Integrating ESG into Corporate Valuations: An ESG adjusted valuation of Pandora A/S

Abstract

It is estimated that by the end of 2022, environmental, social, and governance (ESG) assets under management will reach USD 41tn. The market for responsible investing has drastically increased over the last decade (Kishan, 2022). The growing demand for ESG will have implications for the valuation of assets. Previous and current literature on the relationship between ESG and financial performance is highly ambiguous. Recent scholars have tried to minimize the ambiguity by distinguishing between material and immaterial ESG issues (Freiberg et al., 2019; Grewal et al., 2021; Khan et al., 2016). This thesis investigates the relationship between material ESG issues and firm value. The Sustainability Accounting Standards Board’s (SASB) materiality assessment determines the issues considered material. These issues are linked to ESG category scores from Refintiv, specifically: emission, innovation, product responsibility, and workforce. Following Cornell and Damodaran (2020), the firm value is decomposed into three cash flow drivers; revenue growth, profitability, and investment efficiency, and one risk driver; non-diversifiable risk. Capital expenditures are included as an additional cash flow driver. To exemplify the value of ESG, the danish jewelry company Pandora is applied as a case study. The thesis relies on a peer group analysis to estimate the impact of material ESG issues. The peer group consists of 84 firms based on SASB’s (2022a) “Apparel, Accessories & Footwear” industry description to which Pandora belongs. ESG data, historical financials, and the three-year consensus estimates are collected for the peer group from 2013 to 2021. The effect of ESG on the forecasted value drivers in the consensus estimates and the systematic misestimation related to these are estimated using fixed and random effect regression. Combining the two effect estimations allows for predicting future financials based on the market's expectations while accounting for systematic errors. Using the predictions in a discounted cash flow model (DCF), an ESG-adjusted enterprise value of EUR 26bn as of 31/12-2021 is estimated for Pandora. The material ESG issues constitute approximately 12% of this enterprise value. It is found that investments in material issues on an aggregated level generate value for Pandora. However, only product responsibility and workforce contribute positively to the enterprise value. Moreover, it is found that none of the material ESG issues have a significant impact on risk. Thus, the ESG impact on Pandora’s enterprise value can be attributed solely to cash flow drivers. The generalizability of the methodological framework constructed in this thesis is discussed, along with the necessary modifications. The case study findings suggest that ESG should be considered a separate issue rather than an aggregate level. Furthermore, it is concluded that the materiality assessment of a more narrowly defined industry can reduce the uncertainty associated with the prediction of financial forecasts. Consequently, allowing investors to invest in welfare without compromising returns with higher accuracy