue ribbon award for doing good things was summed up in a statement by John Berisford, the president of S&P Global Ratings. "(ESG) risks and opportunities have the potential to affect creditworthiness," he said. The company's analysts "work to ensure that we provide essential insights into ESG factors as they relate to the financial markets."