In the initial surge of the COVID-19 pandemic, analysts across our firm sought to assess how portfolio holdings were responding and addressing core concerns including the health and safety of employees, and the maintenance of safeguards around supply chains to avoid exploitation.
Health and Safety Due Diligence
To better understand company responses pertaining to workplace practices, one of our investment teams leveraged big data to cross-reference public statements from companies against third-party information on employee feedback regarding companies’ human capital management and engagement efforts. This gave the team insight into worker sentiment regarding management responsiveness. To further supplement the data from these sources, the team also sent select portfolio companies a questionnaire with COVID-related questions on health and safety, hazard pay, shift adjustments and economic issues.
In light of the extreme challenges of the period, the responses we received to the questionnaire suggested that generally, companies were attempting to take positive actions. Among the examples of positive action, is a U.S. railroad that set up furlough boards to adjust workforce without layoffs and planned to add extra benefits for workers, believing that retention will be an important issue as recovery takes hold and a U.S. bank that provided critical frontline employees with a 20% wage premium. However, since many policies lacked discussion of contractors or contingent employees, we encouraged companies to clarify their positions on these issues.
Looking Beyond Frontline Workers
At the outset of the pandemic, our investment teams were concerned that the crisis could worsen labor exploitation, particularly among businesses in the consumer sector that often rely on third-party suppliers operating in regions where there are reports of forced labor. The teams conducted virtual meetings with companies, including high-risk sectors such as apparel and footwear to better understand their commitment to sustainable production despite limitations imposed by COVID-19. They found that many companies were rapidly adapting with extra measures designed to promote worker safety and fair labor practices within their supply chains. For example, despite temporary disruptions, one global athleisure company resumed its on-site audits where possible, and it continues to monitor local conditions on an ongoing basis.
Taking Lessons From our Outreach
We were pleased to see many of our portfolio companies’ commitment to health and safety and sustainable supply chains in the midst of COVID-19. While there are challenges to creating a positive labor force management plan during a pandemic, we found that companies with preexisting constructive employee relationships and policies were well positioned to support workers and minimize disruptions during the pandemic. Furthermore, our investment teams who had assessed similar themes before the crisis were able to gauge the credibility of pledges that companies had made which helped to inform subsequent engagements with those companies.
Talen is a privately owned utilities issuer with a diversified portfolio of power-generation assets, including natural gas, nuclear and coal power plants. Given its relatively high allocation to coal assets, Talen was working on a transition to cleaner fuels. However, we believed it needed to better communicate its actions, reduce financial risk and implement a faster timeline on reducing its coal exposure to avoid increasing its cost of capital.
Scope and Process:
Based on our due diligence (regular discussions with management, site visits and consultations with competitors, industry experts and the company’s financial sponsor), we believed there was significant potential for management to reduce the company’s environmental impact and risk profile through operational improvements, equipment retrofits and plant retirements. At the same time, we believed that its financial policy was relatively aggressive and did not appropriately position the company to navigate industry changes. In regular engagements held over multiple years, we sought to encourage a more conservative balance sheet strategy and a continued focus on shifting away from coal.
Outcome and Outlook:
Management and its financial sponsor were responsive to our suggestions. The company implemented a more conservative financial policy and disclosed expectations for future emission reductions. The company subsequently took additional steps and announced that all wholly owned coal power generation will be transitioned out of its portfolio over 2025 – 2028, in conjunction with a preliminary agreement with the Sierra Club to avoid future coal litigation and increased investment to expand solar, wind and energy storage. The transition is unusual not only for its ambitious timeline, but also its conversion (rather than divestment) of some existing facilities to use energy sources with a lower emission profile. Talen also improved transparency by providing historical emission and safety statistics, attending industry conferences and hosting recurring Analyst Days to provide updates on its progress.
Univar Solutions Inc. is a leading global chemical and ingredients distributor and provider of specialty services. A private company until 2015, Univar acquired a key competitor in early 2019 to become one of the largest North American players in a fragmented market, and is in the process of streamlining its assets and enhancing its digital capabilities to better connect with customers and suppliers. In initiating our position, we saw potential for cost synergies and increased asset efficiency due to the acquisition, but also some issues in corporate governance. We believed we could leverage our knowledge to help guide this recently public, smaller-cap company on how a top-tier public company should look and act.
Scope and Process:
Starting in early 2019, we engaged with senior management and the lead independent director on various governance issues. During in-person meetings and conference calls, we argued that the management team should clarify its messaging to the investment community, adopt a mandatory retirement age policy for the Board of Directors and hire a new CFO to develop and implement best practices. As part of our inaugural NB Votes initiative, based on what we considered an excessive Chairman/ex-CEO pay package, we withheld votes for the Directors on the Compensation Committee, indicating our position to Univar and publicly disclosing it in advance of the annual meeting. Recently, we began communicating with the company’s CFO and general counsel on their employee satisfaction, diversity and inclusion metrics.
Over the course of the past year, most of the changes we requested have occurred. The Board of Directors implemented a mandatory retirement age of 75, strengthened its “claw-back” incentive compensation for executives, and reduced the number of public Boards upon which the CEO and Directors can serve. Univar also hired a new CFO and, with our input, revamped its investor presentations. In October 2020, the Board of Directors appointed a leader for its newly formed Governance and Corporate Responsibility Committee with the plan to lay out more goals on diversity, inclusion and environmental metrics. This progress has helped reinforce our confidence in Univar.
The COVID-19 environment has changed consumer, investor and corporate behavior as society has collectively sought to safely progress through the pandemic. The effects have varied across sectors and companies, creating dislocations in some areas yet accelerating demand in others.
We established a position in BJ’s Wholesale in the early stages of the pandemic, believing it was well positioned to capitalize on increased home storage of groceries and eat-at-home trends due to social distancing. During this time, the company continued to focus on delivering value for families and initiating a shift to a faster-growth business model
Scope and Process:
In our research, we identified several ESG-related opportunities at BJ’s Wholesale that we believe could create value for shareholders. Engagement is crucial to our process; and we interacted with the company’s senior management team on multiple ESG topics. We sought to address shorter-term challenges, including their response to COVID-19, while also considering medium-term objectives such as diversity, inclusion and capital allocation. Our goal is to ensure BJ’s Wholesale is competitively positioning itself to have greater resilience both during the pandemic and through the recovery.
Regarding capital allocation, we supported the company’s strategy to use its growing cash flow and improved balance sheet to increase new store openings and return capital to shareholders. In response to COVID-19, the company acted prudently by increasing pay for frontline employees during the crisis, adjusting its absentee policy, improving safety and social distancing, and donating perishables to food banks. We also asked for more disclosure of pay parity and key performance indicators to address equity, inclusion, and diversity (EID). Research has repeatedly shown that EID has a positive impact on business performance, organizational health, innovation and resilience, all of which will be much needed as companies recover from the COVID-19 crisis.
Outcome and Outlook:
Since going public three years ago, BJ’s Wholesale has made significant strides on ESG matters that have also supported the company’s buoyancy against market uncertainty. Examples of recent progress include its agreement to a shareholder proposal to declassify its board (so all directors stand for election each year), a sustainability website, and a public stance against racism and violence. The company is also committed to provide more disclosures in accordance with the SASB standards.
We will continue to monitor the company’s progress, and encourage management to prioritize efficient capital allocation, and customer and employee safety. In our view, BJ’s Wholesale can readily achieve these goals while providing critical services during a difficult period, and beyond.
LKQ Corporation is the world’s largest auto parts recycler and a longtime holding. As an aggressive industry consolidator, the company historically enjoyed significant growth and competitive advantages but was somewhat undisciplined in its use of capital. Over time, its portfolio of businesses became unwieldy, while its stock became stuck in a pattern of dashed expectations and disappointment. In 2017, the departure of its CEO provided a new opportunity for us to engage with the company.
Scope and Process:
Over several years, we had regular meetings and calls with senior management, asking questions on pivotal issues and providing our views on how to enhance business practices. We also consulted middle management, former employees, competitors and customers, (as well as a large activist investor in the company), to gain more understanding of its governance and operations. Based on this due diligence, we made several requests over time, including: the reduction of financial leverage, better executive compensation alignment, a fresher and more diverse board, a clearer plan to improve profit margins, more disciplined M&A and a general capital allocation strategy.
Outcome and Outlook:
We have enjoyed a collaborative and constructive relationship with management, which has been receptive to our ideas. Since 2017, there have been 12 board membership changes (total additions and exits) and management enhancements to broaden skillsets and perspectives. In 2019, the company made significant upgrades to its executive compensation plan and field-level incentives, including closer alignment to stakeholder interests. In recent quarters, execution has improved and with reduced M&A activity, debt ratios have declined.
LKQ’s business is highly relevant to a world where environmental sustainability is growing ever more important. We continue to engage with the company to help with its strategic goals as it seeks to deliver for stakeholders