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Thu 3 Oct 2019 03:03 PM

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Taking plastics seriously

By addressing their plastic consumption, companies not only benefit the environment, but also create opportunities to differentiate themselves

Taking plastics seriously
Around half the plastic produced is used for consumer goods

Plastic is high on the corporate agenda. We looked at the companies within our portfolio to assess how this topical issue might influence their sustainability of returns on capital.

The world is drowning in plastic. A 2016 report (The New Plastics Economy: Rethinking the future of plastics) by the Ellen MacArthur Foundation predicts that, based on current trends, there will be more plastic in the oceans than fish come 2050. Around half the total plastic produced is used for consumer goods packaging, usually single use, and very little is recycled, whether due to economic or technical reasons.

We believe taxes on plastic packaging, including outright taxes on virgin plastic, higher waste processing fees, and the introduction of deposit return fees, may all have a material effect on consumer staples companies in the future, unless they manage to adapt.

In terms of cost, we have identified two main ways in which plastic may impact fast-moving consumer goods (FMCG) companies, in addition to reputation or brand damage.

Plastic taxes and regulation

The aim of a plastic tax is not to raise revenues or reduce plastic use, but to encourage an increase in recycled content, (e.g. a tax is levied on any packaging with less than 30 percent recycled content). We would anticipate any such tax being large enough to be noticed by packaging manufacturers (with their low margins) and their FMCG clients, but not so large that it would hurt final consumer demand if passed on.

The tightening of extended producer responsibility (EPR) rules would have a similar impact to the introduction of a tax. EPR means that companies producing any kind of waste have to pay the costs of dealing with it. The most comprehensive scheme is in Germany where brand owners are compelled by law to pay 100 percent of the net cost. Meanwhile, in the UK, the system only covers about 10 percent of the cost, although this is currently being reformed. The EU, too, is reviewing EPR requirements across the bloc. To quantify the effect, we calculated the potential cost impact of such a scheme on an American beverage company we own.

Should the whole world move to the German model, it would cost this company 4 percent of sales, while a move to the average EU cost would have an impact of 1 percent of sales.

Strong consumer brands have significant pricing power and have historically managed to pass a substantial proportion of their input cost inflation to their customers. We believe this would also apply to plastic. Similar to raw material inflation, if regulation increases companies’ costs, every company in a given country will be impacted similarly and will likely try to pass cost increases onto consumers. Given low price elasticity in consumer staples, we believe the volume impact of such industry-wide price increases would be limited.

Increased cost of recycled material

There are over 350 signatories to the Ellen MacArthur Foundation’s New Plastics Economy Global Commitment, representing around 20 percent of global plastic packaging use. Their aggregate commitments to increase recycled content amount to five million tonnes of additional demand for recyclate by 2025-2030, compared to current market demand of what we calculate to be around three and a half million tonnes. Such a significant increase in demand may, in the medium term, push the premium up until enough capacity comes on stream.

With consumers ever savvier about responsible corporate behaviour, our engagements with the FMCG companies we invest in show they are taking plastic waste seriously and, in preparation for the upcoming impact of stricter regulation and plastic taxes, have dramatically increased their commitments to virgin plastic reduction. Plastic may not currently represent a material risk to the sustainability of returns of consumer staples companies, but the potential of it doing so in the future, not to mention reputational damage, is too high to dismiss.

In April 2019, Morgan Stanley launched its Plastic Waste Resolution, committing to facilitate the prevention, reduction and removal of 50 million metric tonnes of plastic waste from rivers, oceans, landscapes and landfills by 2030.

Vladimir Demine, Head of ESG Research, International Equity Team, Morgan Stanley Investment Management