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

Hey, everybody. We'll just start the session now. So a very warm welcome to Fredrik Rystedt, Group CFO of Essity; and to Johan Karlsson, Head of Investor Relations for Essity too. So I will now get out of the way and break over to you.

Tom, thank you. So a pleasure to be here, and I'll start by just giving an overview of the company and who we are. So to put it into context, our turnover in 2022 was roughly about SEK 156 billion, as you can see here. We're active in 150 countries and roughly 48,000 employees to just give you that context. And the company brands or the company name, Essity is really not that known because obviously it's not used for any of our products. But as you can see, the brand names that we have under our umbrella, they're quite known, obviously. So if you just take as an example, Tempo here that you see at the bottom. It's actually the most well-known brand in Germany, beating brands like Mercedes or BMW. So within these different brand names in all our different business areas, we have some very, very strong market positions and some very, very strong brands as I'll come back to quite soon. And this is actually interesting. Every day, our products touch about 1 billion people. So it's generally something that we feel is a strong purpose of ours. We bring well-being to the world basically. So if you look at how we are divided, we have 3 business areas. I'll come back to the content and the size in a second, but the first one is basically Health & Medical, and that's incontinence and for institutional use. And it's also medical businesses in 3 different [ therapeutic ] areas. So one is wound care, advanced and more basic wound care. There's also compression products for medical treatment of lymphology and phlebology as an example. And finally, we also have orthopedics that treats things that you very much have known, if you break your legs or have other injuries relating to orthopedics. Consumer Goods contains sort of incontinence for the retail sector, so what you would buy in some warehouse or some shop. It contains the feminine business across the world, baby diapers or adjacent products to babies. And finally, Consumer Tissue. And the third business area there, Professional Hygiene, is what you would find in restrooms, in hotels or restaurants or airports or whatever. So basically dispenser, typically dispenser-based tissue plus soaps, sanitizers, cleaning equipment, basically for the professional hygiene area. So just to kind of show you a bit what does this look like in terms of net sales split, again, this is 2022. So starting with Professional Hygiene, there, roughly about 23%. If you look at the Consumer Goods, it's the largest part, 61%. And of that, the biggest part, as you can see, is Consumer Tissue and the other 3 baby and incontinence and in feminine, roughly the same size. And finally, Health & Medical, where incontinence for the institutional user for health care is slightly bigger than the medical or pure medical business. We're largely European. We're a bit over 50% European and the rest is spread in North America, Latin America and also Asia. And in Asia, the biggest market is by far China. So this is roughly what we look like. Now what are we kind of acting, where are we acting in which environments? And obviously, we think this is one of the very, very key points of our company and the markets that we're active in. We are engaged in markets which are subject to very favorable market trends, as you can see. Growing and aging population, of course, obviously, that's helpful if it's growing because that means more consumers or customers for patients or whatever. But they're also aging, which brings additional and enhanced use for incontinence products, for wound care products and for many other areas of -- or as you can see, prevalence of chronic conditions that's triggering the use of our products. Obviously, as disposable income or higher living standards increase, people tend to use more of our products and especially also the premium end, which we are very much addressing of the different markets we're in. Generally, health and hygiene and the connection to well-being is an increasing trend pretty much all over the world. And all of that is obviously benefiting our underlying market growth wherever we happen to be. Sustainability, and I'll come back to this. This is an obvious trend that you all track so well. For us, this is super key. And as you'll see a bit later, I think it's quite clear that the companies within our sector that are doing this in a responsible and good way, those are the companies that will prevail, and those that don't will basically die. And that sounds a bit dramatic, but I think this is very, very much the way we look at it. And then, of course, obviously, digitalization is changing all industries on the planet, ours included where e-commerce is clearly growing, the use of sensor technologies also in the products that we sell. And of course, not least from a process standpoint in production and SG&A. So there are many, many trends that underlying is supporting what we do. And of course, this we feel is very much a privilege. So how are we addressing these mega trends? How are we addressing our different segments? And obviously, I can't go through all of them. I'll just mention a few. And of course, what is absolutely crucial to us is generally innovation. And pretty much every company that you're listening to here, I guess, would be advocating exactly, this innovation is everything. And of course, it's true and it's very, very true for us because I used the exact same impression when it comes to sustainability. Those that do that well, they prevail and they're able to attract constantly better margins and superior growth to the others. And those that don't become need to producer or private label or more like OEM producers with lower profitability. So clearly, innovation for us is what actually supports our brands and it is what enhances our mix improvement in terms of growth and also margins. I'll come back to it later. But as we have set our targets when it comes to growth, about 1/3 of the yearly expected growth for us would come from mix. And just as a proof point, those of you that have followed us in the last year or 2, when disposable income have been impaired by -- for many inhabitants on the planet on the basis of high inflation and other things, when that has happened, of course, what we have seen in the world as a trend is basically downtrading. We see that in Latin America. We see that in Asia. We actually see it here in Europe as well. But if you look at our mix numbers in Q1, in Q4, Q3 and pretty much most of the quarters also before that, you will actually detect a product mix improvement. So despite all of that downtrading, we have been able to improve our mix. And of course, this does not come from any -- from nowhere. This basically comes from the innovation that we do. So all of this has brought us, as you can see here, in #1 or #2 positions in 90% of all the branded sales that we do. So just to emphasize the importance, this is point number one. Now point number two, also related to, obviously, innovation, partly has to do with the climate footprint. So we are engaged into segments that, yes, basically consumes plastics, so single-use plastics. We bring greenhouse gases to the world in our production processes. And to secure that we constantly reduce this footprint, we're working on many, many different fronts, both from a product standpoint, of course, obviously, from a process standpoint and from many other in recycling and many other areas. I'll show you that in a second. But one very key thing is exactly innovation. We are addressing washable absorbent underwear where you, instead of single-use plastic, you will rewash your products and use it many times. We've launched baby diapers with a washable chassis that you reuse as just one of many examples. So innovation is very much also geared towards a lower carbon footprint. We have set very clear targets, science-based targets. And as you can see, we're well underway to achieve those targets for 2030. And generally, coming to sustainability that, as I just said, will lead to more reusable, more sustainable solutions, we have just -- and we've spent a few years in developing a complete new process technology when it comes to consumer tissue. And this is where we're using most of our energy to make sure that we, not in next year, maybe not in the next 5. But over time, we'll be able to completely redefine how to actually manufacture consumer tissue and consuming a lot less energy and as well water. So this is something we believe a lot in, and some of you may have seen those -- some news about that. We are using alternative fuels as an example for our manufacturing sites. We're the one -- we're the first one using hydrogen in one of our plants for tissue production. We're using geothermal. We're using biogas to fuel another plant, and many other ways we are working on this. And of course, we've got lots and lots of awards. This means absolutely nothing. Of course, an award is nothing than a piece of paper, but it is at least a sign to us that we are recognized for heading in the right direction when it comes to sustainability. So point number two of innovation and sustained -- or point number three, sustainability and innovation were kind of one and two, then obviously, the third thing we're constantly working on is basically efficiency. We need to continue to become state-of-the-art. We feel we are, but we have further opportunities in this field. Now obviously, energy savings as I've talked about, material rationalization, using less input material in what we do. Waste reduction, just one example. We continue to optimize our footprint. We -- in Q1, we launched some news about how we intend to restructure a bit of our Professional Hygiene business in Europe, and you'll see some more. The major grips around our production footprint we have already taken, so we're happy with it. But of course, we constantly secure additional efficiency in various programs in what we call the manufacturing road map. We work with an integrated supply chain. So we have centralized all the demand planning, all the supply planning, all the logistics planning into one global hub in Barcelona, making our operations so much more efficiency -- or efficient, obviously, using technologies such as machine learning or artificial intelligence, but generally increasing our efficiency. And we're working in many fronts also on the SG&A side. We've centralized our back operation into 2 hubs, 1 in Mexico, 1 in Portugal. And we'll continue that journey to make ourselves a lot more efficient also in this field. Now -- so if these are the 3 components where we kind of strive to improve both our growth and our margins over time, we also complement this with one other thing. We allocate, from a capital allocation standpoint or resource allocation standpoint, we allocate our resources to the areas which are high yielding, so low capital intensity and high margins. And of course, that means growing the medical business, the feminine business, parts of the Professional Hygiene business as just examples, more than, for example, Consumer Tissue. And we also complement all of this organic capital allocation by acquisitions, and these are just some examples. In last year, we took the opportunity in just one blow through the acquisitions of Knix and Modibodi in leakproof apparel or washable absorbent underwear to become the global leader of this segment, which is super important. This is a segment that's growing roughly about 20% a year. High gross margin and, of course, constantly becoming a bigger part of the intimate hygiene side. So a couple of examples there. Legacy is a company engaged into industrial wiping, which is a very high profitable and growing segment of Professional Hygiene. But these are just examples, we've done many more also in terms of acquisitions in the medical space. So we complement the organic portfolio, capital allocation also by acquisitions in various forms. So what does this lead to? We have set very clear targets financially, as you see on this slide, but also from a sustainability picture that I alluded to earlier, not just for carbon footprint but also for other things like plastics or usage of fiber, et cetera. These are the financial targets. We strive to grow 3% organically and another in average, about a couple of percent of acquisition-led growth. We have also set a target for ROCE, so roughly 17% or there above no later than 2025. And so some of you will just say, okay, what is your margin target? And just to kind of obviously translate this, it roughly equates to about 13.5% or in that order of magnitude, 13.3% in margin and roughly about 1.25 or so in capital turnover. Obviously, that changes as kind of prices move up or down, but roughly, that is the target. And I'll come back to how we intend to reach it, but you've got most of the clues already. When it comes to capital structure, maintain a solid investment grade at all times and dividend long-term stable and rising. So these are the financial targets. Now some of you may have noted that in connection with the first quarter result, we announced what we define here as a strategic review of the ownership that we have in Vinda in China and also of the Consumer Tissue private label division that we have in Europe. So why did we do this? Well, as some of you that have followed us for some time, we have set very clear strategy, as I already alluded to, to expand more on the areas with high yield. So low capital intensity and high margins. And when you look at Consumer Tissue being roughly a bit over 40% of our group, that is the area where we see the lowest capital turnover. It's also the area which historically at least has had fairly low margins in comparison to many of the other areas that we have. So we have looked at various portfolio, ways of reducing Consumer Tissue as total share of sales of the company. We've analyzed all our Consumer Tissue businesses, and there are basically 2 parts that could be, potentially, we have not taken such a decision, but potentially could be divested without impairing the competitive power of the rest of the business. So if you look at Personal Care in Europe as an example, it's quite dependent on the large Consumer Tissue business to produce an adequate go-to-market organization as an example. But both Vinda and the Consumer Tissue private label division are areas which can be divested without impairing the rest of our business from a competitive standpoint. And this is what we have then done. So we are engaged now into these reviews. We are exploring the possibility of divestment of these entities and that is, of course, the option should the terms and conditions be attractive. So we are exploring various options for this. And just to highlight what are we talking about here. So Vinda is a company listed on the Hong Kong Stock Exchange. We own roughly 51.6%, but we consolidated fully. The turnover in '22, as you can see, roughly about SEK 25 billion and say with an EBITA of about SEK 1.1 billion. So this is what it looks like. It's predominantly tissue. So you can see here, 83%. The rest is Personal Care. That Personal Care business is mainly in Malaysia and Southeast Asia. So if you look at the Chinese part, it's predominantly, you can say, tissue, and there is an attractive and healthy but relatively small family and incontinence business. So it's an overall, you can say, in China, a tissue business. When you look at Consumer Tissue private label, this is a division that we are in the midst of creating. It was integrated fully into the rest of the European structure. But what we did here was that we took 7 factories. We took all the pure private label business that we did. And private label in this context means that you simply respond to an RFQ from the likes of -- or hard discounter as an example. When it comes to tonnage or grammage, you don't provide innovation, you don't provide typically a category captainship and you don't provide other categories. So from that context, it's a bit separate from the rest of what we strive to do, and we are in the midst of creating that. Sales, roughly about SEK 10 billion, roughly about 1,900 employees. We're nearly complete with the carve-out or with this separation. From a production flow standpoint, it will be completely separated as of the early part of next year. But we have now also here, as we have done with Vinda, engaged in exploring potential alternatives for the future. So let me just finish with a couple of quick highlights on the interim report. Of course, the longer-term picture, not least 2025, is a lot more interesting. But just to give you a bit of a flavor, obviously, we've had some really, really challenging years behind us. First, the pandemic and obviously then hyperinflation that has hit us quite severely when it comes to all sorts of input costs that we have seen now. And obviously, this is now a very different scenario as costs are either stable or coming down. And as you can see, we continue to grow as we have continued also to enjoy a very healthy price development. We have proved that our assumption that we can always compensate cost through pricing. We have proved that to be the case. So we have, as a consequence, very, very high price improvement, but also hidden in those numbers, a continued positive mix. There is a bit of volume decline that we have seen now. Partly, that's for structural reasons that we have undertaken ourselves. So partly because of Russia that we are exiting, and we have shut down our baby diapers business in Latin America. And so this has been part of the reason for the volume decline that we saw in Q1. And as you can see, obviously, both margin and result is very, very much improving, obviously. So the environment is considerably more favorable than it was during last year. And if you look at the kind of a bit longer trend and this is 5 quarters back, you can see that we have gradually increased now the margins from what we define as the low point in Q3 of last year. So it's become better and better. And obviously, as I alluded to before, we strive to get to much higher margins than what you've seen here. So just to end this a bit, this very superficial overview of the company, we strive to reach 17% of ROCE. And I already gave you the components when it comes to margin and capital turnover. So what we need to do then is to raise our margin with roughly about 3% or a bit more than that, 3.5%. How is that going to be done? Well, obviously, price management is very key. So we have compensated in most parts, but not all parts of our different businesses. Particularly when it comes to Health & Medical because of fairly rigid pricing structures that may be long-term tender contracts, that may be reimbursement systems or other things that makes pricing fairly slow, we still have a fairly significant price-cost gap that we need to compensate. But we also have other pockets of our business where we continue to need additional price-cost gap to expand. So this is roughly about 2% of that gap. Now 2% may sound like a lot, but you've got to remember, if you looked at the previous couple of slides here that we have increased prices with 18%. So in that context, 2% may not sound as much. So of course, price management is continuously key. And the rest of the 1% -- a bit over 1% and 1.5% will come from the other areas that I have alluded to, innovation and continued mix improvement, extremely important. Obviously, efficiency, as I have mentioned before, and then continuously keeping on with higher growth in the higher-yielding areas is equally key. And we remain committed to the 17%. We have not just set the target. What we have done is to split that target into many different road maps for all the units. So each of our business areas and the units underneath them have their own road maps to get to a specific target. And all of that combines into the 17%. And this what we call road map to 17 is what we also track every month and every quarter. And if we are seeing that there is a deficiency in any of the plans, we take mitigating actions. And this is how we work to make sure that we are reaching the aspiration and the target that we have set for 2025. So with those words, this is basically where we're heading. So thank you for listening.

Again, thank you very much indeed, Fredrik.

Do you want me to sit here?

You are very welcome to sit down, if you'd like please. So we're now obviously open to Q&A. We have already first a question at the back. And I think a microphone will come take to you there, please.

I think it's interesting, the divestments. Is it also -- has it the potential to change the organic growth algorithm of 3% once you divested these assets?

Yes. It's a good question. And if you look at the historic development and, of course, obviously, that is at least one, Vinda in China had a faster growth than the average for a number of years. So it's obviously the Chinese market has been growing faster. So in average, it takes out a bit of growth from the total number. When you look at the private label division, it's typically not growing as fast as the rest of the group in general, very much in general term. And if you kind of add those and you just look at history from that perspective, it will take out a bit of growth from the overall company. Now having said that, this is a very general statement because if you look at the last 1 or 2 years, obviously, the private label division has contributed a lot to the growth, obviously, because if you look at the cost increases that we have seen in the group, a lot of it has been on pulp. And obviously, the pulp content for the private label division has actually been -- is very, very significant. So where we have the absolute highest price increases in any place of the group has actually been private label division. So clearly, from the -- if you just look at the last 1.5 years or something like that, then private label, that's actually brought a lot of growth coming just on price. But as a more general comment, Vinda growing faster, private label, generally a bit slower, in average, it will take out a bit from the organic growth.

Can you talk a little bit about pricing? I mean it's clearly been a big theme in '22 with input cost inflation and you haven't passed it on. Commodities started to ease, you've seen some deflation from the highs. What do you think of the pricing outlook for the rest of this year? Are we going to see further hikes? Or do you actually think we'll see cuts?

Yes, it's always difficult. We don't really give pricing outlooks because it's not that relevant to us, if I put it that way. What is relevant is what I alluded to before, the price-cost gap. So I think it's likely it's difficult to comment. But if you see very radical cost deflation as an example, I think you cannot rule out that prices on our products or competitive products will also come down. That is, of course, a potential scenario. But for us, of course, the price-cost gap is what we're aiming for. And there, we're absolutely convinced that we will be able to achieve the -- roughly about a couple of percent that I mentioned before. So I find it a bit difficult to -- what you have seen now in the last couple of years is that we have been able to fully compensate for most of our businesses. We haven't completed that journey when it comes to, for example, Health & Medical yet, but we have been able to fully compensate. And of course, then we assume and we're convinced that we're going to be able to compensate also the rest as necessary for us to completely kind of mitigate the price-cost gap. When it comes to pricing in general, I think it's very difficult to comment. It's likely that if you see radical cost deflation, you'll probably also see, potentially going forward, price declines.

Maybe a question on margin, but we've seen European energy and gas prices fall pretty dramatically this year. How quickly does that fall through to your margin?

Yes, that's -- thank you for that question. It's a bit of -- it's been a very, very kind of dramatic market there. Last year, we benefited very significantly from the hedging position. This year, not so really. It's not materially weaker, but we are hedged to roughly about 70% for the -- or 60% roughly for this year, and so what you will see there if you compare Q1 to Q2. And the reason I'm now mentioning sequential development is that comparing year-to-year is always a bit tricky because you've had very dramatic increases throughout last year, and this year, it's going the other way. So average to average becomes quite kind of odd. So if you look at it sequentially, we estimate that cost will be roughly similar between Q1 and Q2. And of course, as you may wonder, why is that? And the simple math of it is that our hedging cost is higher in Q2 than it was in Q1 but the spot prices are lower. And if you take the average of that, it's roughly about the same. Now we are hedged throughout this year to roughly about 60%. So it's going to flow through of -- yes, about 40% will then flow through and the rest will not. As we go into the next year, '24, of course, our hedging position is much lower. So you will see the kind of full effect as we go from 2024 and onwards.

Maybe just to round out the comments on vendor and the strategic decision, and so there's the organic growth impact, the return on capital impact but then presumably a volatility of earnings impact as well, those businesses, that they would see a higher rate of volatility in margin over the close of the cycle compared to the rest of the group as well. But when you look at the capital allocation priorities, would you expect to reinvest? Should a sale happen and the Ts and Cs be right to reinvest all of that back into the company? Or is there a proportion of that, that you may consider higher cash returns to shareholders at all?

Yes. So we feel -- Tom, that's a great question. We feel quite privileged. If you look at our different business areas, we feel that there are opportunities to strengthen our business, both from a kind of pure scale perspective, technology perspective and geographical perspective, all of those 3. So in Health & Medical, particularly on the medical space in wound care and compression, I think there are many opportunities there that would strengthen our position geographically perhaps in North America, and technology-wise and also just scale-wise in wound care and compression. When you look at Professional Hygiene within the cleaning and wiping space, sanitizing soap, all of that are areas where we believe that with our very, very healthy customer base and strengthening our offer and capture much more of the benefits that the customer base can bring. And of course, obviously, if you look at Consumer Goods, we'd be very happy to look at all sorts of feminine assets, just like you have seen that we have continued to do, incontinence in general. And there are also other areas, for example, menopause or adjacent areas, liquids and other things in the consumer goods space, where we feel that we can strengthen our footprint. And geographically, obviously, there are many areas also where we have possibilities. So our ambition is to, of course, continue and potentially use then proceeds from divestments to continue to strengthen our different businesses in line with what I've just said. Now having said, that, it sounds great, but you also got to do better financially attractive terms. So you've got to create shareholder value. And of course, we need to secure that we can do that. And we believe very much that we can do that. We are not in a hurry, but we believe that we can do that over time. Should that assumption be wrong, then yes, we would be able to deploy that to shareholders through buybacks or special dividends, but that's not our kind of first priority. We believe we have the privilege of having more of these opportunities.

Okay. You mentioned the technology. So should we view that as a chance to move for sustainability needle as well as in the ESG needle as well in the company if you're reallocating capital?

Yes. I mean obviously, we can do -- we can move that needle in many different ways as we are already doing. And I showed you here. I mean we're engaged into all sorts of different fuel projects, as I mentioned, technology when it comes to Consumer Tissue and different product set-ups. We are -- we have invested into alternative fiber production, where we use wheat straw instead of cutting down trees to manufacture pulp that we put into our products, and there are many, many different ways. Most of this is done organically. But as you saw with Knix and Modibodi here, it's a good example where we actually acquired a very, very sustainable position. And so they're more like more opportunities like that. But I think typically, it's more the organic angle that will tilt the needle in terms of sustainability.

I think the ratio -- or the strategic rationale for the strategic review of Vinda and the European tissue, that business is very clear. Now I was wondering if you could give some color as to why it is the right thing to do now, not just the strategic rationale midterm but sort of why is it the right thing to do now. Because I would assume that those businesses are now, for example, in a very low margin level. So just a bit more of your thinking on the timing, that would be helpful.

Yes, this is always the question that I think is a very relevant question. So there is -- it's always a good time or never a good time. It depends on how you look at things. If you look at private label division, it's actually not low margin. It's -- they have been very, very successful in increasing their prices. I think their margins are pretty normal, if I would put it that way. So I think from that perspective, it's a good time. When it comes to Vinda, clearly, they have a kind of a profit improvement that they would need to -- that they will achieve. And if you look at the kind of cost -- underlying cost development that they're facing, it looks, of course, obviously, very beneficial. Now clearly they have a longer lag than the rest of the group because of their long lead times when it comes to pulp purchases, so it's lagging from that perspective. But of course, obviously, the margin expansion from -- the future margin expansion is, of course, very obvious. So from that perspective, we think it's a relevant time table also for Vinda. Once again, we have not taken a decision to divest. This is a process where we are exploring different alternatives. And should this be from a timing perspective, not adequate, then of course, we're prepared to wait. We're not -- this is not a kind of a fire sale in any sort of way. We have -- we don't feel we have any urgency in any of them. So we're out to make sure that -- I mean, Vinda is a great company from every possible -- it's the market leader in China, has got really, really good technologies and prospects and capabilities. So we're not interested to sell that to a price that isn't attractive. We believe it's a very attractive asset, so we believe there is interest out there. If that's not the case, we're very much prepared to wait. Same goes for private label division.

Maybe finally, you've described the potential raw material impact on implications for the top line as well. But how would you view the volume outlook if there is a moderation in the rate of increase in pricing or where the gross pricing goes? What is the volume outlook across the different parts of the businesses, and that's excluding restructuring?

Yes. So I mean, it's always a tricky question. There is always just kind of estimations of what the markets will do and how things will play out. What we have said previously, and we did that in connection with Q1, that we expect volumes for the year as a whole to be largely stable or slightly up. That's basically what we assumed and -- but we also communicated very clearly that we'll see large variations on the different quarters just as we have actually seen in the last year or 2. And one of the potential reasons is obviously that -- and at least that's our perception now of the marketplace, that if you anticipate as a customer that there will be potentially lower prices ahead, you tend to destock. And this is one of the reasons why volumes may vary over the quarter. So it's always very difficult to give a volume estimate for any individual quarter. But for the year as a whole, and if you -- especially if you look forward, the 3% organic growth target that we have, roughly about 2% relates to volumes. So the inherent, an underlying growth of our markets and our business is roughly about 2% or a bit more in terms of volume. But any other comments is, of course, difficult. Now if you look at complete net sales, so to speak, that's obviously very much impacted by the pricing picture as you see. You don't grow 18% coming from volume. That was a large -- part of that was obviously then price. So of course, if prices eventually would come down, that would also impair net sales from that perspective.

Fantastic.

Okay. Thank you very much.

With that, thank you very much indeed for your time.

Thank you for listening.

Thank you.