Analysing Fairlight’s Carbon Risks

Whilst Fairlight’s primary objective is to deliver superior investment returns to clients, we believe this can be achieved in an environmentally and ethically aware manner. We do not market ourselves as an ESG Fund, however the outcome of our pragmatic, research driven approach to ESG is a portfolio that is 95% less carbon intensive than the benchmark. This is achieved despite owning two relatively high emitting companies that score poorly on widely accepted ESG scorecards. In this piece we highlight how the ‘green’ credentials of these two companies form important parts of their competitive advantage and how counterintuitively both will be critical to meeting the world’s future net zero ambitions.

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Lennox International

Lennox International is a manufacturer of HVAC (heating, ventilation and air conditioning) products, primarily for residential homes in the US. Lennox is the most carbon intensive company in the portfolio, emitting 40 tonnes of CO2 per million dollars of revenue and produces a total 168,074 tonnes of Scope 1 & 2 CO2 (refer to March 2020 article for definitions). While on first glance these figures may appear high relative to the portfolio, it would be shortsighted to label Lennox an environmental risk before fully considering the impact of its products in totality.

90% of Lennox’s revenues are derived from replacing existing systems, many of which are decades old with incredibly high electricity consumption. By replacing an old system with one of Lennox’s industry leading efficient systems a homeowner can cut their total electricity usage by 25% or more. While traditional carbon intensity analysis focusses on the carbon cost to manufacture the system, we are of the view the net benefit over the life of the system more than outweighs the initial cost.

Further proving Lennox’s green credentials, in June 2022 Lennox won a challenge set by the US Department of Energy to design a highly efficient cold climate heat pump. Heat pumps can heat and cool homes and buildings using half of the energy used by traditional heating systems. Importantly, heat pumps use electricity to transfer heat from one location to another, rather than generating heat by burning fossil fuels like gas or oil. This means for an energy grid powered by renewables (i.e solar) a heat pump can heat or cool a home with no impact on the environment.

Rolling out heat pumps is a key plank of the Biden administration’s environmental policy, with the recently passed Inflation Reduction Act containing hefty incentives to encourage households to purchase heat pumps. To contextualize the size of the opportunity, there is currently 58 million legacy heaters in the US that heat homes by burning natural gas, all of which will need to be replaced on the journey to net zero. Given Lennox currently boasts the most efficient cold climate heat pump (as evidenced by the DOE challenge win) we believe they are well placed to benefit from this multi decade tailwind to revenues and play a pivotal role in reducing emissions.

Hexcel Corporation

Hexcel Corporation is one of two manufacturers globally of aerospace grade carbon fibre and it is a key supplier to both Airbus and Boeing. The manufacturing process is a carbon intensive one, as the key input used to make carbon fibre is derived from oil and converting it into fibre requires substantial heating and hence energy consumption. Hexcel emits 36 tonnes of CO2 per million dollars of revenue and produces a total 168,074 tonnes of Scope 1 & 2 CO2.

While these figures are the 2nd highest in the portfolio, Hexcel’s products are ultimately critical to reducing the carbon footprint of the aerospace industry. Today, there is over 25,000 planes in service, most of which were built in the 1980’s and 1990’s, primarily out of traditional materials such as steel and aluminum. The latest airplanes designed by Airbus and Boeing, such as the 787 and A350, are now comprised of more than 50% carbon fibre.

Carbon fibre is significantly lighter than traditional materials like aluminum and steel and can be formed into more aerodynamic structures, which lowers fuel consumption and greenhouse gas emissions during flight. As a result, the A350 and 787 are up to 50% more fuel efficient than their predecessors. Unfortunately, these new generation lightweight planes only comprise about 5% of the total airplanes in service today. In order to meet net zero goals over the next decade airlines will need to replace their ageing fleets with new airplanes that will be built using Hexcel’s carbon fibre.

The Fairlight View

Given our quality focused investment process, we are not surprised by the relatively low carbon intensity of our portfolio (we do not invest in extractive industries, utilities or heavy industrials). That said, we are wary of the industry trend towards using blunt measurements such as CO2 emitted to screen companies out from investible universes. We prefer to analyze each company on its merits, evidenced by the case studies of Hexcel/Lennox where there is substantial nuance in their environmental contributions.

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