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

Hello, everyone. Thanks for tuning into the session. My name is Rashad Kawan. I'm part of the EU Consumer Staples team here at Morgan Stanley, and I'm delighted to be joined by Fredrik Rystedt, EVP and CFO of Essity. Before we begin today's session, I'd like to remind everyone that for important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. Fredrik, thanks for joining us today.

Thank you, Rashad. Pleasure.

So let's start maybe by taking a bit of a step back and talking about the Essity journey. You guys have had a long history of transformation in the past, pivoting to changing consumer behavior and trends. Where would you say you are now on your transformation journey?

Yes exactly. As you say, Rashad, we come a long way, but of course, we have also a long way to travel, and it's very clear to us where we would like to go. So clearly, we have gradually moved into more value-added parts of our business, more branded, more premiumized parts. And of course, lately, also much more specifically into the health and medical side of things. And of course, all of this will continue. So we have lots of value to create from continuing that journey.

And a couple of weeks ago, you announced the reorganization of your reporting structure and with it, you announced the new sales targets. Talk to us about the rationale for the new business area structure and how you think it will better position the company to achieve your new sales growth targets? And just a reminder for everyone. I mean, you guys -- your targets were 5% growth, which includes organic sales and M&A and a target for adjusted return on capital employed above 17% by 2025. So talk to us a little bit about the rationale there?

Yes. So you can say we have changed a bit the way we formulate ourselves from -- here, we have a product, and this is how we sell it to more, here, we have a customer and what can we sell to that customer. So from a philosophical standpoint, it's quite an important shift. So we are now defining or will define as the 1st of January, our business and segment our business into the 3 business areas, Health and Medical, Consumer Goods and then Professional Hygiene. And this is largely, you can say, how we work already, internally, we have worked this way for some time, and it has had and will have going forward to several implications. First of all, I think we were -- we are broadening a bit our spectrum of products to look at, say, what do we supply to our customers. It provides a broadened perspective of what we can acquire as a company. And so it will bring further growth. It will bring much more transparency and easier also to compare to relevant competition. So it's a very, very natural thing for us to do.

Absolutely. Absolutely. And then if you think about those 3 business areas, are there specific categories, segments or markets where you have a particular focus to accelerate the pace of growth?

Yes. So if you look at Essity 5 years from now or 10 years from now, I think it's clearly our ambition that Health and Medical, that part of our business, which is now roughly 17%, 18% in that ballpark will be a bigger portion of the totality. That's clearly what we want to do, both from an organic growth perspective, it grows a bit pass-through there, but also from an M&A perspective. When it comes to specifically Consumer Goods, to us, clearly, if you look at decompose that there 4 different areas, there is incontinence on the retail side, to retail customers. There is a feminine side. Both of those representing very, very good and a very profitable growth areas for us. And then we have baby and Consumer Tissue, both being a bit more cash flow oriented or supporting growth in the other areas. So clearly, you would expect 5 years from now that feminine and incontinence retail would be a bigger portion of Consumer Goods. And then finally, Professional Hygiene. It's a very good area. And there, you can say roughly about 20% or so relates to what we perhaps sometimes call adjacencies like skin, wipes, cleaning equipment and those kind of things, very profitable and growing with good speed. We would expect that portion to be bigger 5, 10 years from now. And generally, the premiumized end of our offering, dispenser based [ strategics ] or solutions also being bigger portion of Professional Hygiene. So this gives you a bit of feeling for the direction of the total portfolio, so to speak.

Yes, yes, yes, absolutely. And you touched on M&A in the context of Health and Medical. I mean, you guys have been refreshingly open about your M&A strategy, frankly, and how you intend to make that kind of a core part of your story. Is that -- in Health and Medical, is that where you're really focusing your M&A strategy there?

Yes. I think we've quite often said exactly that it's within that area. And that doesn't mean that we wouldn't be interesting in acquiring, for instance, a company within a family or incontinence, retail space or within skins and wipes in Professional Hygiene. We'll be glad to do that. The reason it's most often we talked about medical is simply that the medical side of our business operates in more fragmented markets. So there simply more available targets in that space. So this is likely where you would see most of the acquisitions. But frankly, we'd be very happy to acquire in other areas as well.

One part that was interesting that you guys have mentioned a few weeks ago around emerging markets. You had stated an ambition to get this up to 50% of sales from around 38% today. How do you plan to achieve that? Is that organically through M&A, a bit of a combination of both? Obviously, you've been active on the M&A front there as well?

Yes. It's a good question. This is not a target per se that, that we want to achieve that. I mean, we want to create value and we think that growth in emerging market is clearly a way to accomplish exactly that. So clearly, about 50% of the market is located in what we would loosely define as emerging markets. So there is a faster growth. There are bigger opportunities perhaps over the longer perspective. So organic growth in countries like China and Brazil and many other areas, of course, are already -- growth is already strong there. So we continue to grow from that perspective. So organically, yes, I think M&A, absolutely a possibility. And of course, we are always trying to identify potential targets in those areas too.

Great. Great. Let's pivot a little bit to sustainability. You guys have a target obviously to achieve Net Zero emissions by 2050. Maybe talk to us a little bit about the initiatives you're implementing in order to get to your goals there?

Yes. Obviously, it's not just 1 or 2 or 3 things that will take us to Net Zero. And of course, achievement of our science-based targets in 2030, there are many, many different things. But just to kind of just generally say, we have identified a very concrete road map with a number of different activities. I'm just mentioning a few, and of course, mainly within the supply chain, but far from everything and starting perhaps with raw materials, so with low carbon footprint. And here, we have just decommissioned our first alternative fiber production in Germany, just recently, and this is an example that it's possible to use raw material with much, much less carbon footprint. That's one example. Another example could be the usage of post-consumer waste. We have something we call Tork Papercircle, where we take back used hand towels or paper mugs, and we reuse it. We produce big pulp out of it and use it in the production again. And there are several things just like that. Generally, replacement of fossil fuels. We use fossil fuels in our plant, not least in Consumer Tissue. And there are just a couple of examples there. We started to use biofuel in one of our plants. We are going to produce from a paper machine fully fired by geothermal energy, and we are now working on starting production using only hydrogen in the third plant as just one example. So these -- and there are many more. In fact, if you look at our Personal Care production, today, we are only using green electricity there. So in parts of our business, we have come a long distance. And in other parts, we will gradually, yes, move into various actions to fulfill that. We are working on a number of other things, including breakthrough technology. I don't have enough time now to talk about some of the extremely exciting things that we're working on to convert the current energy consuming tissue production, as an example, into much, much more efficient into less carbon emitting processes as an example. And finally, maybe just as an example, on the product side, using all other materials, but also reusable products. So sustainable solutions like washable underwear, where we're launching a number of examples. So these are just some. But of course, I can speak about this for a very long time.

Yes. I think we can have an entire session on sustainability if we wanted to, but maybe one last question there. Talk to us about where you think the consumer is today versus a few years ago. Listen, I think if we look at our data, I mean, to us, it seems that consumers are much more willing to pay a premium now for products that drive a sustainability agenda relative to a few years ago. So do you see a similar trend at Essity? And if so, I mean, do you see any opportunities for sustainable products to really drive more brand loyalty?

Yes, absolutely. And it's already happening. So this is not something that we believe will happen. This is already happening. So clearly, for some of the ranges that we have fully organic range, as an example, or as I just mentioned, washable underwear many of these products are already in the market, and there is clear willingness to pay for them. So this will be a key driver as we go forward, clearly.

Yes. Yes. Okay. Let's switching gears here to an exciting topic, innovation. So you guys have obviously talked about the importance of innovation for a while and how it helps shape the company's position across brands and markets. Talk to us about how you think Essity differentiates itself from peers through innovation and how important it is to the strategy going forward?

Yes. I mean there are many ways where you can differentiate it. And so if you look back a couple of years or 3 years 2 or 1, whichever actually time frame you look at, we've gradually taken market share in most of our markets. And of course, that comes from a large spectrum of things like supply excellence or delivery service levels or whatever, but a very large portion has to do with what we would refer to as superiority on products. And so what we do there is we define very clear growth ambitions by geography and by country, and we set out to define how much innovation do we actually need to fulfill those growth targets. And then we measure that clearly. Do we have sufficient innovation or don't we? And is the superiority, good enough? So if you look back to few years, you can clearly see that market shares have been improving, but not only market shares but also the mix contribution that has come from innovation. So this is not only creating a differentiation versus competition is also creating a financial value through better margins in short and, of course, also improved growth. So it has had a huge impact. And we've gradually upgraded our competence. We are very different now than we were 5 years ago. And of course, this is a key contributor also going forward.

And then related to that, on digitization. Obviously, that's also been a key focus area for you guys. And e-commerce now is 14% of sales at the high end of, I'd say, consumer staples. Do you have any targets that you're looking at for the next 5 years or so around digital? And do you view your different segments differently with respect to digitization?

Yes. I mean, the word digital is so broad that it almost become pretty meaningless because we -- you can say one part, which your question relates to is perhaps e-commerce as such, but there is also everything from solutions that we are marketing, and we put on the market, which are very, very key in most of our areas. So there is product based on solutions and software rather than physical products are, of course, very core in many of our businesses. But when you specifically talk about e-commerce, we don't have a target stating that in 5 years, we're going to have 50% or 30% because, of course, it will depend a lot on how the market in total and the consumer and customers actually transformed. So what we have set is a very clear target is that we will be bigger in the online channel than we are in the respective offline channel. So we should always have a bigger share. And if we are able to accomplish that, we will grow of course, faster than the market at large. And you can say, if you look at all our businesses across, we are fulfilling that with very, very few exceptions. So we are typically succeeding, and this has to do with -- to a very large extent, by all the investments that we have done under, yes, for many years now despite very small proportions. And of course, here, COVID has not been positive in any sort of major way. But here, it actually has. So it's clearly contributed.

And when you think about consumer behavior in digital and e-commerce relative to in-store, what do you see are some of the key differences? As an example, private label versus branded products? Are consumers behaving differently online versus in-store?

Yes. I mean there are many similarities on how you, for instance, present yourself. And so the kind of online store shopper, you can say, perception or experience is as important as the online. So from that perspective, there are a lot of similarities. But having said that, I think it is clearly so that yes -- I wouldn't say there is a big difference in general. But clearly, if you look at the market today, it's largely branded. Whilst the proportion of private label is much bigger offline. Whether this will persist, hard to say. But clearly, from where I sit right now, it's clearly much more branded, and it probably will stay that way to -- for a long period of time, I think.

Got it. Got it. That's helpful. Similar on kind of a similar note. A lot of companies obviously been talking about data and the power of data and analytics and how that kind of helps shape company strategies. What type of data do you have on consumers and what type of analytics do you perform on that data to better understand consumer behavior and kind of help shape the company's approach here?

Yes. It's absolutely crucial. And of course, we collect and we buy lots of data in many different areas, both from a shopper insight, as we talked about before, from an innovation side and also when it comes to e-marketing, so being able to fully understand how to best reach our customers and how to best present ourselves. And then, of course, we collect lots of data to understand pricing and understand how to price our products in different geographies as an example. So data collection is quite key. If you look at our business, most of it is not direct-to-consumer. A lot of it goes through e-tailers or retailers or other type of channels. There is a portion of it, rather small portion, which is direct-to-consumer growing, but still relatively small. So we are also beyond collecting from there also buying lots of data.

Got it. Got it. So moving on to a topic that's obviously been in the news for the past, what seems to be a few months on input costs and supply chain. I mean, can you give us an update on cost inflation and supply chain constraints on your side and how you've been navigating, I think, a very challenging landscape that keeps, by the day, getting more and more challenging here?

Yes, it's a very good question. And of course, I, unfortunately, don't have the crystal ball here. So giving a forecast is not what I intend to do. But having said that, if you look back in the past and through many cycles, I think it's very, very clear that we have been able and not actually only us, also the markets in which we operate has always compensated cost inflation through price, not price and mix or growth or whatever, but actually through just price. So I don't hesitate to second to believe that, that will be very valid this time as well. So over time, as we go forward and we adjust the pricing on our products, we will eventually recover what the negative impact of cost inflation has been. So that's kind of starting point. Having said that, of course, the drama, and it's not just relating to one raw material like plastic material or pulp, it has to do with kind of everything in distribution and energy. The magnitude and the pace and everything has been quite monumental. So it takes a bit of time to actually make that compensation. But over time, we will. And of course, I cannot say anything else than agility, pricing agility and of course, data transparency and access to data, as we talked about in a second, are very key to be that as price agile as we need to be. So we'll continue with that churn.

And can you give a bit of detail on pricing that you talked about in terms of where you are on timing of the pricing actions versus the input cost pressures on the P&L?

Yes. Frankly, Rashad. It differs a lot between our different geographies and categories. So in some of our markets, where we're able to adjust, of course, always subject to competitive situation or market demand or other things. But in some markets, we're fairly fast in our ability to adjust prices. And in other -- and using an extreme case there, where we have contracts up to 4 years of length, and for instance, incontinence, healthcare, that price adjustment takes a long time. So clearly, depending on which geography and which category we look at, we're kind of a different distance in compensating. So this is something that will gradually be implemented. We've already come a long way. We are basically following the plans we have made up, and we're quite pleased with the accomplishments so far. But the pricing will continue for several quarters ahead until we have fully compensated.

Yes. Yes. And you mentioned before, obviously, periods in the past where we've seen cost inflation. It's generally been dealt with through price. Obviously, it's unprecedented what's happening in the market today. So maybe share some perspective on whether or not you see any resistance or price elasticity across categories? Or if you see any push and pull more so in one category versus another?

Yes. I mean, first of all, there's always resistance -- the day that you have no resistance when you do a price increase, you probably have too low prices to start with there. So of course, there's always resistance. But your question was actually on price elasticity. And to be a bit clear there, we have quite little of that. So if you're a consumer of feminine products or incontinence products, there's quite low price elasticity. So you would consume the same number of products, even though it's 10% higher in cost or whatever. So generally speaking, price elasticity is quite low. There are a couple of exceptions, which are normally short-lived, but if you have very rapid price increases in some emerging countries, you can see a bit of a trading down for a while, but that fairly soon recovers. So in the end, I think from price elasticity and a consumer standpoint, it's not a huge issue. So you can say the time it takes to implement price increases has to do more of the functionality of the retail market or distributor markets or other types of customers that are intermediate in that sense. So not the consumer itself.

Got it. Got it. And then talk to us a little bit about cost-saving initiatives that you're implementing and where you are relative to your targets there? Because you guys have talked about some successful initiatives. So maybe talk to us a little bit about that and how it's going.

Rashad, we -- if you look back a few years, many years, actually, we continue to improve our structural profitability quite a lot in all our areas to be frank. It's been a very good run structurally disregarding whatever short-term turmoil or volatility that comes from raw material. But structurally, it has continued to improve. And there's been a -- you can say, mainly 2 parts of that. First of all, it's the innovation and the strong brands that we've already talked about, that's a very, very key part. But the other part clearly is efficiency and it's efficiency in many different aspects. So clearly, cost of goods sold, becoming more efficient in what we do there. Very important, but we also work extensively to become more efficient in our SG&A activities. Looking at the cost of goods sold. We have a program that we referred to as Manufacturing Roadmap, and it consists of many parts, everything from integrated supply chain, factory optimization, factory or footprint optimization, being able to achieve better productivity in all plants. And there is also a fairly big sustainability portion in that manufacturing footprint. And we have already communicated that we expect to bring roughly about SEK 0.5 billion to SEK 1 billion per year in savings. And this is clearly our ambition. We think we will deliver based on all the activities that we have defined there. So we're progressing and quite pleased, but we've also done that in the past. So we feel quite comfortable on the capabilities here.

Got it. Got it. A couple more questions here, and then we'll wrap up Fredrik. But let's talk about the Consumer Tissue Private Label segment. Can you talk to us a little bit about the rationale for creating a Consumer Tissue Private Label Europe division and update us on where you are in that process?

Yes. So the rationale is actually quite simple. And this is -- I mean, just to frame the discussion, perhaps, Rashad, in the beginning. This is a European project in the sense. So it relates to our European Consumer Tissue business. And if you look at that, it's -- and decompose that a bit, you can say that of the full Consumer Tissue business in Europe, roughly, about half is done under other brand names than our own. So if you take that 50% that is with other brand names and not our branded business, then about half of that relates to long-standing strategic relationships where we typically develop the retailers' branding or market it, and we provide innovation, and we typically provide category captainship and other products to those. We call that the retailer branded part. So that's about half of the total non-branded. The other part is what we would refer to as pure private label. And what I might -- what I mean by that is you typically receive a request for quote from a retailer. It states that it should be a certain [indiscernible] and basically, that's it. So we provide very little value add. And just from saying this, you can hear that this is an efficiency gain. So clearly, what we have now done is we will take that part, that pure private label, put it separately and optimize for those customers. Needless to say, of course, the way to win there is different than for the branded and the retailer branded parts of our Consumer Tissue business. So we have said that we will be operational as the 1st of January. We will report on it to some degree after 1st of January and then gradually implement the changes in the internal organization. So it creates from customer benefits, and from an efficiency standpoint, internally, quite huge benefits. And clearly, you can say, since we are very much innovation driven, very much branded driven solutions driven company this is perhaps the one that's farthest from the kind of core of the company, core competencies of the company.

Yes. Yes. Understood. And just finally here, maybe we'll take it up at a high level here, just to wrap up. And just if we take a step back and think about the world over the last 2 years, how do you feel about the business today relative to, call it, the pre-COVID world, right? Do you see any permanent changes in consumer behavior like increased hygiene awareness in self-care? Do you see that reshaping certain aspects of your business permanently or for the long run?

Yes. I think before even commenting on the world, which is a really big subject, I guess I can comment on the way we set out to come out of the pandemic as a better company than we went into the pandemic and that we are quite proud of in many ways because I think we feel in many ways that's been delivered. I already talked about higher market share. I already talked about e-commerce. I already talked about many different things. We have continued to spend on marketing or A&P throughout this. We have continued to launch a lot of products, and we have not stopped our innovation, and we have adapted in many, many different ways to the pandemic through, as an example, innovation targeted at specific health trends during the pandemic, and we've kept our supply chain open at a little time. So we're quite, from that perspective, proud of and we feel really that we are in a better shape now than we were. Now having said that, your question was not relating to us specifically, but mainly to the world. And I think there is -- clearly, there are a couple of differences. E-commerce would have probably gained ground anyway over time. I think we've speeded up that process. I think data savviness and perhaps the uses of solutions, clearly, that has also been speeded up to some degree. And frankly, that's also beneficial as we have many digital solutions within incontinence or Professional Hygiene and other areas, and this is clearly a positive area. The area having been most affected, I think, if you look at our businesses, it has been Professional Hygiene. And clearly, there, a significant portion is within HoReCa, commercial buildings and public schooling, et cetera. Those are major parts of Professional Hygiene, all been having been impacted. Looking forward, I think it's likely. I think we all see that, that people will have an increased degree of flexibility when it comes to working from home. So we will have a little bit less or lower starting point for the commercial sales that we would do. There might be less business travel even likely. So perhaps the hotels will be a little bit less a starting point. But there are other trends that you can say far outgrow that. Even if you look at Professional Hygiene, just general awareness of health and hygiene, there are replacements with air dryers, as an example, increased usage of wipers to basically clean in the industrial sector between shifts and many, many other examples. So generally, I think that even Professional Hygiene having been so much affected. I will think also there, it is an attractive -- very attractive future going forward. So generally, perhaps, I think in the longer perspective, COVID may for the company, perhaps not the world or not for the world, but for the company, probably have proven to be over the longer run positive.

Yes, yes. And then we look forward to seeing how the journey shapes up from here. I think we'll wrap it up here, Fredrik. Thank you for joining us. Thanks for everyone for listening in, and we'll wrap up here.

Thank you, Rashad.