Morningstar - Q1 2020 - 28

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0.6

Spotlight:
54 ESG Risk

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40
EXHIBIT 4

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0.2

Profit Windfall Danish utility Orsted earns 88% of its profits from offshore wind
0
farms.
A focus on wind has allowed Orsted to develop a narrow moat since it sold
2000
2005
2017
its oil and gas
exploration and production
business2015
in 2017.
% Oﬀshore Wind in Orsted's EBITDA
% E&P in Orsted's EBITDA

0

Orsted's ROIC
30%

100

88
75

15
8

50

0

25

0 -15

0
2014

2015

2016

2017

2018

2019

Source: Company reports.

Improving its environmental footprint by focusing
on offshore wind has allowed Orsted to
develop a moat since the company sold its North
Sea oil and gas exploration and production
business in May 2017. The oil and gas business
had low returns on capital and volatile
earnings. Its sale drove a surge in Orsted's returns
on invested capital, which had been negative
in 2014 and 2015 because of large impairments
related to the oil and gas business.
Unlike power generation, most greenhouse gas
emissions from oil and gas happen when
they are consumed, not when they are extracted.
Therefore, it's difficult to measure the positive
environmental impact from Orsted's exit from the
exploration and production business.
At its power generation business, Orsted directly
reduced its emissions by closing coal plants
or converting them into biomass plants
while investing heavily in offshore wind farms.
This transformation enhanced its moat
because coal plants tend to have lower returns
and higher volatility than do offshore
wind projects.
Finally, the surge of prices of CO₂ allowances in the
European emission trading system since 2017
significantly reduced coal plants' competitiveness
against other power generation sources.

Morningstar Q1 2020

Social
Earning the Public's Trust, or Losing It
Social risks are diverse and numerous, ranging
from effective use of human capital to
human rights in developing nations. Social issues
tend to involve the impact a company has
on all of its stakeholders: employees, customers,
suppliers, and local communities. A firm's
ability to avoid damaging its relationship
with these stakeholders can be an important
part of sustaining its long-term competitive
advantages, particularly when the firm relies on
the public trust in its products or services
to maintain its moat. Two companies in different
industries-AstraZeneca AZN and Equifax
EFX-demonstrate how social risks can be
handled to the benefit of investors or downplayed
to their potential detriment.

AstraZeneca
As a global pharmaceutical firm with an evolving
product portfolio, AstraZeneca supports
its wide economic moat with smart strategic
decisions on drug pricing and product governance,

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two of the biggest social issues affecting the
2017
2030E
branded drug industry.
Strong pricing power around Astra's portfolio
of drugs is a core pillar of the firm's wide
moat. Pricing dynamics have an impact on public
access to basic healthcare services (a central
ESG issue), and Astra has a history of fair
U.S. price increases for its oncology portfolio.
These products dominate Astra's forecast
as older respiratory drugs lose patent protection.
Astra's oncology portfolio likely has not built up
significant discrepancies in price between the
U.S. and international markets, further supporting
reasonable prices globally and introducing
less risk to Astra's U.S. drug prices if federal policy
is reformed. An analysis by the Institute for Clinical
and Economic Review, a U.S. cost-effectiveness
group, is largely supportive of the majority
of Astra's cancer and cardiometabolic drugs.
On the product governance side, or the quality of
Astra's management of its products, Astra
has done a good job of lowering its liability risks by
focusing more on life-threatening diseases with
acute treatment. Drugs treating life-threatening
diseases such as cancer rarely face significant
side-effect issues that can lead to major product
liability cases, given that the high severity
of the underlying disease tends to offset most
potential side effects.
As the first chart in EX HI B IT 5 shows, we project
that less than 15% of sales over the next five
years will come from drugs treating less-severe
diseases that require chronic treatment-
drugs that we think are more likely to be litigation
targets. Less product liability costs should help
support the high returns that are emblematic of
a wide-moat company. Lower litigation costs
around product governance should improve Astra's
ESG standing and support its moat.
Looking ahead, as the second chart in EXHIBIT 5
shows, we are projecting legal exposure at 1% of
annual income. This is significantly lower than the
previous five years, which is due to less exposure
to drugs associated with high product governance
issues. Also, the projected amount is slightly
less than its peer group because of the company's

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Morningstar - Q1 2020

Table of Contents for the Digital Edition of Morningstar - Q1 2020
