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

As one of the world's largest tissue and hygiene companies, Essity is seeing volume growth rebound as the world emerges from lockdown, but rising input costs have begun to put pressure on gross margins. Essity has continued with active capital allocation this year, buying out other shareholders in its Lat Am JV, Familia, and its Australian associate, Asaleo. We're delighted to be joined by Magnus Groth, the CEO of Essity, and he will update us on how things are going. Magnus, thank you so much for joining.

Thank you. Good to be here.

So just to kick off. I mean you've got a portfolio that covers most tissue and hygiene categories across most geographies and most channels. When you think about the growth engines over the next few years, where do you see the top line growth in your business coming from? You've got a target of 3% plus organic sales growth. What would be driving that?

Yes. So if we split it into kind of the health care arena where we have our Incontinence Care health care and medical business [indiscernible] growing above 3%, maybe 4% to 5%, and the same for our Professional Hygiene business, which then both of these 2 account for approximately 20% of our sales. Then moving over to our consumer goods categories, they typically have a slower growth of maybe 2% to 3%. And they -- that's why as a combination, we arrived at over 3% in addition, of course, to the market share gains that we're used to having contributing to this growth. And within the consumer categories, Fem Care and Baby Care is typically growing very slowly, both in mature and emerging markets, due to these categories already being fully penetrated, while Consumer Tissue is growing slightly faster and with a big difference between mature and emerging markets.

And thinking about returns, you're targeting 17% plus adjusted ROCE by 2025. Can you just remind us, please, what that was in 2020? What's going to drive the improvement over the next 4 years? Will it be more margin or capital?

So for next -- for last year, I believe we achieved 15.7%, and that's why we decided to increase the target because we achieved that both annually and also for a period rolling of 12 months when we made the change in the third quarter. And we believe that most of this will come from margin improvement. And the margins we need are basically around 18% to 20% adjusted EBITDA margins in the Professional Hygiene part of the market and in the Personal Care part of the business. While in Consumer Tissue, we -- which is approximately 40% of our business, we expect to have margins between 13% to 15% by the end of the period that we're looking at, which is until 2025. Of course, we would very much like to achieve these ROCE targets well before that. But the time horizon is until 2025.

And I guess sticking with margin as a theme, you've done much to improve margin in recent years driven by both cost savings and mix. Can you talk a little bit about your current Manufacturing Roadmap program, please? How is that going? What sort of savings can we expect to come in coming years?

Yes. So this program, which is also a 5-year program, just launched in the third quarter of last year, is a follow-on from the Tissue Roadmap program that we ran for the 5 years up to then and includes also our Personal Care plans where there's less need for restructuring and major changes, but where we still a see continuous improvement potential very much coming from digitalization, so new tools enabling us to find further savings. And our target is to continue to achieve savings and cost of goods sold of between SEK 500 million and SEK 1 billion per year over the next 5 years. And as I said, a lot of this is coming from digitalization in our supply chain.

Just -- you mentioned digitalization there. How are you capitalizing on digitalization opportunities more broadly, for instance, when it comes to e-commerce and offering digital solutions?

Yes. So since many years, we've had a simple strategy of focusing on overtrading in the winning channels and with the winning customers because then we gain market share. And we already identified the online channels as being the future winners many years ago and prepared for that. And we have seen the benefits during the pandemic when the online channels grew disproportionately, not only in Asia, but actually also in Europe and in Latin America. So currently, we have approximately 14% of sales from online channels, being nearly half in China, and only a few percentage points in Latin America, so big differences, but still growing very healthily. And the opportunity is here that typically consumers seem to be preferring strong brands in the online channels, and that's an advantage for us. And in general, for the bigger players, and it seems to be a disadvantage for the smaller players who are not as well prepared to win in these new channels and formats.

And perhaps just to stick with that sort of route to marketing. So looking at Professional Hygiene, can you remind us of the end market split of that business, please? And how much of a headwind did you have from lockdown last year? And how should we think about the recovery potential in Professional Hygiene over the next couple of years?

Sure. And I have to remind myself a little bit here, but hotels, restaurants and catering account for nearly 40% of sales, with a bias towards the U.S. that actually recovered very quickly now in the second quarter of this year but was significantly impacted by lockdowns and restrictions last year. Commercial buildings is 25% approximately. So that would be office buildings, typically. Public interest, 15%, and then around 11% each for the industrial segment and the health care segment. So that's our sales fleet. And of course, hotels, restaurants, public buildings and commercial buildings were all significantly impacted by lockdowns and restrictions and the recovery we have seen so far. So in the second quarter of this year, we were back to approximately 90% of sales compared to 2019. And a big improvement over last year, of course, came from actually the recovery in hotels and restaurants while we're still waiting for the recovery in commercial and public buildings yet to be seen, but the gradual improvement we expected especially in Europe now over the next couple of months.

That's very helpful. And I guess turning to Personal Care. A fair amount has changed there in the last couple of years as well. Can you talk a little bit about the channel and product shifts that you saw around the lockdown as consumers moved online into big box stores? How did behavior change? How is it changing now as lockdown is pretty much over? And how is that impacting you? Where are you overweight and underweight?

Sure. Just before leaving Professional Hygiene, I just want to underline that, I mean, this is a key business for us where we are the world's #1. So we've invested during the pandemic and gaining market share also in the segments where we're undertrading like industrial and health care. So we're kind of coming out of the now lockdowns and restrictions and those negative impacts with the stronger market positions and stronger market shares than before. And that's why I optimistic about the recovery that it might not take as long as the worst-case scenarios maybe 6 or 9 months ago. But moving then to Personal Care, yes, very surprisingly, it turned out that the lockdowns and restrictions -- I want to separate that, as you did, also, Iain, from the actual pandemic because the focus on health and hygiene is good for us in general, but lockdowns and restrictions are terrible. And they actually led to a reduced consumption of Personal Care categories, so Baby Care, Incontinence Care products and Fem Care products and also our medical assortment. And for the first 3 categories, this is just a consequence of people using a little less product every day when they are in lockdown because they are close to their own bathrooms and they don't need to have that extra sense of security and freshness as when they are out and about. And we are seeing now in different countries that are out of lockdowns and restrictions that consumption is normalizing again, so that maybe one more incontinence pad or one more fem care liners being used per day again. So that's normalizing. Medical is different, but we've seen a very, very strong recovery. And in the second quarter, our medical business was actually stronger than 2019, and especially Wound Care that's coming back to partly because of a pent-up demand for surgery that has been delayed but actually also a recovery in general in the compression part of the business where we're still waiting for the orthopedic goods part of the business to recover. But overall, still growth compared to 2019. And we feel that we have this business now in a very good shape, very strong brands, strong market positions. We continue to invest through the pandemic and coming out with growing market shares and good margins. So very optimistic about the Medical business now. So things are normalizing. Also here, getting back then maybe to the consumer-related Personal Care categories, we saw a shift to online and benefiting the big and strong brands, which are typically the brands that we are representing.

That's very helpful. And just your last division, I guess, but by no means the least, so Consumer Tissue, your largest division. Your Asia subsidiary, Vinda, has been a key growth engine in recent years. And what's driving its growth there? And how should we think about the long-term run rate? It's been amazing how much is there left to go for, I suppose. And then secondly, if I may, you've recently placed Consumer Tissue private label Europe in a separate division. What's the rationale there? I'm sure you can imagine that people will always read stuff into something like that. How should we think about the rationale?

Absolutely. Yes, Consumer Tissue was actually maybe surprisingly the only category of ours that benefited from lockdowns and restrictions since people needed more consumer tissue when they were at home, replacing the away-from-home or professional hygiene products. And of course, we've worked hard through the pandemic to manage the ups and downs and the volatility from panic buying and empty shelves and so on. And things are normalizing now. And Vinda specifically has had an amazing development, and this is because they built the strongest brand in China many years ago. And then they were also first in understanding the strength of the online channel, so a very strong presence in Alibaba and JD but also the new and upcoming channels like live streaming on TikTok and the other new developments we're seeing very much coming from China, and they are always one step ahead of competition and have actually both gained market share and increased premiumization, and by that, also improved price and mix and margins throughout the pandemic. So they continue to do an excellent job. Right now, we have a little bit of a specific situation in China when it comes to timing. It's been that all along since China has had bigger challenges with the supply chain and a different phasing of the lockdowns, so that most of the Chinese players are still benefiting from extensive pulp stocks, which means that the price increase regime that we have throughout the group will come 1 or 2 quarters later in China since all the players there are still kind of benefiting from significant pulp stocks that were acquired at lower pulp prices. But Vinda continues to kind of expand their lead in the Chinese market and also in Personal Care in adjoining Southeast Asian markets like Malaysia and Taiwan and South Korea. So fantastic development there.

And are you able to comment at all on the private label Consumer Tissue Europe [indiscernible]

Sorry. Yes. I got worked up about...

It's a fantastic business. I don't blame you for [ getting excited ].

So yes, so in Europe, we typically have actually 3 types of businesses. We have our strong brands in all our consumer categories, including tissue, Consumer Tissue, where we service most of the European retailers. Then there are some formats where we provide both our own brands and we help the retailers develop their retailer brands or private labels typically in long-term partnerships, developing the whole category with the multiyear plans going forward. But then we have a number of customers with actually only a handful that are the real hard discounters where we have a much more kind of short-term relationship based on pricing on specifications provided by hard discounters. So very transparent, very price-sensitive. And this is the business that we're putting into the private label division because it doesn't require as much innovation, R&D, as much focus on things that are key to us like sustainability, digitalization, product development, but more just providing products at a very, very cost competitive way to these hard discounters. And this is a healthy business with good well-invested assets that had really good margins last year but also very volatile margins, more subject than to the raw material volatility that we're seeing now. And we are in the middle of this carve-out of this division and in that process, we're, of course, learning how big is that volatility, how is that impacting us as a group in total and how does that fit into the company, but that is something that we would have finalized by the end of this year. And of course, this is realizing that the margin volatility that Essity is experiencing, which, to some extent, is higher than for other consumer companies is something that we are aiming to minimize in every way, as we did with the Tissue Roadmap, as we've done by investing in premiumization, in innovation, in the less raw material intense categories in our portfolio. So let's see how this fits into that overall picture going forward.

Very clear. And then given that you mentioned sort of margin volatility, I suppose we probably need to talk about input costs and pricing dynamics. Now we've seen significant input cost inflation across consumers today both in recent months. Essity has been no different. How should we think about the pressures there? What [ are the key ] raw materials for you? How long does it normally take you to recover input cost inflation by pricing? When is the sort of maximum point of margin pressure at current spot levels, I guess? And when should we start seeing pricing really taking away the [ pay ]?

Yes. So we have input cost increases in all our different input costs, with the biggest one being then fresh fiber pulp, also recycled fiber, the oil-based material we're using for our Personal Care products and in addition, also energy, transport and distribution. And I'm sure you hear this from many other staples companies, as you said. The biggest impact being in pulp. The reason is, one, that the prices -- the costs have increased very, very rapidly and also to all-time high levels, which are currently at approximately 50% higher than they have -- they were a year ago. So it's also a significant increase that we're first seeing here. And already in the first quarter, we mentioned that our ambition was to be back to some kind of normalized tissue margins by the end of the first quarter, and we still stick to that even though pulp prices have continued to increase since then throughout the second quarter and until now. And actually, just this month, it seems as if pulp prices are doubling out. The last price increases announced by producers have not been completely put into the market, and some of the major companies making predictions about future pulp prices are predicting a stabilization and maybe a slight downturn towards the end of the year. Let's see. I mean we are committed to realizing the full compensation both in Consumer Tissue, but also in our other categories. And especially in Consumer Tissue, we're committed to achieving that by the end of the first quarter. And the reason why I'm mentioning this is we have some annual contracts that we have not been able to renegotiate midyear but will only be done then from the beginning of next year, and that's why we're talking about the end of the first quarter. When it comes to the oil-based materials used then in Fem Care, Inco Care, Baby Care, the impact on margins is lower. We are working very hard to increase prices and to reduce costs with material rationalization. And in other ways, it typically takes somewhat longer to achieve price increases where we are not the market leader or just because of the tenders with 3 years contracts like in health care, for instance. But very, very committed. And I think one example or proof point of that is that in April, we even, to make it clear to everyone, issued a press release towards our global customers since we're present in 150 countries that we were aiming to increase prices as quickly as possible in Consumer Tissue and also preparing price increases in all the other categories. And I think at the end of the second quarter, we announced that we had achieved close to 5% price increases in 1 quarter in Consumer Tissue in Europe, but we need much more than that. So we have to go back now. And I mean that's a significant price increase. We never did that before, but we need much more this time around. So we're continuing, and I'm very confident to stick to the time plan that we have set out. It's easier to raise prices in general in Latin America and in other emerging markets because of currency fluctuations and just the general inflation with the exception this time of China where that will then be this lag due to the high stock levels that most tissue providers are having in pulp stocks. So that's kind of the overall situation. So it's a big challenge, but I feel very, very confident. And we're much -- in much better shape than 4 or 5 years ago, 2017, '18 because we have taken out significant capacity in Europe. This overall supply/demand balance is better. We have stronger brands. We have invested in innovation. So -- and of course, we learned from last time to be very, very fast and very aggressive. So you could argue, since April, it will be then approximately somewhere around 3, 4 quarters before we're back to some kind of reasonable margins, as I put it, because last year, we had fantastic margins in Consumer Tissue.

Got you. Understand. Well, end of Q1 is what we'll be looking forward to see then. But just coming back to something you said earlier around portfolio management and your decisions to be more strategic about where you play. Portfolio management has been a key driver of value creation at Essity in recent years. So thinking back away now, but you've exited forestry. Before that, you exited packaging. You increased your stake in Vinda, which, with hindsight, was a fantastic deal. You've acquired BSN Medical. More recently, [ we've had the Board ] buying out the other shareholders in Familia and Asaleo. So when we step back, what's your strategy for portfolio management and capital deployment? How do you decide which assets to dispose of and which to invest more capital in?

Yes. So the focus is clearly to overinvest, both organically and through M&A in the least capital-intensive, least volatile and highest margin parts of the business that are still close to our core competencies in absorption and skincare. So this includes the medical categories, Incontinence Care, Feminine Care and the Professional Hygiene. So that's clearly where we want to invest going forward, allocate our capital and in less -- and then invest relatively less into Consumer Tissue and into also Baby Care where we see a slower underlying growth and a very difficult competitive situation in general. And as I mentioned as we started this meeting, there's a very, very good underlying growth in the categories I just mentioned, also just from the fact that people are living longer and also with chronic conditions that increases the need for the medical products, but also the Incontinence Care and Fem Care products. So it's all kind of helping the underlying development of these categories, aging populations, of course, as well.

That's good to hear and very clear. So I suppose -- stepping back a bit, ESG is an increasing area of focus for everyone. I suppose when I think about Essity and ESG, there are 2 kind of questions that immediately come to mind. So firstly, how do you think about sustainable sourcing? And then secondly, what could be done to reduce the environmental footprint of disposable products like diapers and [ as somebody who ] speaks from experience, you fill up in bin bags pretty quickly. What are you doing in those areas?

Absolutely. And we like to state that we are in the lead here, both when it comes to managing the carbon footprint of our business, sustainable sourcing as well as, of course, managing the waste, which, in many cases, is a plastic disposable product, as you mentioned. And when it comes specifically then to sourcing, our fiber supply target is to be fully certified by FSC or PEFC. And last year, I think we achieved 95%, which is quite unique, because only 10% of the world's forests are certified according to these global NGOs, really. So that means we have full traceability on our fiber supply more or less everywhere, including China. When it comes to disposable products made out of oil-based materials, we are looking at different ways of reducing the impact. And over the years, our products have become thinner, more comfortable, more discrete, but also using less material, and combining that with the -- with less waste in our production, less energy consumption in our production, using green electricity, changing fuels in our [ plants ] to sustainable fuels, we have reduced the carbon footprint there significantly. And what we're doing now in addition to continuing this work is also that we're adding, for instance, reusable products. So washable products, both in Incontinence Care and in Feminine Care, absorbent products that will then replace onetime use disposable plastic products. We're also -- starting to do this under the Tork brand. So replacing paper wipers with, for instance, microfiber wipers, but also putting in place recycling programs, whether -- I think the one that's really gaining traction in Europe now is Tork PaperCircle where we have over 100 customers in 10 countries where we now recycle the paper handtowels and reuse them in our plants again. So many initiatives here. And of course, we raised our target when it comes to, yes, the science-based targets aligning to The Paris Agreement just 1 week before the IPCC report here recently in August where we commit them to net zero greenhouse gas emissions by 2050. And we raised our target for reductions to 2030 as well. So very ambitious plans, and I think this is recognized, we're in the Dow Jones Sustainability Index, for instance. So a lot of work going on here, and I think this will be a competitive advantage to be in the forefront in this area going forward.

That's very clear. [indiscernible] And I guess we have just 1 or 2 minutes left to go, which is good. We're mostly on schedule, which we always like to see. So perhaps just to finish off, what are you most excited about over the next few years? What are the key opportunities for Essity medium term that you think we need to keep an eye out?

Thanks, Iain. I'm so happy not having to talk about raw material prices over the next couple of weeks, but more longer term, I'm happy to talk about something 6 months out and to talk about something 3 to 5 years out is fantastic, where I think the big value lies, of course, in any company our size. And if you look at our performance the last 6 years, it's clear that both top line and margins and profits have been growing year-over-year as well as free cash flow generation, and that's what we expect to continue to do with. Many of the things I already mentioned, so growing over 3% organically, adding acquisitions to that and staying at the forefront of digitalization and sustainability to be extremely competitive, continuing to invest in innovation and to improve also then our overall category mix towards the higher margin, less capital-intensive parts of our business. That's really what we will be continuing doing here over the next number of years. And of course, to achieve the targets of above 17% return on capital employed as well. So...

Well, that sounds great. And listen, Magnus, thanks so much for joining us. Great to hear from you, as always. And enjoy the rest of Q3. We look forward to hearing from you next month.

Okay. Thank you very much.

Take care.

Thanks, everyone.