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

Perfect. Good afternoon. Thanks, everyone -- sorry, just -- sorry. Thank you. So good afternoon, everyone. Thank you very much for joining. For those that don't know me, Charles Eden, Chemicals Industry Manager at UBS. I'm delighted to be joined by Magnus Groth, President and CEO of Essity. In terms of structure, we're just going to jump straight into Q&A. We've got 25 minutes for this session, and I'll leave 2 or 3 minutes at the end for any questions from the audience. So with that, I propose to jump straight into questions of course, Magnus.

Sure. Of course.

Perfect. And maybe we start with volume trends. Because clearly, very strong from Essity in Q3. Remained positive across all business areas. One of the few FMCG companies to report that. If I ask bluntly, is that indicative to you that there's still more room for pricing for you and for the industry in Tissue and Hygiene given that volume resilience?

Yes. Actually, I think we were the only company I could find that had positive volume in all segments, in all geographies in the third quarter. And of course, we have products and services that people use every day. But you're right, we didn't raise price enough since we still had positive volume. Clearly, we need to raise until we lose some contracts. So there's further room for price increases as we have also flagged for Q4 to see 3.5% sequential price increases approximately in Q4 compared to Q3.

Perfect. And of that sequential price increase you're expecting to deliver into Q4 and then into '23, are you able to give an idea of how much of that is already agreed with your customers, how much you're still negotiating? Anything there would be helpful.

Yes. So what's new and make this, to some extent, more difficult, less visible is that we're negotiating all the time now. We're negotiating every quarter with retail customers, with our distributor customers in Professional Hygiene and also in Health & Medical. So we've reduced the lag between our price increases when they come through to when we actually saw the cost increases to less than 2 quarters. So we are actually catching up with the cost tsunami that we had over the last 6 -- 5, 6 quarters. So from that perspective, I think it's looking quite good going forward.

No, that's great. And beyond pricing, obviously, one of the other hot topics is down-trading, consumer down-trading. You mentioned that you're still seeing some signs of that, I think Latin American tissue and U.K. tissue in Q3. Any deterioration there in Q4? And what do you expect from your learnings of '09 and other sort of downturn?

So what we've seen historically, of course, nothing looks like what we're seeing now. We are on uncharted territory, I would say, is that we had quite a limited amount of down-trading, especially in times of very high unemployment. And then it's typically been temporary. So maybe for a quarter or 2. And maybe a reason for this is that our products are quite a small part of disposable income for most people, and also that after having tried maybe a cheaper product for a few -- buying it once or twice, it's just convenient to go back to the brand you trust and love. So that's what we've seen historically. We've seen consumers turning to smaller pack sizes because there disposable income or out-of-pocket money just comes down, but that also typically reverses because consumption doesn't decrease. So you just have to increase the frequency of your purchases. We've seen some of that historically also. So down-trading from that perspective hasn't had a big impact on us. And of course, we are also positioned in the good, better, best tiers and also in private label. So typically, we can still catch those volumes even if it will be at lower margins.

That's helpful. And I guess the 2 categories with meaningful private label exposure that you serve will be Consumer Tissue and Baby Care in Europe where there is a high private label share, you have a big private label business in both. Can you just talk a little bit around the margins. Is that a massive negative on your margins if there is a shift to private label? Or is it gross margin dilutive, relatively similar at EBITA?

In Baby Care, it's quite similar in -- which is, today, less than 5% of our overall sales, the Baby Care category. And mostly coming out of Europe, but also, to some extent, Malaysia and Latin America. Consumer Tissue, clearly, we have better margins in the branded part of our business, because the price of a branded toilet roll is historically 20%, 30%, 35% more expensive than that of our private label toilet roll. So even if the margin is the same, the profit per roll is always higher on the branded product. So -- and we've been very successful over the last 10 years to really year over year over year increase the percentage that -- of sales that's in the premium segment. And that's going to be our focus also going forward even in times like this. But again, we're happy to pick up that volume then with our good, better, best assortment.

That's great. And thinking around volumes, pricing, obviously, we've already touched on. Volumes, very resilient in Q3. Is there a level of volume declines that you say, okay, we've gone too far? Is there a number that you look for? Or is it sort of very pragmatic and as long as profitability is right, you'll continue to take pricing?

So currently, we have prioritize pricing above everything else. Of course, we are closely following market share development and also volume development. We want to retain a high capacity utilization in our production assets, which we're seeing currently. We have lost some market share, especially in Consumer Tissue, and we've done that very -- with open eyes because we need to get the margins up. And we also feel confident that we have such strong brands and market positions and strong relations with our customers that we'll be able to recover that eventually. So currently, when we're operating with 7.5% operating margin, it's all about pricing. And it's very -- I mean, historically, we have many negotiations, that we love with our customers, about developing the category, innovation, launching new sustainable products. And that's how we've improved our margin year over year over year for many, many years before this last cycle here. And we're still doing that. But when you come back to the customers every quarter asking for double-digit price increases, of course, that becomes a smaller part of the discussion for a time period. But I'm sure we're going to get back to those more exciting, more interesting discussions eventually here as things stabilize.

Got it. And I do want to come back to your sustainability product portfolio, because you've made a big effort there. But maybe just to round off on pricing, and then I'll leave it behind. What are you seeing from competitors in sort of pricing response? Obviously, in Tissue, you are the leader in the markets you compete in, on many of the markets you compete in. How are competitors responding? We've seen the capacity outages on some peers in Tissue. Can you talk on the pricing dynamic?

Yes. So we achieved 14.5% price increase in the third quarter over the previous third quarter, the year before. So that's quite massive, but we need even more. And in Professional Hygiene, 20% of our sales, we're having great momentum and a feeling that our customers are typically large distributors, as Bunzl and others, they're pushing those costs through to the end users of those hand towels and napkins and other products we supply in Professional Hygiene. In Consumer Tissue, there's also been very, very strong pricing momentum because the supply-demand balance has shifted a little bit partly due to the pandemic. There's been very little new tissue capacity in the world and in Europe. And partly because of some of our smaller competitors have been challenged by the high gas prices and actually been stopping production for -- during certain periods in the third quarter. So it's put some pressure. There's less supply currently than demand, and that makes it easier for us as a big, stable, high-quality supplier with high service levels to raise prices. Then in the Personal Care category, so Baby, Feminine and Incontinence Care in the retail channel, there's also momentum but a little less momentum than in Consumer Tissue. However, we don't need as much pricing either because the impact from raw materials and energy is less than in the Tissue categories. So raising prices everywhere. In the medical categories, we've raised prices more than costs, actually, we're ahead of the curve. And in Incontinence Care in the health care sector, it takes longer because we're typically on 3-year contracts with counterparts like the NHS in the U.K., and it's more challenging. In spite of that, we achieved 7% pricing year-over-year. So we're getting pricing every year. And on average now, we're compensating for cost inflation with less than 2 quarters lag.

No, I get it.

So it's really accelerating. That's the message on pricing. And it takes us even shorter now to compensate in the Tissue categories and a little longer in the Personal Care categories.

Got it. So pricing, pricing and more pricing.

Absolutely. That's still the message. You can't complicate things right now.

No, I get it. And you've done a very good job so far. Let's take a step back from pricing and talk about market shares. Obviously, your track record on percentage of the portfolio that's been holding or gaining shares has been very, very strong. I think at your CMD last year, you talked about 70% over the prior 12 months. You mentioned that Q3 has come down a bit. So maybe you could talk about where we are on that today. And then what is the healthy number? What do you target in terms of holding, gaining share for us to -- obviously, 100 ideally, but what would be a good number?

Yes, this is something we follow closely on group level, on all levels, every month at least. And of course, especially in the retail channel where it's easier to follow and, in some cases, now even weekly. In the B2B parts of our business, we don't get those exact numbers on a monthly basis. But really, really important. And it's been a top priority until we started this pricing journey and we said we believe in our brands, our market positions, our strong customer relations, our go-to market. We are willing to push price even at the expense of market share now, especially in Consumer Tissue. So that's where we've seen some negative impact and also in Baby Care, where we're typically holding or slightly growing margins -- market shares in the other categories. So eventually, we will turn that around. But at this point in time, we feel that we have things just quite under control and are managing this situation. Yes, ideally, of course, we would like to achieve our over 5% annual growth ambition in the long term. We need to grow organically over 3%, which means that we need to grow in -- not only in price and volume, but actually a little bit in market share every year. So we should have growing market shares with 50% of our market category combinations and stable in 25, 30, something like that. There will always be markets in there where we lose market share because we might be restructuring or we might be taking some other decisions. So there will always be 10%, 20% where we're at risk at losing market share. And for instance, earlier this year, we pulled out of baby diapers in Latin America. And of course, that has a negative impact on market shares until we lap that a year from now. So that could also be the case. But something in that vicinity.

North of 50%.

Yes.

Perfect.

Yes. And of course, we linked this clearly to continuously -- continue to also measuring product superiority and brand equity and all the other KPIs that kind of makes us confident that we will be able to regain market share when we decide to talk more about that going forward.

Perfect. You mentioned one of your sort of medium, long-term ambitions, the top line. The other, of course, is the greater than 17% ROCE target. How should we think about the profit development? Obviously, 7.5% EBITA margin in Q3. Where does that need to get to given the capital turnover for you to hit that target? And remind us when you're aiming to hit that target by.

Yes. So to put this in perspective, we have a financial target of achieving a return on capital employed over 17%. And our previous target that we then increased was to be about 15%. And in 2020, we had achieved over 15% return on capital employed for 6 quarters. So the Board correctly decided, we're now stabilizing above 15%, let's raise the target to above 17%. And then, of course, we had this cost anomaly that we've been experiencing. But this is less than 2 years ago. I think it's worthwhile to remember. And in 2020, we had adjusted EBITA margins of 13.5%. So what you're implying and what's quite interesting is that with the huge top line growth that we're seeing currently, being 20% year-over-year, we need less margin to achieve the ROCE target. So actually, with 13.5% margin, we would achieve 17% ROCE with the current growth that we're seeing. So that's something to keep in mind. And also to keep in mind that the current new ROCE target we promised that, latest during 2025, we'd achieved above 17% target. So there's still some time to go, and this can change quickly. So both ways. We were -- for 6 or 7 years, we improved the margins and ROCE by 0.5% to 1% every year when raw materials and energy were quite stable. We did this by efficiency improvements and premiumization, innovation, focusing on the most profitable parts of our businesses and shedding some of the less profitable and more capital-intensive parts of the business. And all that work is still happening and still ongoing, but it's kind of invisible that we make these improvements of maybe 50 basis points per year when year -- when we year-over-year have headwinds of 1,270 basis points from energy, raw materials and distribution, as we had in the third quarter -- over the third quarter last year. It's mind-boggling numbers, really. And we were willing to -- or we were able to offset a lot of that, but still some way to go. But it shows that pricing power. And again, underneath all this discussion and focus on price, we continue to achieve a lot of efficiency improvement and working then on improving the overall structure of the group to achieve improved mix and pricing going forward. And we've seen a positive price and mix improvement now for many years in almost all our categories and almost all our geographies. So we're good at improving mix. And even now in the third quarter, in spite of the massive pricing, we still had positive mix in most areas or in all areas.

Perfect. And clearly, price will be a significant component of that margin improvement and the sort of catch-up of that 2-quarter lag that you've already referenced. But obviously, you also have the manufacturing road map program to come. Where are the incremental cost-saving opportunities in Essity? Obviously, you've been leading in terms of technology implementation in the industry, it could be argued. But where do you see is the incremental cost-saving opportunities on top of that price recovery?

Yes. So we see that we have real tangible savings -- net savings dropping down to the bottom line of SEK 0.5 billion to SEK 1 billion per year. And we started this program 7, 8 years ago, and actually folks on low-hanging fruit. So restructuring, taking out old capacity and efficient capacity, focusing on the big plants that are integrated and well located, and investing in them. And since then, we have shifted towards working very much with just improving machine efficiency, so using the assets better. Moving from that to a very much material rationalization. The product design, which takes longer, because you innovate, come out with a new diaper maybe that has 15% less material content and it's cheaper to produce. We're seeing benefits from that. Recently, of course, energy efficiency, which has a big -- been a big and important part of our programs for many years. But the payback time on those initiatives is much, much shorter now. And then since 3, 4 years, a lot of digitalization. So we have maintenance -- online maintenance systems on all our paper machines in almost all our converting equipment now, which means that every moving part is continuously monitored so that we can maintain or exchange a component when it's necessary. And of course, this improves the runability, reduces the unplanned stops of the machines immensely. We put vision systems that we used to have on all our baby machines and inco machines in the world. Also, now on our converting assets where we convert the mother reels to finish the Consumer and Professional Hygiene tissue products. I think we're first globally in putting visions systems. So typically, we then take pictures of every toilet role to see that it's correctly placed in the pack, that it's high quality and so on. So instead of doing manual checks and I mean, again, unplanned stops and so on, it's all automated now. So we typically have -- even on a 20-year-old paper machine, we now have 2,000 sensors on that machine that we didn't have 3 years ago to have automatic feedback loop. So that temperatures, chemicals, the speed of the different rolls can be adjusted in real time. And all of that is improving quality of the product, reducing downtime and really contributing to efficiency. It's quite exciting. And energy and staffing levels also in the plants.

That's great. One last question for me before I open it up to the floor. And I said I wanted to come back on sustainability and sustainable innovation, so I'll do exactly that. Obviously, being key to the Essity strategy, Essity story now for a number of years, evidenced, I guess, by the United Nations Foundation partnership, which you extended recently with the #EqualEverywhere, promoting gender equality. Could you just talk about, a, the importance to sustainability to the company as a whole and why it drives you? And secondly, some of these new innovations in this area, so sort of maybe those who are less familiar can learn of these?

Yes. So sustainability is at our core. I think ever since we were actually a forest company, before the split from SCA, it's always been at the heart of what we do. And in the recent years, we were one of the first companies globally to sign up for the, what's today called, the net zero ambition. And we have very, very ambitious targets, and we are reducing our carbon emissions, both in our production but also very much in the disposed products and in the energy that we use. And of course, the payback on those investments, like using hydrogen to fire a big tissue plant in Germany or biogas from municipal waste in Sweden to fire our paper machine in -- or less fuel in a paper machine, it really helps in these days. So that was the first focus. The second was that we realized that we could help our big customers by making them more sustainable with recycling programs like Tork PaperCircle, for instance, where you can recycle used hand towels. Because many of our big end customers, they want to find ways of becoming -- recycling paper cups for McDonald's in Europe, for instance, and so on and so forth. But now we -- actually, since the pandemic and continuing now, there is a real increased interest in sustainability also from consumers. There was always a small, small group of consumers who are interested in textile baby diapers or in very, very crude sustainable products. But now there's a clear purchase -- increased purchasing intent in general for sustainable products. And what we're doing is that we have just more sustainability claims. All our tissue in Germany now has 15% of the pulp coming from straw, that's locally sourced from the fields close to the mills, for instance. So much more sustainable than cutting down 70-year old trees in the Nordics or sourcing from Brazil. And recently, also, then reusable products. Made some acquisitions of the leak-proof apparel. We just launched a baby diaper that's hybrid. So actually, the -- it's a textile pant with an insert that's then disposable. So it reduces the carbon footprint with over 30%. So we are really walking the talk and doing this. And we've done the same in Professional Hygiene. We launched microfiber cloth. It's nothing new, of course, but our Tork brand carries those types of products very well also, because there are so many Tork products on the cleaning cart anyway, so we can add those types of sustainable products also.

I think that's great. We're now very near the end, but I did said I'd open it up. So if anyone does have a question. We do. Thank you.

Yes, just on costs. I mean you obviously felt costs for raw mats going up very early in the inflationary cycle. As we go through Q3 to Q4 into the first quarter, can you just highlight which of those are sequential cost pressures? I mean, clearly, energy is -- it's gone up a lot, some spot prices are coming down. Can you just talk through what are the sequential deteriorations that you're still seeing? And maybe building into that, pulp has obviously gone up a huge amount. It's got a lot of energy in it, but it's at very high level. What -- any color you can give on...

Yes. So we gave an outlook on the fourth quarter, and that's, I guess, as far as we have some visibility. So on the raw materials, to start with, if you look at global raw materials that we use, they seem to stabilize going into the fourth quarter from the third quarter. We will see some high costs in our books in the fourth quarter for 2 reasons. One is just currency, we buy pulp in dollars and the dollar strengthened in the fourth quarter compared to the third quarter. Second reason, there's some delay in some raw materials, mainly pulp going up. slightly in Q3, and that's rolling over now in -- or not rolling over, that has full impact now in Q4. So some higher raw materials in Q4 than Q3. But overall, of course, we see a stabilization. Distribution costs, we expect to be unchanged. And when it comes then to energy, it's so difficult with what's going on in Europe. 70% of our energy costs are hedged. We see higher costs in the hedges, now 70% in the fourth quarter than in the third. The hedges are built up over the last 3 years. So the hedges we have in quarter 4 now are built off of hedging we've done going back 3 years. And of course, it's now gradually getting higher, the cost of those hedges. On the other kind of opposite side, we have the 30% that's unhedged, where we're seeing gas and electricity prices in Europe now, so far -- actually, so far in the fourth quarter, that are half or less than half than in the third quarter. So that's kind of what we're seeing currently in Q4 compared to Q3.

Energy prices?

So for next year, we're hedged to 50% on natural gas and 60% of electricity more at the beginning of next year and less, because we have this funnel-shaped corridor of hedging going forward. Now it's 3 years out. And it's not a mechanical hedging. We have some really good energy traders who are making sure that we don't just hedge at any price level or [ tending cost ].

So I'm going to have to stop it there. But thank you very much, Magnus, and thanks for the questions. Thanks, everyone.

Thanks.