Smuckers (SJM) and Others Ignore Water, Climate Risk at Their Peril, says Jonas Kron of Trillium Asset Management

Jonas Kron is a vice president at Trillium Asset Management involved in shareholder advocacy. Trillium worked with shareholders at JM Smucker in a recent initiative to reassess the company's outlook on risks related to changing water and climate dynamics. We spoke with Kron to get an update on the initiative and the increasing investor demand for examination of water and climate risk, which will significantly affect the bottom lines of thousands of companies in 2012 and in coming years. Tell us about the shareholder challenge with JM Smucker you've been involved with at Trillium.

Jonas Kron: Coffee accounts for about 40 percent of the company's net sales and close to half of its profit. Coffee is also what a lot of people would refer to as a "goldilocks" plant - it doesn't like it too hot, too cold, too wet, or too dry. For a firm like ourselves, which looks at the environmental and social impacts and performance of companies, that's a big red flag - a company with a lot of eggs in one basket that could be at risk for changes in the hydrologic cycle, climate change, and so forth. We went to the company to ask them to be public about how they are going to deal with those risks to the company's supply chain and the company's profitability. That was our shareholder proposal that we filed about a year ago. The proposal went to a vote at the company's annual meeting in August, where it received about 30 percent of the voting shares in support of the proposal - essentially 30 percent of voting shares urging the company to have a strategy to deal with the risks and opportunities to the company's coffee-related businesses as climate change and water have an impact on that. Unfortunately, the company has put out a couple of vague assurances that they are thinking about these issues and dealing with them, but there is no substance to those assertions and no way to really verify or confirm.

It seems like a lot of these initiatives when undertaken are relegated to a company's environmental accountability division and the like. It almost demands a higher priority than that, correct?

Jonas Kron: Right now, agricultural water demand is projected to grow about 45 percent in the next 15 years. Just this year, we've seen a lot of water pressure on the food supply chain. The 2011 Texas drought and heat wave contributed to the price of peanuts, for example, going up from 30 to 40 percent (an important piece of the picture for Smuckers). Coffee prices were up around 35 percent over the year, and how companies are going to be dealing with those pressures is becoming increasingly important. We are looking for companies to have a system in place to be dealing with the challenges of climate change more broadly, and then the impacts of water on their supply chain.

Why is, say, using coffee futures contracts in the commodity markets to hedge against rising costs not an adequate approach for producers like JM Smucker?

Jonas Kron: There are two limits to that approach. The first is that trying to deal with risk simply through the use of financial instruments has its limitations. We are talking about potential changes to roughly 60 percent of the coffee-growing regions of the world. So, you can hedge - and hedge successfully - but there is a limit to that. At a certain point, you aren't going to be able to hedge your way out of that situation. The other side is looking at long-term growth and profitability of the companies, but also the economies in which they are operating and contributing. From our perspective as long-term investors, we are looking for companies that are not going to avoid through hedging instruments the impacts on themselves and their environments, but really have a long-term approach to creating value and prosperity for the company and the communities that depend on them - taking into account the realities of climate change and the changes in the hydrologic cycle. Some companies have that long-term vision and strategy, and some companies haven't shown evidence of that yet.

Companiesthat are not directly exposed to climate change or water risk can still be significantly affected through exposure from their suppliers, correct?

Jonas Kron: Absolutely. The supply chain, particularly for food companies, is where all of the risk and opportunity lies. We're looking at companies in terms of how they are measuring these issues in their supply chain, how they are engaging their suppliers, and how they're disclosing that. [We are] also understanding on a management level where the responsibility for this question lies and making sure that it is given appropriate attention given the risks.

What is on the horizon for the relationship between water management performance and stock value?

Jonas Kron: That quote came out of some work that is being done by the Carbon Disclosure Project, which is representing trillions and trillions of dollars of investor capital, that sends a survey to companies around the globe to understand how they're dealing with climate change and mitigating the risks. The most recent report found that companies with a strategic focus on climate change have provided investors with approximately double the average total returns of the Global 500 looking at a time period from January 2005 to May 2011. So they're starting to see the relationship between climate change strategies and investor performance. We're at an earlier stage on water. The Carbon Disclosure Project has a nascent water survey that they have rolled out over the last three years, and that's going to start to mature over the next year. It is going to be interesting to see if we start seeing a similar relationship there - between water management and financial performance. Water is really the way in which climate change is going to express itself in the most tangible ways in the immediate future. As we get more data on how companies are dealing with water risk - how they're measuring it, how they're managing it, how they're engaging their suppliers on it, how they're disclosing it - and the relationship with financial performance, it will be interesting to see if we see [something] similar. That's something that we're going to be looking for.

What will it take to tip management over the edge in this direction?

Jonas Kron: I think with most of these systemic changes there is never going to be one single event. It's going to take increasing questions from investors and regulatory interest in these issues. I think there are some real reputational issues for some companies, so that is going to be an important piece [of this] as well. Part of it will have to be internal - as senior management starts seeing the physical risks and start making that a priority for their company. The pressures of water scarcity or overabundance and climate change are going to be steadily coming at us, and I think those pressures will weed out the companies that don't deal with it and foster growth in the companies that do address those challenges.