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

Well, Magnus, thank you for coming here today and to come back again for the Barclays Consumer Staples conference in 2023, and thank you for those in attendance here. Also, I know we'll have the webcast people online. So thank you for your interest in Essity and Barclays.

So there's a lot to touch on, very busy in Essity in the last 12 months. And I think a good place to start maybe is the strategic review. Just on where we are in the process with Vinda and maybe the Private Label business?

Absolutely. Yes. We are, as you know, looking at Vinda, the Private Label business in Consumer Tissue in Europe, and the strategic reviews could include also divesting these businesses. And when it comes to Vinda, I think it's quite well known now that we have a process running and that process is running well, but it will be another couple of quarters before we see how that plays out. Private Label is maybe in an earlier stage, still finalizing some details on the carve-out that we've been working on for a couple of years, but also in this case quite a lot of interest in our review and what could kind of come out of that. So it's all progressing according to plan.

So if there are potential divestments of Vinda and the Private Label business, would you revisit your financial targets? And have you thought about maybe getting rid of any further Consumer Tissue brands?

I think it's too early to talk about revising the financial targets. This would improve our return on capital employed, but to what extent, I think, remains to be seen. So that's regarding the targets. The remaining Consumer Tissue business, we definitely tend to keep and see as a core business for the future. It's very value creating, strong brands, strong market positions. It gives us a lot of leverage with our customers, the retailers. It typically helps us being one of the top 10 suppliers to retailers in Latin America and in Europe. So that's definitely something we will continue to develop to create more value just like the other parts of the business.

Okay. So maybe thinking about capital allocation, again, going through a potential situation of a divestment. Is there a priority list between reinvesting back in the business, further M&A, debt paydown?

Yes. I mean, so far, we have always worked towards our growth target of 5%, which includes approximately on average 2% of contribution from acquisitions because that's typically what we've been able to fund on our own balance sheet. So of course, that could definitely be an opportunity. We could also see opportunities to deleverage; share buybacks, maybe not something we have done historically, but that's not impossible; or a combination of all of these could be possible. Again, it's early days, but we would consider all of these different ways of creating shareholder value.

Okay. Maybe to frame it in a different way just because I think for investors out there, it would be good to understand beyond the strategic review what would the priority be. Is deleveraging maybe more important in this interest rate environment compared to M&A? I know you have the 5% target, 3% is organic, 2% inorganic. So maybe M&A is more of a priority, but what's the balance [ stream ], let's say, M&A and deleverage is more of a preference towards one or the other?

It's definitely -- it's -- I can't say because it depends on opportunities. It depends on the prices on potential acquisitions. And of course, with the higher interest rates, it doesn't make it easier before maybe multiples come down on acquisition targets also. So I actually foresee that it will be a mix of all these in one way or the other depending on opportunities. So also, adding to that, I expect us to have a strong cash flow, both throughout the remainder of this year and last year. So we will -- next year. So we will also deleverage just based on that over the next years. So looking forward to having a very strong kind of firepower for whatever we want to do here within the next 12, 18 months.

Okay. That's interesting. I guess, thinking about, let's say, move away from strategic review, what would be the priority once that's out of the way? I'm sure you're so tired of talking about this ever since you broke it earlier this year. But what's the vision for Essity beyond strategic review?

So taking a step back. We split from SCA about 6 years ago. We have acquired a medical business that's doing really well now after the pandemic and a lot of hard work. . If I look forward to this, I believe we will have a much more balanced portfolio than what we've had today. Today, 40% of our business is Consumer Tissue. And parts of it, the ones we're looking at in our strategic review, are quite volatile and capital-intensive. And without them, I foresee an Essity, which will contain 4 equally sized businesses. So 25% consisting of Professional Hygiene, which is doing extremely well. I believe it will continue to do extremely well. 25% Health & Medical. And then splitting then the remaining half and half, half Consumer Tissue and half the Personal Care categories, Feminine Care, Baby Care and Incontinence Care. So a much more balanced portfolio. We will reduce our pulp purchases, which contributes to volatility, in our case, by half from 3.3 million tons to 1.6 million tons. We will reduce the part of our overall business being Consumer Tissue from about 41% to then approximately 1/4 of the business. So a much more balanced portfolio. And then to continue to invest both organically and with -- when the opportunity arises primarily then in medical in Wound Care, in Incontinence Care to the extent we find opportunities, that's more tricky, and definitely in Professional Hygiene, which is doing so well in small adjacent categories like skin care, soaps, industrial wipers and so on as we have been doing. And we have been making acquisitions in these areas over the last years, so we're all performing really, really well. And actually some exciting acquisitions also in Consumer Goods, where we acquired Knix and Modibodi in leakproof apparel. So I mean, that could also be an opportunity, maybe not specifically leakproof apparel, but kind of future-oriented businesses. So I think we have a good track record in doing that. And of course, our starting point already this year, before all this has happened, is that I expect this year to be the highest sales, the highest operating profit and the highest earnings per share we ever had. If you actually look back 8, 10 years, you will see that there's been a positive development more or less every year for the last 8, 10 years with the exception then of the pandemic, the following raw material, of course, shock where we encountered and then the bottlenecks in supply chain and so on. And that impacted 2 years out of these 8 years. And if you look back, we've actually been growing top line by approximately 5% per year, year-over-year-over-year and 10% when it comes to operating profit. And this is because of just managing the business, building strong brands, innovation, investing in staying ahead of our competitors, of delighting consumers and customers. And we tend to forget that there are so many moving parts. But that's kind of the underlying hard work that's going on all the time. And you will see by the end of this year that we're back to that very positive trajectory again that was kind of put off [indiscernible] like the pandemic and the war, I forgot to mention, and with terrible impacts like that. So a very good starting point, I think, for a more -- I think we've done the biggest parts then of the restructuring after the strategic review. And then we can build on this very, very strong base that I just described.

A lot to discuss there. I mean, one interesting point you made was the consumption of pulp that will fall by half. Can you just outline maybe some of the other benefits that will bring?

Another benefit is that -- and one of the reasons why we are including within the strategic review, it's a fantastic company, it's where we manage strong brands. Of course, a growing market, but it's also very, very capital-intensive because the way we've been going there on the tissue side is by just adding more capacity and that's really, really capital intensive. So we will be able to reallocate not only opportunities for M&A, but also capital expenditure to the other categories and drive even quicker growth in some very exciting basic areas we've been growing for years, like in the strategic parts of the Professional Hygiene with the PeakServe dispense range, with the Xpressnap dispenser range that actually is 50% of the napkins in the U.S. are dispensed through a PeakServe dispenser and we achieved that in less than 20 years. It's quite amazing. In Incontinence Care, where we've just grown the [ pants ] business year-over-year, [ just adding ] more and more capacity. We will be able to reallocate to growing those basic but very, very high gross margin businesses with an underlying growth faster also.

Okay. So talking about the faster growth trajectory, the current algorithm now is 3% organic, 2% inorganic. Is there any uplift on the, let's say, the organic side, excluding Vinda and the Private Label business?

Well, in the short term or if we look back historically, Vinda has contributed very positively in the growth, of course, because Vinda has been growing double digit year-over-year-over-year. That's not what we see this year and maybe not what we're seeing in the next couple of years either. But of course, we will have to replace that growth engine as part of this equation with something else. And I believe the way it is to really double down here as where we are already growing. So it's kind of a lower risk strategy, and we will be able to maintain those 3% organic, which means that we also keep going up with the market share slightly year-over-year, which we didn't do during the -- well, after the pandemic when we raised prices dramatically, of course. And we have a small dent in our global market share. Much smaller than I had expected considering the price increases actually. But in the longer term, of course, that's also very, very important for us to continue to keep #1 or #2 positions, where we are present and that we also grow those market shares year-over-year slowly step by step.

Okay. That leads me on to my next question about pricing, which I know you probably expected. It's the topic of the last year for many companies and staples. But now as we kind of head to second half of the year, that's going away. Can you just talk about the pricing environment in Europe considering if we look at retailers across U.K. and Europe, there's been some deflation. We saw CPI numbers in France and Germany showing prices were falling for 2 products recently. How is that impacting Essity? And my second question would be when retailers are cutting prices, is that impacting the pricing you're putting through? Or is that coming out of retailers' pockets?

So actually right now I'm not so concerned about the relations with the retailers and those negotiations. I don't see that there's anything specific really to mention. That's kind of business as usual. What we have -- what has been a little bit of a concern on the first half year are our overall volumes. And if that's due to consumers consuming less, which we've never seen before in our categories, our categories are typically very, very resilient since it's essential, it's necessities, or if that's something that will remain, I think it's yet to be seen. But regarding our negotiations with retail, there's nothing special. I feel that the retailers are having sufficient margins. There is some additional promotion, there is some down trading, but nothing that we can't really manage. And of course, this is very much now related to Consumer Tissue in Europe. When it comes to our other consumer categories, FemCare, Baby Care, there's less price pressure and we're actually, in some cases, still on that price increase journey, especially with FemCare, and to some extent, toward the inco retail also. And then let's not forget the 40% in business. We tend to forget them. We're always talking about Consumer Tissue Europe. And in Health & Medical, we are still increasing prices and we'll continue to do that for the remainder of the year even though we're now starting to see declining costs also in this area with a lag compared to our other business areas. In Professional Hygiene, we have been incredibly successful in raising prices. Feel that we're in a quite good spot right now and kind of recalibrating, focusing on growth. But this is a category where we are so strong that the pricing pressure is not the issue for us. It's just to continue to grow on our way with healthy gross margins. So just a very positive scenario for Professional Hygiene. So it's quite different between different parts of the business.

Yes. It's obviously -- the headline always comes to Consumer Tissue, but...

Yes. Of course, after the strategic review, I guess, that focus will be different. I'm very much looking forward to that. Yes.

You mentioned something there very interesting about FemCare and Incontinence Care about pricing still coming down in the pipeline. I mean how long should we think about that? Is that going into 2024 as well?

It's difficult to say. Right now, we're seeing costs coming down also on these oil-based products. I had some questions today regarding oil prices moving up. I think it's too early to say if that will impact oil-based products because it's not only the oil price, it's also the processing costs and so on. In general, going forward, I mean, you mentioned that this equation of us having 3% average organic growth, typically, historically, we said 2% would be volume and 1% would be mix because prices were always falling like 0.5% per year for like 10 years or 20 years. But now I think there will also be an inflation [ from ] Vinda for sure. I mean we need that because even if [indiscernible] would recommend, there will be some inflation in maybe cost in other ways -- coming into our costs going forward. So we [indiscernible] for that as well, like everybody else.

Fair. I mean I think the one narrative investors are always talking about and you mentioned, I think, since Q3 last year, you saw some down trading in Lat Am, a bit in the U.K. The price gap between you and the private label players, has it remained relatively consistent? Or has that started to widen a bit?

Yes. And of course, we're also big private label player so far [indiscernible] in Europe, which is under strategic view. But having said that, the price increases on private label were almost higher over the last year because gross margin is lower. So this -- they need more and the pulp kind of content of the overall cost and the overall value is higher so -- and energy. So the gap narrowed actually. And now some retailers are promoting private label a little bit more. And we're seeing some down trading. We're also seeing a down trading within brands and that's something that we are working hard to make sure that we have a very attractive value offering also in our brand so that we don't lose consumers from the brands. They stay -- even if they trade down, they stay with our brand. So that's a very strong effort. The premium segment is still quite okay actually. It's not declining. People have been buying in a good/better/best scenario. The better products are moving down to good products. And also, of course, out of that we expect they are moving to hard discounters and the new formats that we're starting to see in Europe [ where they have ] these super hard discounters.

How does that impact you, the move to the hard discount channel? I mean, is that even more of a channel shift concern?

Yes. We didn't have a channel shift for many years until recently. The hard discounter style, the Aldis and Lidls of the world, they become more similar to normal retailers. So it doesn't impact us that much. Now you see new formats coming in below them like Action, for instance, I guess, or dollar stores and so on. Let's see how successful they are. Some of them seem to have also some trouble with their financials because of the price pressure [ where they're ] trying to create them and trying to build volume. So I'm not too concerned about that. We believe that building strong brands, providing fantastic [indiscernible] performance to our consumers year-over-year-over-year is the winning formula for the long term. So even if we see some small shifts back and forth, typically, historically, we've also seen that consumers down trade for a couple of quarters and then they come back because the benefit of down trading on cost is not visible maybe from any kind of the lower quality or people just prefer the brands they are used to and will typically come back. So that's what we are expecting in this case as well. So our focus -- and I mean that's also the reason for -- one of the reasons for the strategic review is we aim to have a bigger and bigger part of our sales from our own brands and reducing our dependence on private label also in Europe.

So if we're thinking about the consumer environment then, big picture, I mean has anything changed over the last few quarters? I mean, Q3, I think, is again when you called out the down trading. Has there been improvement metric trends for you guys or no?

It's not really -- it's -- I think it's early to say how this is going to develop also, depending if we see kind of a soft landing or a recessionary environment. Again, typically, our categories have been very resilient. And considering all this, again, we were looking at an operating profit in the second quarter at 50% higher than last year. I mean, overall, our business is [ streaming along ] very, very nicely. We had a little bit of a negative surprise from Vinda. But overall, the business is doing really well, actually in almost all categories. So I have an optimistic outlook in spite of [ the risks that you said ]. It's nothing new for us. It's something we have always managed than being in the U.S., where maybe private label is something less prevalent and so on. I mean this is something we're used to since in 30, 40 years and we're also supplying private labels. So I think we'll manage this the way we always did and keep on innovating, keep on -- we have a very exciting launch program in all our categories and making our consumers happy and choosing us for value for money so [ giving ] a superior product and also the sustainability offering that we have and the overall package. And I expect it to continue to be successful. There's no reason for us to make any drastic changes from that perspective.

Okay. So one thing you talked about in the last few calls has been the Cure or Kill Program, which in other words, is kind of an SKU reduction program, I guess, across your business. Can you just comment on how that's going, maybe the impact you're seeing to volumes? And what's the positive elements you're going to see in the next 6, 12 months from this exercise?

Absolutely. The Cure or Kill, we've been running that for quite some time, had a big impact 6 years ago when we took out a lot of underperforming Baby business and some underperforming Tissue -- Consumer Tissue businesses as well. After that, it's been more or less a system that we've been running that's been highly efficient and always having the 10% of the business that's the least performing in some kind of intensive care, where we follow those category-country combinations and set the target for them to improve in 18 months. And if they don't, we will restructure, that's the kind of Cure or Kill premise. This has become more relevant now after the raw material shocks and kind of changes in overall gross margin development in different categories and so on. And what we've done recently that we announced in the first quarter and then in the second quarter is restructuring of our Professional Hygiene business that's already doing extremely well, but we said this -- we shouldn't allow that to hide underperformance. If you look at just the overall Professional Hygiene business, it looks really well. But even here underneath, we have businesses that are very low gross margin, we're just keeping machines running because we have them and so on. Doing some significant restructuring, it will add 2% of the margin to our Professional Hygiene business year-over-year. So a really, really important step. So that's 0.4% for the overall group. So that's maybe the most recent bigger example. But then we always have -- it could be, I don't know, Consumer Tissue in Chile or something that they know that they're in intensive care. They have to improve or we were going to do something. It's a very efficient management tool that we've been running over the years. Some more visible impacts right now this year are these 2 in Professional Hygiene.

And just thinking about -- because you mentioned the volume headwinds this year, can there be an uplift for 2024? Because we talked about pricing coming off, and therefore, 2024 across both companies and staples will be about volume growth or volume/mix. Should there be a visible uplift next year from it?

I don't know. I mean this is what we're aiming for, always having a positive volume development because it's good for cost efficiencies. It shows that you're winning in the market, of course. It's typically also a consequence of growing market share. So definitely, that's something we want to see. Historically, we always have positive volumes in Essity before the fourth quarter of last year and then the first 2 quarters this year. And it actually has come as a little bit of a surprise to me, it's partly an impact of us taking decisions, especially in Incontinence Care, in Professional Hygiene to step out of underperforming contracts, in some cases, restructuring, like I just mentioned. But in other cases, we see kind of a soft demand, which is very surprising to us. We never saw that before in toilet tissue or in FemCare liners or baby products. We still think that it should eventually normalize, let's see how that develops. But let's put it this way. We're always aiming for volume as part of our overall growth, for sure. But I think everyone is now kind of uncertain because of the development over the last few years with the pandemic and everything. I mean, before the pandemic we knew, and this is still the case, that in Incontinence Care, it's always growing because of aging populations. People suffer from conditions, diabetes, obesity, cancer survival and so on. We know that FemCare liners is quite stable. It's fully penetrated, liners and pads. Toilet tissue was growing 0.5% to 1%. It was super stable year-over-year-over-year. Professional Hygiene was down maybe 1%, 2% 3%, depending on the market. It would be surprising if it -- and Baby Care was very flat due to falling birth rate. It would be very surprising if we don't get back to that. That's how I see it. But we've had some, of course, upsets over the last couple of years So this is what I would expect going forward is that...

Those factors you just outlined there, those are the drivers you think behind the soft demand you just quoted there. You've said you've never seen soft demand in the last few years, the last 8, 10 years in the category, forever really. So these dynamics, the lower birth rates, maybe the impact from COVID, those are the drivers? Or is there anything else we should be thinking of?

We don't know if this is going to happen yet so and why we have the slightly negative levels this year. It's to some extent, again, self-inflicted, Cure or Kill. We have to remember that and that -- we're, of course, showing the comparables next year. But again, we're doing this for the long-term so it's the right thing to do and we're very happy and it helps on our margin journey and we're going to use those resources to focus even more on growing faster the high gross margin parts of the business. Then when we talk about the underlying demand, I'm sure there's positive [ growth ] for many of our categories for all the underlying reasons I just mentioned. People are there -- there are low birth rates, but people are also living longer. They have high disposable income. They want to remain active. They want to be out paying golf when they're incontinent and when they suffer from chronic wounds and so on. So I mean many other categories fit perfectly with this, and they want to use premium hygiene. Hygiene becomes more important and they want to use a premium hygiene product. All of that, I think, underpins a growth case definitely for us in the next couple of years. But if that will come for next year, let's see.

Okay. So you talked about a few interesting kind of drivers of category growth within hygiene and we talked about inorganic M&A before. What does the ideal asset maybe look like expanding on? I know Wound Care, the U.S., they're all attractive areas for growth. But is there certain category that you think you need to penetrate further? And then I guess also is there any multiple that you'd be looking at in terms of an ideal framework? I know we looked at Knix and Modibodi and you've given some examples before of maybe a lower multiple to pay for some targets. But is there any kind of template we should be thinking of?

Good templates are the acquisitions we already made, as I mentioned, including an Hydrofera and ABIGO, the 2 advanced wound care companies that are doing really, really well. Good margins, good growth, also here in the U.S. If we could do more of that, that would be ideal. Then, of course, [ outputs ] and so on, this will change now with increasing interest rates. And so depending on how those businesses are developing in those categories going forward, I don't think I can speculate about that. We have to look at case by case, of course, how attractive the company is in terms of growth and margins. But that's very attractive to continue to grow them in these very value-adding adjacent areas in Professional Hygiene where we are always so successful with the top brand like industrial wipers, earlier mentioned also sanitizers and so on definitely. I see opportunities also in the Personal Care product consumables. There are fewer opportunities in Incontinence Care, we're already the global #1, of course, with 20% global market share. To build a bigger position in the U.S. would be a dream. It's the biggest hygiene market. It's the biggest incontinence care market, but very few opportunities really for inorganic growth. And maybe we will see in the future that we kind of put more efforts into organic growth because, in many cases, we have fantastic products. We have really strong brands and good innovation coming and that could also be a very value-creating way of growing. But still a mix. Acquisitions, you can't predict it. You never know when you have the opportunity or if it's big or small or how attractive it is, what's the right price?

Okay. You mentioned margins there and I just kind of want to circle back to the return on invested capital, which the 17% target for 2025. The question is, do you still think that's on track? And I guess, the target EBITDA margin is about 13.5% or thereabouts. How confident do you feel in that 17% target?

Yes. I'm very confident. So we need another 3% of margin because most of the road towards that target needs to come from margin enhancement, maybe 0.5% or something from more efficient capital employed. And we are working on our working capital, which is very high right now and putting some under levers, but most have to come from margin improvement. We've come a long way how we were at, yes, 10.7% margin in the second quarter from just the price increases and managing the short-term situation. But we know if we look back again [ 18 years ] that we've had a nice margin improvement of 0.5% to 1% per year. Just from hard everyday work that I mentioned now several times. We keep progressing because it's so volatile here for a couple of years of just investing in innovation, but also in digitalization, in cost efficiencies. And we lost a few years of cost efficiencies in our supply chain when it was more or less close to the outside world during the pandemic and now we're seeing lots of opportunities. Of course, we are working to reduce our purchasing costs, working with procurement in more efficient ways, machine efficiency improvement, energy savings. All of those opportunities are still there. And we lost a few years of that and I think we can accelerate that now. And so all that just hard work from different areas will help us to reach our 17% return on capital employed. And then always, of course, balancing that with having a reasonable volume growth, market share positions and so on. And this will look very, very different from category to capital and from country to country. But this is still our ambition, absolutely.

You kind of left the door ajar there on the efficiencies you can gain for what could a royalty look like post Vinda private label, and I promise that's the last question I'll ask...

Yes, yes. I think that's speculation, but it's clear that without -- and I think we show that without Vinda being in the private label division in the second quarter, thus the operating margin would have been 12.5% instead of 10.7% in that specific quarter, of course. So it kind of shows now it was a very bad quarter for Vinda, but we have a lot of capital deployed also in those businesses. So if it would have a positive effect, how much, I don't -- I think we will see when that is finished, but it will be a positive contribution even though the 17% we set the course before we set -- we decided on the strategic reviews. And over to the caveat that we need to manage the overall balance. We're not going to do something drastic just because of the ROCE, though it's a very important target. But growth is also very important and the overall target is also to [indiscernible] cash flows and develop the business, gain market share are also important targets for us.

Is there one that's a priority instead of top line growth?

I think it's the return on capital employed target and the growth targets that are both very important for us.

Okay. Just because I'm constantly running out of time, one last question I wanted to ask was on the topic of sustainability. Essity is one of the leaders in Europe on sustainability from a [indiscernible] perspective, also performance. Moving away from pulp-based products is going to, as we talked about, help. Can you talk about how that's going to help your sustainability score and how that's going to help in terms of your emissions?

Yes. I don't have the numbers. But of course, almost all our greenhouse gas emissions come from the Tissue business, basically over 80% or over 90%. The Personal Care factories typically run on green electricity, and that's it, while [ we've seen mainly produced ] through gas-fired tissue machines. We're converting them out to biogas. We have some real exciting stuff going on. We use hydrogen in Germany biogas in Sweden and so on. But of course, without -- assuming we're beyond this strategic review, those numbers will look better.

And then any other interesting innovations you're working on, sustainability?

We have so much sustainability innovation going on. If there's something that already launched a few years ago now, it's the wheat straw plant we have in Mannheim in Germany where we are sourcing fibers from farmers who actually operate farms around the Mannheim tissue plant, it's our biggest tissue plant in Europe. And it replaces wood pulp that comes from typically the [ cylinder ] in the Nordics, so you avoid one step in the transporting, in the processing of this pulp because the wheat straw goes straight into the process. And it's highly renewable because you have that [indiscernible] wheat straw coming out in the fields every year. It doesn't have any value currently for the farmers and 15% of our consumer tissue in Germany these days comes from this wheat straw source. And of course, also a way for us to replace fresh fiber for sustainability reasons, but also to be less reliant on these big pulp suppliers. We are collecting paper cups from McDonald's in Europe. We're collecting Tetra Pak mix all over Europe and recycling them. So recycling our own hand towels in 10 countries in -- Tork hand towels in Europe. So many new sources, which are much more sustainable and fiber also is another example.

That's fantastic.

I can talk about this for a long time, I know we're running out of time.

We are. Appreciate it. Thank you, Magnus, and thank you, everyone who's listening in. Appreciate it.