Sustainability is the key to Wesfarmers' success

Saturday, 01 May 2021

Deborah Tarrant photo
Deborah Tarrant

    Wesfarmers Limited managing director and CEO Rob Scott on how the diverse group plans to achieve its ambitious sustainability goals and shareholder returns.

    Big goals have been set. In 2020, Wesfarmers announced net zero targets for carbon emissions for the West Australian retail and industrial conglomerate’s divisions. For the household retail names it owns — Kmart, Target, Bunnings and Officeworks — the date is set at 2030. Wesfarmers industrials division has a far longer horizon to 2050 for carbon neutrality.

    Then there’s its profitable chemicals, energy and fertiliser division, WesCEF, which also aspires to the 2050 goal, but currently has no clear way to achieve it. WesCEF faces a “tricky” long-term transition issue, admits CEO Rob Scott — one reflective of many parts of the economy. It produces ammonia, a key ingredient in fertilisers and explosives used in the mining sector, and is responsible for a significant chunk of the company’s Scope 1 and Scope 2 carbon emissions, according to Wesfarmers 2020 annual report. And it’s engaged in a waiting game.

    “There is currently no technology commercially available to produce ammonia without emitting carbon,” says Scott. “You can’t offset it by moving to 100 per cent renewables because the process itself produces carbon. We’re optimistic there will be technical and commercial solutions for this, but it is probably going to be over the next decade and beyond.”

    And therein lies the catch 22 for Wesfarmers, a company that’s “very ambitious” about its sustainability goals. Despite WesCEF’s deployment of abatement technology, risks present whichever way you look. As Scott outlines: “If the world ceased production of ammonia via the current processes then billions would starve because there wouldn’t be enough fertiliser to sustain food production globally. To be clear, WA farmers wouldn’t be able to grow and export grain and iron ore producers wouldn’t be able to export iron ore.”

    Your performance in sustainability becomes a critical factor in whether a consumer will deal with your business.

    Climate change awareness

    When the one-time investment banker and former 1996 Olympic rowing silver medallist took on the top job at Wesfarmers in late 2017, he landed with a firm grasp of climate change issues courtesy of his six-year stint as managing director and CEO of Wesfarmers Insurance from 2007–13.

    “There’s always education,” he says. “I did an enormous amount of work a few years ago because I realised you can’t often believe what you read in the press or see on social media. I actually went through a process of reading an awful lot of academic material to get my head around some of the science of this — and I know a lot of our board members have done exactly the same thing — because these are emerging areas. What we learned at university and school 20, 30 or 40 years ago isn’t necessarily going to help us comprehend today’s issues.”

    Scott is not shying away from some of the more gnarly aspects of sustainable practices, the realities of working towards goals that bear risks and opportunities for one of Australia’s oldest and largest companies.

    Wesfarmers had a head start on sustainability. Founded as a farmers’ cooperative in 1914 and listed on the Australian Associated Stock Exchanges in 1984, the company could lay a legitimate claim to a long-term people and planet approach that pre- dates widespread recognition of climate change as an environmental threat or ESG as the corporate acronym of the 21st century.

    Scott paraphrases the six-part credo that’s been in place since Wesfarmers listed in 1984. “We must anticipate the needs of our customers, look after the safety of team members, treat our suppliers fairly and ethically, look after the environment, contribute to the communities in which we operate, and act with honesty and integrity.”

    Since then, a revolution in global thinking and approaches to corporate sustainability has occurred in tandem with shocking evidence for climate change and a global pandemic. Board and management have been working to stay ahead of an incessantly changing game — reporting on sustainability since 1998, consistently showing progress, prioritising ethical sourcing for the past decade and driving sustainability through its 16,000 suppliers globally. The company has been using the Task Force on Climate-related Financial Disclosures (TCFD) to report on climate change since 2019.

    The shareholder factor

    However, upfront in The Wesfarmers Way — the framework for the company’s business model and value-creating strategies — its stated primary objective is to deliver “satisfactory returns for shareholders”. How does Scott reconcile that with its stated sustainability drive? “We don’t apologise for being very financially focused, but we believe strongly that to deliver top-quartile returns over the long term, you simply have to operate your business in a sustainable way,” he says.

    Some companies treat sustainability as independent to their financial objectives, notes Scott. “We fundamentally disagree with that. Sustainability is fully integrated with our long- term objective to deliver superior financial returns. That’s an important way we differentiate from many other companies. Ultimately, your performance in sustainability becomes a critical factor in whether a consumer will deal with your business, whether a worker wants to work for your business or whether a shareholder wants to invest in your business. It’s a risk if we don’t embrace it and it’s an opportunity if we get it right.”

    We believe strongly that to deliver top quartile returns over the long term, you simply have to operate your business in a sustainable way.

    Wesfarmers chair Michael Chaney AO FAICD told shareholders at the AGM in late 2020 that the company has always been adamant it can only achieve good returns in the long term if it looks after the interests of all stakeholders, suppliers and employees, customers and the communities in which it operates. “COVID-19 has given us an opportunity to put those words into action,” he said. Chaney added that this was because Wesfarmers had been financially prudent and maintained a strong balance sheet and because of its culture. "Even though we are a diverse business with autonomously run divisions, there is terrific collaboration across the group,” he said.

    Taking opportunities

    Earlier this year, Wesfarmers took the opportunity to support the growth market for electric vehicle batteries with startup funding for a plant in Kwinana, Western Australia — to process lithium hydroxide from its Mount Holland project, a joint venture with Chilean giant Sociedad Quimicay Minera de Chile. The company expects to spend about $950m developing the mine, concentrator and refinery. Mount Holland is the major asset of Kidman Resources, which Wesfarmers took over in September 2019.

    The company deferred its final investment decision on the project in January 2020. Lithium prices were weak at the time, but a year later, they had started trending up as Scott announced that the company would go ahead, following talks with battery manufacturers. His claim of a “positive outlook” for battery-quality, sustainably sourced lithium hydroxide may be an understatement. Financial services multinational Morgan Stanley predicts electric vehicles will account for almost one-third of global car sales by 2030.

    Last year’s risk had turned into this year’s opportunity. “There are always judgements you need to make and choices around investment and focus,” says Scott.

    Risk and reputation

    One area of risk that’s non-negotiable, he says, is reputation. “If there was a choice on a sustainability matter that we felt would expose the group to an unnecessary reputational risk, then we would always err on the side of doing what would protect our corporate reputation,” he says.

    Collaborating on climate change

    Collaboration is widely acknowledged as crucial for wrangling the complexity of sustainability issues. Externally, Scott is a member of the Climate Leaders Coalition, an affiliation of 22 CEOs from Australia’s biggest companies, including BHP, Qantas, CBA, Fortescue Metals and Santos. The group is convened by former Lendlease senior executive Lynette Mayne AM, who heads the Australian branch of Richard Branson’s B-team initiative.

    “What attracts me [to the group] is the opportunity to be really open in talking about the really difficult issues,” says Scott. “What are the things we’re struggling to work through? We can focus on areas of mutual interest — whether it’s how the offset market will evolve, the opportunities with hydrogen, or carbon capture and storage.”

    Scott’s remuneration package and those of the managing directors of Wesfarmers’ divisions — all of which operate autonomously — are tied to sustainability objectives. Scott claims the leadership team is already so committed to ESG issues that incentives may not be necessary. However, they send a symbolic message that reinforces what’s important to the company — as relevant for external stakeholders as it is for employees.

    A particular focus is Indigenous employment, while safety represents 10 per cent of the annual scorecard. And there’s a catch-all edict that allows the board’s remuneration committee and Scott to make adjustments to executive remuneration for deficiencies or breaches that actually impact the company’s reputation.

    Keeping a handle on risk in an organisation with 107,000 employees working across Australasia, Asia, the UK and the Middle East requires a strong focus on robust reporting and monitoring systems. In the long transition phase ahead, Scott believes transparency about what’s not working must prevail. “As you take greater focus and embed new processes in any area of sustainability, one of the most important points to recognise is that you will ultimately find problems,” he says. “There will be issues. Maybe you weren’t adequately measuring or reporting something, or maybe there were critical breaches in your supply chain. It’s important to bring those issues out. In Wesfarmers, we use the term: ‘The best demonstration of openness in our culture is that bad news travels faster than good news’. Identifying and raising issues is not a failure — it’s a success that you have identified an issue.”

    Wesfarmers has had its share of such “successes”. In recent years, the company has outed itself for payroll errors in its industrial division, and at Bunnings and Target, to the tune of $30m. And, in Australia’s new era of modern slavery reporting, it is also hitting its straps.

    Dealing with modern slavery

    Wesfarmers’ 2019–20 modern slavery statement identifies 340 critical breaches across 105 suppliers, which were identified by the group’s divisions in an ethical-sourcing audit of more than 1800 suppliers. The majority of breaches included allegations of excessive overtime, transparency around recordkeeping and documentation, safety, unauthorised subcontracting and bribery. Four critical breaches related to three suppliers, which were immediately exited, while Wesfarmers says it ceased ordering from 17 more.

    We shouldn't pretend just because we are a developed Western economy that these issues [poor work practices] don't exist in our country.

    “There are many issues within Australia that require close monitoring because they are susceptible to areas of abuse of subcontracting and other poor practices — areas that have been on our radar, such as the subcontracting of cleaning services when we owned Coles,” says Scott. “The horticultural sector is another where we needed to make sure we had strong processes in place. That’s still relevant in the context of greenlife, given we sell plants at Bunnings. We shouldn’t pretend just because we are a developed Western economy that these issues don’t exist in our country.”

    Wesfarmers was more prepared than most for what was coming through its exposure to the UK’s frontrunning modern slavery reporting regime, via the Workwear and Homebase groups. Its takeover of Homebase, the UK hardware chain, represented a $1.7b loss on investment for Wesfarmers in 2018.

    “One should be suspicious if a company reports no critical breaches in its supply chain,” says Scott.

    In 2018, with CFO Anthony Gianotti, he visited Bangladesh to see the challenges of manufacturing “ethically sourced” goods in a developing economy. “You can’t fully understand some of the challenges and opportunities unless you have physically been there,” he says. “It was a major eye-opener and highlighted a lot of the risks of doing business in Bangladesh and the importance of having people on the ground.” The company has nearly 800 employees in China, India and Bangladesh.

    The trip also emphasised to Scott “the positive impact big companies can have”. An example of this impact is Wesfarmers participation in ACT (Action, Collaboration, Transformation), which brings big- brand retailers such as Zara and H&M together with trade unions to collaborate on achieving a living wage for local workers through industry-level collective bargaining and purchasing practices.

    But when Scott met with a group of NGOs to seek their advice on how to push the issue forward, he was surprised by their response. “Please be patient,” they said, referring to massive economic and developmental changes underway in the emergent economy. Once again, time had raised its head.

    Scott returns more than once to the risks of disenfranchising people in the rampant push for sustainable action. In the broadest sense, he’s concerned the world’s poorest countries will be most exposed to climate change and their people will bear more than their share of the burden due to the lack of infrastructure for resilience.

    Transition risks

    Closer to home, Scott has his sights on communities affected by the transition from fossil fuels and other big-emitting businesses. It’s pivotal to his thinking on how Australia approaches the coming decades. The changes around decarbonisation are an unstoppable trend and clearly certain businesses and economies will benefit disproportionately from the opportunities.

    “Where the politics become difficult is where people try to resist change in an effort to protect a particular community or cohort of people who are going to be disaffected,” he says. “The better way is to be very open and honest, and acknowledge the impact then leverage the enormous capability and financial strength we have to support those people.”

    Within Wesfarmers, Scott feels well supported, and constructively challenged, by a strong, experienced and gender-balanced board led by former MD Chaney. The directors bring awareness of sustainability issues, a diversity of perspectives and insights from their directorships at other companies on arguably the most urgent topic of this millennium.

    Wesfarmers has successfully made it through its first century, but what will it look like 100 years from now? “Over the past 50 years, the company has looked different every decade,” says Scott. “I can’t anticipate what the world is going to look like, but we’re well equipped as a group to rapidly adjust our processes and where we allocate our capital.”

    Climate change risk management

    Analysis of three climate scenarios is at the centre of Wesfarmers’ climate change strategy. The scenarios reflect the limiting of global average temperature increases above pre-industrial levels by 1.5°C, 2°C and 4°C by 2100.

    The company’s 2020 annual report disclosures follow the Financial Standards Board Task Force on Climate-related Financial Disclosures (TCFD) recommendations. The report outlines the strategy, risk, metrics, targets and governance actions that reflect its desire to “contribute positively” to the global goal of achieving net zero carbon emissions by 2050, consistent with the Paris Agreement.

    Each division assessed risks and opportunities against the scenarios. Each scenario was assessed over the short term (one to five years), medium term (five–15 years) and long term (15-plus years).

    Wesfarmers has considered the physical and transition risks and opportunities in the context of its businesses, industry, operations, products, supply chain, customers, geography and scale. Physical risks are assessed as acute or chronic, and transition risks are assessed through the lenses of policy and legal, markets, reputation and liability.

    Across existing businesses, climate-related opportunities are listed in five categories: resource efficiency and cost savings, renewable energy, new products and services, access to new markets, and resilience in supply chain. The performance goals and remuneration of the managing director and divisional MDs include individual performance assessments.

    Scenario 1.5°C

    • Strong, rapid reduction in emissions driven by government policy, with focus on minimising climate change.
    • The energy system quickly transforms to zero emissions via the uptake of renewables.
    • Carbon-intensive industries can only continue if they invest in carbon capture and storage technologies and/or are among the most efficient in their industry.
    • Consumption of non-essential items falls and people reuse/recycle more.

    Scenario 2°C

    • A market-led transition enabled by a policy environment that drives rapid reductions in emissions.
    • A decentralised energy system emerges, dominated by demand management, renewable energy and storage technology.
    • Global trade flows remain strong and the focus on circular economies grows with an increase in recycling and decoupling of resource use/growth.

    Scenario 4°C

    • No coordinated global action on emissions reduction.
    • Business does not change significantly to address climate change.
    • Fossil fuels deliver about 50 per cent of the global energy mix.
    • Acute (extreme) and chronic (long-term) physical impacts of climate change are felt, with significant cumulative impact on the economy.
    • Economic growth continues to 2030 and then declines as ecosystems struggle to support increased environmental impact.
    • Resource depletion causes food/water scarcity; increases risk of conflict.

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