Essity AB (publ) (ESSITYB) Earnings Call Transcript & Summary

Essity has had an eventful year with COVID-19 driving significant swings in demand for many of its products as consumers stockpiled ahead of lockdown. Despite top line volatility, margins have been impressively resilient as the company adapted to a rapidly changing landscape. We're delighted to be joined by CFO, Fredrik Rystedt, who's going to tell us more about the business. Over to you, Fredrik.

Yes. Thanks, Iain. I will talk a little bit about the volatile year and COVID, of course, but I'll also focus a little bit on the perhaps more important long-term strategy and the activities we're driving. So let me just start by saying Essity, for those of you who are not so familiar, it's actually a new company in the sense that we were created 3 years ago. But of course, we have a much, much longer history than that. The name Essity comes from the 2 words, essentials and necessities, which represents fairly well what we do. And we used to have also a forest company, and these 2 companies were separated 3 years ago, 2017, and that's when the name Essity came about. We are a leading global hygiene and health company. And if I just give you a little bit in brief what we look like, roughly about SEK 130 billion in sales in 2019, close to SEK 16 billion in adjusted EBITA. We're present in 150 countries and with 46,000 employees. And what we do in terms of our sales, we're divided into 3 business areas. So Consumer Tissue represented about 40%; Professional Hygiene, about 25%; and then we have the Personal Care side, which is the rest with the 4 different categories: feminine care, incontinence, of course, medical and baby products. So this is what we look like in terms of business distribution. If you look at it by geography, it's still a very big part in Europe with a bit over 50%. We have a very growing share in Asia and predominantly in China, but also in Malaysia and other parts of Asia; North America, close to 15%; and Latin America, the majority of the rest. Distribution channel. I'll come back to that a little bit more, but we have in that sense, maybe different to perception sometimes. We have a big part that's actually B2B. So roughly about 40% of our business is actually B2B divided by the health care sector and pure B2B in the Professional Hygiene space, and the rest is retail. So this is what we look like. Now if I should give you a little bit in a very, very short way what is Essity and what we're trying to achieve, what are we working on. It's basically all about our value creation journey. And what we do to create value, shareholder value, is to do that through profitable growth, and we couple that, of course, with value-adding acquisitions. So of course, we are dedicated to improve well-being through leading hygiene and health solutions. So that's basically our vision, of course. We have, as you will see, favorable market trends. We have really strong market positions that we have built up over a long time and continue to strengthen. Successful innovations, renovations, in general, is at the heart of everything we do. With successful innovations, we do well. If we don't do that well, of course, that's not a good ground for success. So it's extremely important for customer and consumer value, but also to drive mix and organic sales. Digital transformation is very, very key, and I'll come onto that a little bit. But of course, the growth of e-commerce is incredibly important for us, and we've spent a lot of resources in the last several years to enhance our capability in that field. I'll show that a bit later. And of course, digital is not just important for e-commerce. Digital marketing is growing a lot, coupled with e-commerce, of course. And then we see an emerging business of digital-enabled products that we sell and develop. And of course, we use digital to a greater extent every day in the operational part of our business in manufacturing, in SG&A, et cetera. We have a very clear category. So I'll show you -- you saw that before, the different categories that we have. And what we do there is to continue to invest in the high-yielding parts of our business. And those that are more capital-intense, we utilize the strong cash flows from that to basically grow in the high-yielding areas. Part of the growth story is to continue the growth in emerging markets, and we're very clear with where we are growing and in which categories. Of course, all of this has to be coupled with a continuous improvement in the cost structure. And we do this a lot in terms of continuous improvements in cost of goods sold through restructuring or just continuous improvements. And we also use it, not least in our administrative setup and everywhere else. So this is, of course, extremely key for us. And surrounding all of this, which is incredibly important for us, we have to contribute to a sustainable and circular society. Now if you look forward 5, 10, 15 years from now, those that do this well, sustainable -- sustainability and CSR, in general, will prevail, and those that don't will not survive. So this is -- if you don't remember anything else, please, this is what you should remember about Essity. And I talked about a little bit about the different category and the portfolio strategy. And this slide illustrates that very well so where we actually put most of the resources to grow is in the upper 3 parts of this. So Medical Solutions, it's a very high-return business, so very low capital intensity and good margin. So of course, growing in that area creates significant value. It's also the same for Incontinence Products and Feminine Care, both of those areas all yielding very, very high returns. And we continuously put focus on growing them wherever we happen to be. Professional Hygiene, a little bit more capital-intense but still with very good margins, and also there and especially in the adjacent part of professional is clearly a growth area. Whilst the 2 lower parts, Baby Care and Consumer Tissue generating significant cash flow, but there, the focus is much more on perhaps enhancing margin and improving capital turnover rather than growing faster than the market. All of this, what I've just talked about, is intended to deliver on the financial targets that we've set out. So what we have stated clearly is an annual organic sales growth of more than 3%. And as you can see, in 2019, we achieved more than that, 4.5% and the adjusted return on capital employed of more than 15%. And we still have, if you look at 2019, some way to go to reach our target. And primarily, of course, this isn't a margin issue. So continuing to grow in the high-yielding, high-margin businesses, and of course, coupled with general margin improvements in all our businesses is the mean for us to go to 15's% and, of course, also beyond. And just to note that we have actually been above 15% in the last few quarters here. And of course, just to mention also the other financial targets that we have. We talk about the capital structure at all times, maintain a solid investment-grade rating. And finally, the dividend policy there to have a long term stable and rising dividends. And some of you may have noted that we -- in the spring, we postponed the decision to -- for the dividend this year. And in fact, this was not done because of lack of cash flow or weak financial position. On the contrary, the cash flow is very strong, has remained strong, and the financial position is also strong. The decision to postpone was simply taken because of the very, very significant uncertainty that COVID brought with it. And we said at the time that we will revert back with our decision later this fall, and we will also do that in the next coming months. I talked about the favorable market trends, and there are actually many in our favor. But let me just mention a few. Obviously, we have a growing and aging population, which brings, of course, a bigger and further need for medical business. It's also for our Incontinence business. Higher disposable income generally throughout the globe means that you spend -- typically spend more on the hygiene products that we sell. So when you have enough money to support the basics of your life, you tend to spend more on the hygiene products. And clearly, this is, of course, in our favor. The increased awareness of hygiene and health is also -- and of course, the role that plays for increased well-being is also a trend that has been there for some time, and it will continue to be there. And clearly, as we talk about the longer perspective of COVID, this is strengthening exactly that trend. Digitalization is another market trend. Clearly, that's in -- to our advantage. We're able to capitalize that in -- through that in many different ways that I'll talk a little bit about later. And of course, sustainability. As I mentioned, those that do this well will prevail, and those that don't will clearly fail. So all of these are examples of favorable market trends that we are encountering. The global market that we are acting on is growing roughly about 3% to 4% a year, about that much. And of course, the absolute fastest-growing part is Asia. And if you looked at this slide 2, 3, 4 years ago, North American market was actually bigger than Asia. And now clearly, Asia has surpassed. And the absolute dominant part of the Asian number that you see here is, of course, China, but 6% growth roughly versus the clearly lower market growth that you see in North America on this slide also in Europe whilst you have a clearly a good trend when you talk about general market growth in Latin America and the Eastern European market. So relatively good growth underlying. And of course, we also have ambitions to grow market shares. And talking about market positions, we are global #1 leaders for Incontinence Products and Professional Hygiene. And the 2 brand names that we work with in these 2 areas, TENA and Tork, are widely known throughout the world. When we look at our other categories, Consumer Tissue, we're close to #2 there. There, you will see many brands that are -- that we use, but they all have the same brand promises wherever they are. So all of them are very, very strong brands. If you take, for instance, here Vinda, it's the largest brand in China. Zewa is the largest brand in Germany, et cetera. Regio is the same in Mexico. So we have very, very strong markets positions in Consumer Tissue. Medical Solutions in the categories we're in, #4 also there with very, very strong brand names, so Leukoplast. Most of you probably know JOBST and Delta-Cast and Actimove depending on the different categories we're in. Clearly, if you look at Baby and Feminine Care, we're #5 and 6 globally, so a lot smaller in relative size. This is not because we are small wherever we happen to be. On the contrary, if you look at Feminine Care, we're #1 in -- basically in most of the countries where we're actually active in Latin America. And we also have #1 or 2 positions in most places. The reason why we're only #1 -- #5 and 6 on these 2 categories is that we're simply not present geographically in so many places. So this is the reason why we, on aggregate level, are relatively small. But where we exist, we are typically very, very large. And as you can see, if you take all of these positions, we are -- we have #1 or 2 positions in roughly about 90 countries that we operate in. So very, very strong market positions. And they have been growing. Market shares have been growing as I'll show you later. If you look at the overall result of how this has been so far in terms of financial performance, as you can see here, we have clearly continued to have a really, really healthy growth in organic net sales. And we've continuously improved also on the EBIT margin side. Now I'll come back to that in just in a few seconds, but COVID, of course, is very visible on this slide, especially here in Q2, both as it comes to growth, and of course, also margin. But the long-term trend, clearly, very, very positive. If we look at -- and Iain, you said that in the beginning, it's been a volatile period for us, and we have actually been impacted quite a lot. So if we look to our different businesses, clearly, the B2B businesses, Professional Hygiene and medical are the ones that have been impacted the most. So we saw for all our different categories in Q1 a very, very significant stockpiling impact in Q1, and then we saw a reversal of that stockpiling in Q2. So clearly, it's been very volatile from that perspective. If you look at the demand side of things, the underlying consumption of our products where we're mostly impacted is basically on Professional Hygiene. If you look at the HoReCa segment, which is about 40% of our Professional Hygiene business, clearly, not that much activity with hotels and restaurants, especially now during lockdown, but also generally during COVID. So clearly, that's impacted. And the other big -- another big sector for us is the commercial sort of office space as an example or arenas. And also there, there's been a very big impact. So Professional Hygiene, clearly impacted. The other area that was very much impacted B2B-wise is the medical space. So when everyone stays at home, no one, of course, suffers from fractures or injuries, having a negative impact on our orthopedics business. And needless to say, if you are a compression patient, phlebology or lymphology, you simply don't have the possibility to go out and measure your garments -- compression garments as you need to do to get the product. So both of them were impacted. Also the Personal Care side has actually been impacted. So I mentioned Q1, lots of stockpiling. In Q2, reversal of that stockpiling, but it's also clear that when people stay more at home, you consume less of hygiene products. So less incontinence diapers, less baby diapers, and of course, to some degree also, less feminine products. So COVID has a big impact, and of course, it will have a big impact over some time as we go forward, and especially in Professional Hygiene. But the longer-term picture is, of course, the fact that there is clearly an increase in the awareness of health and hygiene. And there, that brings also many, many different opportunities. What has been very positive as you mentioned also originally, I mean, we've been able to keep margins despite, of course, negative absorption impact. We've been able to keep margins at reasonable levels. And cash flow has remained strong throughout the first half of this year. So reasonably good performance. I talked about innovation being a cornerstone in everything we do, and we continue because, of course, COVID is something that will pass, and we are spending most of our time addressing still the long-term ambitions and the long-term strategic activities of the group. So we are continuing to launch successful innovations, and these are just some examples. TENA products, as an example, with much better absorption capacity for the health care sector; a complete new assortment of liquids and soaps, et cetera, for Tork; new dispensers that have -- a PeakServe dispenser, as we call it, for smaller-sized operations. And this is -- I'll come back to that, but that's a super interesting trend that's now happening. That air blowers or air dryers in restrooms are being gradually replaced, and this is a product that we launched that is typically aimed for exactly that transition. Making jobs more attractive -- if you need compression socks, that doesn't mean that you have to look like a patient, you can look modern, and this is an example of that. And Saba there as an example, also, we have launched a new feminine product with specific fabric that is a lot better and more comfortable for the user, et cetera. And new to the far right here, a new moist tissue, moist toilet paper that's completely free from plastics, so environmentally friendly. I talked about the market positions, and this is quite helpful because in the end, when you have a time of lower demand and lots of volatility, what's super important is the relative development of the group. Now we have, as I said, #1 or 2 positions in 90% of our branded sales, so very, very strong market positions overall. But when you look at the last 6 months, you can see, if you look at the branded sales that we had in retail, that 60% has improved -- 60% of our market positions have actually improved in the last 6 months. And the remaining bit under 40% has largely stayed on the same level. So clearly, from a relative perspective, we have gained during this crisis. And in fact, if you look at that, it's also the trend for all our branded market share in the last 3 years. So 60% has improved. I mean if you would have looked at this a couple of years ago, you will see the same number there being 50%. So we've had a very, very strong development of our market positions and further now strengthening during COVID. COVID is not a positive thing for the world and of course, not for us either, but we've also taken the opportunity to launch new products that are well suited for this environment. Antibacterial product is a good example. Of course, this is clearly much -- a much bigger interest for the consumers at this time. We are repositioning existing products to make sure that the hygienic benefits become much more clear. Obviously, when you look around, walk into shops or any place, you would find a lot more soaps and sanitizers. And we're putting a lot more effort to place more dispensers and to secure that we sell a lot more of these products. And you also saw that, that was part of the innovation pipeline that we had for Q2. And if you look at the Tork PeakServe I just talked about to the rest, there is a significant portion of public restrooms that have air dryers or air blowers and dryers. And of course, this is not hygienic. So clearly, the replacement of all of these air dryers into more hygienic tissue solutions is a very key priority. And here, we continue to push that and also with new dispenser solutions as I mentioned. Digital transformation. We have -- if you look at 2019, we had roughly about 10% of our sales equal to about SEK 13 billion. So we're one of the larger players when it comes to e-commerce also in 2019. And we've invested a lot, not only in just the capabilities that's required internally in terms of investment, but also generally, in how we present our products, all sorts of logistic issues, many, many different investments that we have done over several years. Sometimes, we've done it with very limited sales on the existing market. So for us, of course, the significant increase we have seen generally in e-commerce over the last 6 months has been very, very positive. And you can see that we've increased from about 10% of our sales to close to 14% of our sales now in Q2. And this is a trend that will continue. So we will keep on investing, and we will secure that we have a higher share in the online channels than we have in the off-line channels or in the regular retail side. So clearly, a big priority for us. We continue to invest into digital products. We've launched new products in terms of -- in the incontinent space. We have just purchased the company that through device -- electronic device tracks the content of the bladder, so to speak, to make sure that we complement the incontinence also with continence control. We have the Tork EasyCube, which is helping cleaning firms, et cetera, to become much more efficient. And those that have public restaurants to secure that, for instance, dispensers don't get empty, et cetera. So many, many different things that we are working on, and this will only expand as we go forward. The marketing is growing significantly. And in many markets, what you will see is we will only do the e-marketing. So as many of the competitors will continue to do TV advertising, we have shifted in many places to more or less 100% e-marketing with very great success. And the final part, the internal efficiency cannot be underestimated. On the production side, putting sensors, machine learning on our paper machines or baby machines or whatever and just generally using automation also in the administrative side. Robotics is clearly one being, but general automation is even more important. And this will continue in increasing speed as we go forward. So all of these initiatives, clearly, we couple also with other profitability-enhancing initiatives. We have talked much about Cure or Kill, and this is a program where we identify those that do not perform in terms of returns. So those units within our group that has a return below the hurdle rate that we put for our company, we put specific emphasis on these entities where we define clear business plans, clear thresholds, clear milestones. And we track that until they are in a value-creating position. In rare cases, we have seen that the business plans do not create a net present value, and then those businesses have been executed. We continue with this program. It's very, very successful internally, and we'll continue going forward. Tissue Roadmap is another profitability enhancing initiatives that where we have restructured our tissue manufacturing setup. We have done that partly by shutting down capacity, building new capacity, but the most important, which will continue to go on, is to secure that every plant we have is performing to where it should perform. And there are many opportunities still, not least using digital as we go forward. Material rationalization is another thing. We can continuously make sure that we use less material or use efficient material that's both sustainable and cost efficient. We work with operational efficiency improvements in our SG&A. I talked about robotics and automation in general. And we continue to generate substantial sourcing savings, both on direct and indirect material. I mentioned that in terms of the -- being successful in the future, sustainability is absolutely key. And of course, you can talk about sustainability. Everyone does that. What is important is what you do. And of course, that you set a very clear target for what we -- what you want to achieve and make sure that you track and that you deliver on those promises. And we set a number of different targets. We are part of Science Based Targets initiative that are reducing by 25% for Scope 1 and 2 and 18% for Scope 3 in 2030. We have, just as an example, packaging or plastics target, employee health and safety as you can see on this slide. And we're well on track to achieve those. And just to mention the pictures to the right here is just an example. We are investing now into a Plant 5 alternative fiber where we use wheat straw to manufacture pulp directly and adjacent to the paper making, thereby saving roughly about 50% in terms of carbon emission. And the meanwhile doing that also actually producing a very healthy cost picture, just as an example. But we're also helping our customers to make sure that they are also sustainable in their operations. So one example here is toward PaperCircle, where we recycle their tissue. So we put separate trash cans for their tissue, and we take that tissue back to our mills. We recycle it to pulp, and we manufacture paper once again. And of course, sustainability or CSR is much wider than environment. So we also continue a lot of efforts to make sure that we educate young women, for instance, on menstruation or other types of things. And this is an example for UNICEF in Mexico. So there are many examples of very tangible and concrete things that we are doing on CSR's sustainability. And of course, this is growing. It will continue to grow in importance for us, and of course, for the world. So just to sum up, what we are here to do is to create long-term value duration. And of course, a very, very key and subsidiary cornerstone for that is to maintain the strong brands, fueled by successful innovations and the strong market positions that we have. So we think we have so many leading positions. We are in an attractive market. And of course, if you have those fundamentals, then we need to have a very high-performing organization, a winning corporate culture, and of course, not least, a sustainable business model, and of course, all these value creation through profitable growth. So with those words, thank you. And any questions you have, Iain?

So a couple of questions for me, if that's okay. Firstly, how should we think about the outlook for pulp prices and Consumer Tissue prices for the rest of the year, please?

Yes. We actually get that question a lot, Iain as you can imagine. And we're typically not so great in -- actually, no one is, to estimate whatever happens to raw material prices. In fact, if you look at how we prioritize what we work with internally, it's not about forecasting pulp prices on Consumer Tissue pricing. It is about continuously improving the structural profitability of Consumer Tissue. So we work with innovation, we work with cost efficiency, and we gradually increase the structural profitability of that business. And we've done that for several years now. We will continue. That's the first priority. And the second priority is, of course, being really good at managing volatility in the input market. So if pulp prices move up and down, we've got to be really agile in how we price our products. So as always, because of that input price volatility, you'll always see margins go up and down for Consumer Tissue. But as I said in the strategy and what we do is all about improving the structure profitability. I honestly cannot say where the pulp market will go. I think you've seen in recent times, it's been fairly stable, and we've had some weaknesses in the dollar, which is helpful. But generally speaking, we will manage, whichever way pulp will go.

Well, perhaps going more on your earlier comments around the structural productivity of Consumer Tissue then. You clearly significantly improved that in recent years. How much of that has been driven by Essity's actions? How much of it is industry dynamics and it just being a more profitable industry now than it was? And how far do you think you are along that journey of improving the profitability of Consumer Tissue?