• July 2, 2019

By Jacob London

For the last eight years investors, corporate executives and policymakers have ranked water crises and extreme weather events (exacerbated by climate change) among the top five threats to economic growth and geopolitical stability, according to the World Economic Forum. It's not hard to see why.

Seventy percent of the world's freshwater is used to irrigate crops and raise animals. By 2050, the world's population will reach 10 billion, necessitating an estimated 50 percent increase in global food production. Rising incomes in developing countries will drive increased demand for meat, which is extremely water-intensive. At the same time, many of the world's largest groundwater aquifers are being depleted — after accumulating over millions of years — while rising global temperatures are accelerating the water cycle, unleashing more extreme precipitation and prolonging droughts. These persistent strains on water supplies, combined with massive increases in demand, add up to a water shortage — one that is projected to reach about 40 percent above current sustainable water supplies by 2030.

Water risks have typically been framed as a challenge to address over several decades, so it's understandable that many investors still view water risks as only a long-term threat to financial performance. But, however daunting, long-term projections belie the fact that water risks are already harming bottom lines, particularly for food and beverage companies reliant on agricultural supply chains.

Over the last several weeks, persistent flooding in the U.S. farm belt hasn't just hurt farmers and the regional economy, but has also hit the share prices of some of the world's largest meat producers. The floods have caused millions of acres of corn and soybeans to go unplanted, driving up futures prices for the primary ingredients for livestock feed. As a result, from mid-May to mid-June, shares of Tyson Foods fell 4.8 percent, while shares of Sanderson Farms Inc. and Pilgrim's Pride Corp. fell more than 11 percent over the same period.

The effects of flooding earlier this spring also turned up on the balance sheet of one of the world's largest agribusinesses, Archer Daniels Midland Co. A Securities and Exchange Commission filing detailing "unscheduled material events" projected a negative pretax operating profit effect of $50 million to $60 million in the first quarter due to weather-related disruptions in corn processing and origination — an astonishing 10 to 12 percent hit to the firm's fourth-quarter 2018 net income of $498 million.

For many of these same companies, droughts have been just as harmful as the recent deluge.

Throughout last summer, Argentina was gripped by a drought that reduced the global supply of soybeans, exacerbating price volatility on top of global trade tensions. Tyson Foods cited an $89 million increase in feed costs as one reason for declining operating income throughout fiscal 2018. Sanderson Farms felt its third-quarter feed costs rise by 5.8 percent a pound relative to third quarter 2017. At current prices, increased feed costs could lead to more than $15.2 million of additional costs for SAFM in 2019.

Pilgrim's Pride also had feed costs increase due to a persistent drought across Europe's breadbasket last summer. The company attributed the 31 percent decline in the operating income of its European segment from third quarter 2018 to the drought. The nearly $16 million decline represents 19 percent of the firm's total third quarter 2018 operating income of $85.3 million.

The drought in Europe also harmed the continent's largest sugar producer, Suedzucker AG. The company cited drought across its European cultivation regions as the primary driver of its €87 million operating loss in its sugar segment in third quarter 2018. The sugar segment is the company's largest by revenue, and the quarterly operating loss was the segment's largest over the last 10 years.

These examples are by no means comprehensive. They are drawn only from the last year, and consist only of physical water risks, excluding substantial litigation and reputational impacts. Of course, weather-induced crop failure has always been considered a financial risk to farmers and the companies they supply. However, this acknowledgment doesn't necessarily mean that water risks have been completely priced into public equities. According to the Food and Agriculture Organization of the United Nations, the frequency of droughts, floods, and major storms more than doubled from 1980 to 2014. Over the same period, the average annual economic damage of these disasters increased more than sevenfold, from $14 billion to $100 billion. As these events have become more frequent and more intense, food companies are now already an inherently riskier investment.

To manage water risk, investors are redefining their understanding of the issue. A group of more than 100 institutional investors with more than $25 trillion in AUM are collaborating to advance methods for analyzing water risks as part of Ceres' Investor Water Hub. More investors are exercising active ownership of their holdings in the food sector to proactively mitigate water and climate risks. In January, a group of 83 investors with a collective $6.5 trillion in assets called on six major fast food companies to share how they will manage the water and climate impacts of their protein supply chains.

These efforts underscore how water stewardship is not just an environmental concern, but also a financial imperative. Investors should take note: viewing water risks only as a threat over the long-run will prove increasingly costly.

The blog originally appeared in Pensions & Investments.