Objectives and reader’s guide

This report aims to illustrate how climate change scenario analysis can be integrated into mainstream company earnings and valuation analysis, through the example of the automotive sector. The primary audience of this report is financial analysts who wish to understand the materiality of transition risks on company performance and valuation, and the more technical aspects involved in scenario analysis. The report discusses the methodological and conceptual underpinnings of this analysis, examining particular risks and opportunities the companies might face, how they can adapt and transition to a low-carbon future.

Regulatory risks and financial impact

This section highlights the regulatory risks and financial impact climate change poses on companies in the automotive sector. The authors present the Risk Parity Fund as a useful paradigm to understand the links between risks such as policy and price risk. Analysts must take into consideration both market risks – risks typically faced by all companies – and transition risks – risks faced by companies adapting to a low-carbon future. One severe consequence for companies with a higher exposure to transition risks includes reduced earnings growth potential.

The scenarios: climate change and adaptive capacity

This report applies The CO-Firm’s ‘climateXcellence’ model to assess two climate change scenarios and two pathways illustrating different ways that a company might adapt to the changing passenger vehicle market. Their model suggests that a company’s adaptive capacity is key to its success: companies with low adaptive capacity are likely to be more severely affected by the risks and challenges associated with transitioning to a low-carbon future. It also shows that businesses that are capable of adapting quickly to a low-carbon future are more likely to deliver long-term value to their shareholders.

Key results: Sector and company earnings

The analysis reveals that the valuation of BMW, Daimler, and VW could differ between two climate change scenarios and a market ‘consensus’ baseline. The assessment further discloses how company valuations may differ with two varying strategic decisions they might take to adjust to the low-carbon transition. While these results are specific to BMW, Daimler, and VW, it provides useful insights for company engagement, especially for investors.

Embedding the conclusions within valuations

In this section, the report explains how the results can be integrated into traditional equity valuation models. The assumptions made for valuations can be highly dependent on such external factors as taxation, regulation and geopolitical variations, and also on methodological changes of recognized agencies. The authors emphasise that the valuation results only represent one possible future and must not be considered investment recommendations, financial forecasts or a judgement of their veracity.

Conclusions

In conclusion, this report highlights the criticality of considering climate change scenarios when valuing companies to identify risks, and opportunities associated with a low-carbon transition. Companies that are adaptable and have the technical ability to transition are likely to weather the risks and ultimately feed into higher earnings growth potential. Investors need to recognise these factors tightly and build a comprehensive scenario analysis to account for them in their investments.