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

Good morning, everybody, and thank you for everybody who's [ matched ] to make it through the security this morning. I'm sure some more will be joining us. But delighted to introduce Magnus Groth, President and CEO of Essity, who will make a short presentation, and then we'll move on to some questions after that.

Thank you very much. Thanks for the introduction, and good morning. And I think we're all very safe in here, it seems, the ones who made it inside. I'll give a quite brief introduction, and then we have some interesting questions, I know, then some things to discuss, and I look forward to answering your questions as well, of course. So the Essity Group for everybody and every body, our new tagline, we touch over 1 billion people every day with our products in hygiene and health, and we are active in 150 countries around the world. Some quick numbers for those or maybe not that close to Essity. Essity was created 7 years ago through a spin-off from the hygiene and forest company, SCA. So we're a quite new company from that perspective, even if, of course, our brands and our business has been around for much longer. So close to SEK 150 billion of sales, 36,000 employees. Since our products in hygiene and health are typically bulky, we have 72 factories. We typically have quite local or regional production and supply of our products. We're in hygiene and health, but we're also a leader everywhere. We choose to play more or less by having a #1 or #2 position, it's key. And this is based on actively developing very, very strong brands in our different categories. We're not present everywhere, but where we're present, we definitely need to be #1 or #2, and this goes to whether in business-to-business or in business-to-consumer. And we are present in three very attractive business areas. Health & Medical, 20% of sales. This is where we are the global #1 in incontinence care, in the health care sector. So the reimbursed part of -- which is typically in mature markets of the global incontinence care market. Overall, in incontinence, we have -- we're the global #1 with approximately 20% market share. So -- and of course, this is a rapidly growing category with aging populations, where people want to remain active, live an active life, suffering from chronic condition and the other consequences of aging. In this category or in this business area, we're also present with three therapeutic areas in medtech. This is advanced wound care, it's compression products, and it is orthopedic soft goods. And also here, we are typically in #1 and #2 positions where we choose to play. And it's -- typically, it's the same persons who are suffering from different chronic conditions, could be cancer survival, it could be obesity, could be diabetes, aging that use both, for instance, chronic wound products and incontinence care products and compression garments for that matter. The biggest business area, 55% of sales and the business area, that's often maybe connected to Essity -- Consumer Goods. Many might believe that we're a consumer goods company entirely, but it's actually just over half of our sales, 55%. This is where we are in leading positions in Consumer Tissue, in Baby Care, so Baby Care products, incontinence care products in the retail space and Feminine Care products. And again, where we choose to play, we are typically #1 or #2, mostly #1. And our third business area, which is having a fantastic development, Professional Hygiene with the Tork brand, where again, we are the global #1, when it comes to Professional Hygiene solutions away from home. Like here, for instance, I noticed in the washrooms, there were Tork products, even though it wasn't our dispensers in this case. And this is 25% of sales. We are the clear global #1, 20% market share and growing very nicely here. And also, this is the last part of our business that's recovering after COVID, but now doing really, really well with increased traveling around the world, increased activity in hotels, restaurants and catering and so on. And in all these three areas, we are set to grow. And this is for various reasons, to some extent, number one, we have great margins now. So growth is very value creating for shareholders. Secondly, in Health & Medical, since we have a high fixed cost in this business area and a big sales force, feet on the street actually meeting with hospitals, elderly care homes, participating in [ tender ] processes and so on; we have huge scale benefits from growing in Consumer Goods. We can grow because we now have the margins that, again, justify growing. And of course some of these categories, especially Incontinence Care Health Care, has a fantastic underlying growth, 5% to 7%. So we can really grow that. Feminine Care, Baby Care growing rather flat, 0 to 1%, and Consumer Tissue, depending if it's a mature or emerging market, a few percentage points. And then Professional Hygiene, growing 2% to 3% every year, but we are the clear #1 and also gaining market share here. So exceeding market growth. I want to take a step back because Essity is at a kind of inflection point actually. I already mentioned that we are a young company, only 7 years old. And we were created through numerous, dozens of acquisitions over the last 30, 40 years. As the forest company, SCA acquired companies all over the world in hygiene and health. And then at the time of the split, the hygiene part was 87% of sales. And what we've done since the split is really to create one common way of working, one go-to-market, one supply chain, achieving the synergies, putting in place global business services, global distribution, transportation hub in Barcelona, for instance. Sorting out the supply chain, when you grow through acquisitions, you end up with having maybe 5 factories in one country where you need 2, and maybe no factory in another country where you need 1 or 2. So we closed about a dozen of factories of this year, so a lot of restructuring. And we also achieved big, big efficiencies through all of these activities. And meanwhile, underneath, we have been working -- continue to work with innovation and brands. And also through the pandemic, the following raw material crunch, the energy crunch, the bottlenecks that we saw in the supply chains, we continued to invest, invest, invest behind our brands to make sure that we retain these leading positions. So it's -- from that perspective, it's been a journey where we've been very focused on creating the big machine, that we feel that we now have in place after a decade of hard work. Financially, this is the development. So in magenta there to the left, you see the sales growth, annual SEK 7 billion sales growth, and that is how the operating result has developed. And as you can see here, it's a very consistent trajectory with a dent during the pandemic. And in sales the dent was in 2020 and '21. And in operating profit, that dent then came one year later, because that's when we had the raw materials, the energy and the bottlenecks. But as we proved last year, we're back on track. And I know that this is something we'll discuss also, but I'm completely convinced that this is the trajectory if you follow that path, excluding the dent that we are on, and there's no reason why we shouldn't be. And actually compared to looking back [ to you ] 4 years, we are really, really in good shape. So this is my favorite slide. That's why I'm lingering a bit on this one. And some -- you might ask, so is this now peak profits or peak sales? And my response is here, why would it be? I mean, look at the trend there. This has been going on now for 10 years. And we recovered very quickly after all the issues that we are aware of. Also in Q1, last year, high profits and strong cash flow. This picture actually is our Knix washable, absorbent underwear company that we acquired a couple of years ago, which is the market leader in the U.S. and Canada, in this very new exciting subsegment of Feminine Care, incontinence care products, where -- with a very sustainable alternative of using the washable, absorbent underwear, instead of disposable single-use plastic pads. And in Q1, we had 14% [ EBITA ] margin; fantastic development in Health & Medical, close to 19% adjusted [ EBITA ] margin; strong development in Consumer Goods, [ 13% ]; and over 15% in Professional Hygiene. So we were doing well, more or less across the entire business. And why was this? We improved margin significantly in Professional Hygiene through some restructuring that we did last year, which we're now comparing to, which shows a reported negative growth. However, underlying, we had good positive volume growth in all our categories. Excellent pricing discipline, which is based on our strong new brands, our strong market positions, our pricing power, excellent cash flow. And during the quarter, very important, also while we're at an inflection point, we divested Vinda, our listed Hong Kong company, with a strong presence in China, 17% of our sales. And we divested Vinda as the outcome of a strategic review, where we concluded that we have to reduce our share of sales in Consumer Tissue, which is our lowest-margin, highest -- most capital-intensive business and especially in China where this was being commoditized, and where there's a big need for continuous investments in new plants and machinery and so on. So we finalized that divestment, reduced our share of sales in Consumer Tissue significantly. And it was also a fantastic deal. So you can see sales proceeds of SEK 19 billion and the net capital gain, SEK 9 billion. Of course, this puts our balance sheet in a completely different position now. We have a very, very strong balance sheet. And together with strong cash flows, a lot of optionality for the future. The annual return on investment from these 10 years with Vinda has been 14% per year. So to summarize, Essity is in better shape than ever. This is what I want to leave you with for the Q&A. We worked extensively with our supply chain. We're more efficient than we've ever been. We now have the plans we want to have that are modern, that are well equipped, that are efficient. We see efficiencies going up everywhere. We have lower volatility in our earnings, which were actually already low. And we made some analysis of our earnings volatility just before coming here. And if you look at the volatility quarter-over-quarter over the last 5 years, from a standard deviation point of view, we actually have lower earnings volatility than our 2, 3 biggest international peers. And the same goes if you look back at the last 10 years. So this is partly a myth, I think, because we have this kind of pulp exposure. And then we had the big dent in the curve during the pandemic. But when you run the numbers, our earnings volatility actually doesn't look bad, but we're still working very actively to improve this. And maybe the best way of doing this is to be more agile in pricing. And what we believe and we're convinced, because we did it during the pandemic, is that we can adjust the underlying raw material costs within 1 or 2 quarters through pricing towards our customers. Before the pandemic, this was typically -- took 3 to 5 quarters. So we're much faster here for many different reasons. The whole industry has changed in that direction, especially then in the retail sector. It's also the retailers are willing to kind of discuss and adjust prices quarterly instead of annually. So lower volatility. Pricing power I touched on, something we have proven over the last couple of years. We have a more profitable, we have a more attractive portfolio without Vinda and a very, very strong financial position after the first quarter net debt to EBITDA was 1.36. We had excellent cash flow. We expect to continue to have excellent cash flow. So this will continue to come down. And we will provide new financial targets, including then, how we look at our capital structure going forward, financial policies during the second quarter. So kind of within the next month or so, we promised to come back on that because now we have a lot of flexibility, based on our balance sheet strength and our cash flow, to look at, yes, both acquisitions, investments in the business, of course, but also other ways of using cash in an efficient way. So a very good place to be for Essity, and this is my pitch to you, [ where ] you should invest in Essity. Attractive and growing markets, I should say that, of course, our big bet over 10 years has been on aging, and it's becoming more and more clear. I mean we have been pulling out. We were very, very -- we were bigger in Baby than in incontinence care. 10, 15 years ago, we've been putting away from Baby, investing in incontinence to have a clear #1 position in healthcare and in retail globally. And of course, 10 years ago, it was a joke. People said "In Japan, haha, there are more adult diapers than baby diapers." Now this is everywhere. It's not only in Japan. It's the new normal. And of course, that's only going to change. Also, our stepping into the Medical business also very much supported a very good growth from aging. And of course, attractive also from the perspective, these are products that people use every day. So whether the times are good or bad, people use our products. Leading brands in innovation, 90% of our market positions, market category combination, which were either #1 or #2, we have a -- I haven't touched on that, but we have a very, very strong sustainability agenda, and we walk the talk. So we really invest in this. We are typically recognized and awarded by all the major NGOs and others for our sustainability work. And yes, we believe that this is an important competitive factor also, going forward, and a very strong financial position, as I already touched on. So thanks for listening. Let's have some time for questions.

Great. Thank you very much, indeed, Magnus. And I'm going to ask some questions, but if anybody does have some questions they'd like to ask as well, then please do raise your hand. So I'll maybe go straight to the heart of the issue, and you alluded to it in the presentation that the -- that you've done a lot of work and reduced the volatility of the earnings, as you stated, that the valuation multiples for Essity are relatively low versus their post-listing historic range. And one of the points that people make to us quite often is "We feel Essity's over-earning, particularly in areas where there's a high commodity -- a high COGS component." To what degree can you give that confidence to people that you're not over-earning in those areas? And...

I think it sounds like a good thing to be over-earning. But anyway, no, I -- the confidence is based on that 10-year trajectory. So we heard this many times, "You're over-earning. This is it from this. From now on, things will only get worse." And that hasn't happened. We've proven again and again, we can raise prices. We have super strong brands. We have super strong market positions. Something we haven't touched upon before I forget it, we have really, really good savings. We have had savings in cost of goods sold net in the first quarter of over SEK 400 million. And our guidance this year has been to have savings of between SEK 0.5 billion to SEK 1 billion, and now we're guiding to be at the top of that range. Also coming from the very good development we have in our entire supply chain, not only in the production, but also end-to-end also in logistics and everywhere, actually. So very, very strong savings, which makes us more competitive, basically. Pricing power, I mentioned, we expect to be able to adjust pricing specifically in the Consumer Goods sector because we're now talking about the retailers in 1 to 2 quarters rather than 3 to 5 quarters. And also, again, remember, 20% of our business is in Health & Medical, where we have close to 19% margins, and we don't have a big raw material or energy exposure. 25% of our business is in Professional Hygiene, where we -- which is a tissue business, but it's mostly based on recycled fibers, and that's not as volatile as the pulp. So -- and actually, we have much stronger pricing power in Professional Hygiene because we typically work with distributors or big end-users like airports or universities and so on. And for them, it's not a big deal when we adjust prices. We provide high-quality services, high-quality products. It's easy to work with us because we're a big provider of professional hygiene. So that gives us pricing power. You passed security. Okay. Welcome. And then we come to Consumer Goods, 55% of sales, where, of course, the Personal Care categories, Baby Care, Feminine Care, incontinence care retail; they're not impacted by raw materials or energy either at this point in time. That's oil-based materials. And then approximately 1/3 of our business is Consumer Tissue. But what we have left now, Consumer Tissue is the best part, where we have strong brands, we have good market positions, we have pricing power. And of course, currently, pulp prices are going up. These cycles we see all the time, and we'll manage that over the next couple of quarters. So we're not over-earning.

So you obviously run through the potential mix benefits for you, you've run through the cost savings at the COGS level as well as -- and further down through the organization. So to what extent, therefore, is there still the opportunity for further gross margin -- organic gross margin improvement? And where would you sort of benchmark yourself versus history, if you like?

Yes. We are at better gross margin levels than we ever been. And of course, that also gives us more flexibility in terms of how we want to work with [ A&P ] and so on. So our gross margin was [ 33% ] in the first quarter, which is kind of an all-time high due to the mix changes and so on we just discussed. And what was your question, [ again ]?

Yes. Well, just to the extent to which you can organic...

Organic, yes. And I mentioned a few times that we're at an inflection point. And that means that over the last years, there have been a lot of restructuring, and this has, now and then, kind of come as a surprise, both internally and externally, as we've been running different programs like Tissue Roadmap, the Cure or Kill exercise we did a few years ago. And now last year, when we said that's -- is there anything left that we need to clean up now in Essity? And we said, yes, actually in Professional Hygiene, one of our best-performing businesses, we take out almost 10% of capacity, which is not really contributing to the business in the long term. It was just unbranded, low-value napkin business on old assets. So we closed it. And this is now done, and that means that our new focus is, in combination with the margins that we have, to grow volumes. And with growing volumes, we can clearly see that there's an opportunity to see great operating leverage. So that's the new way of continuing to improve margins over time. With 14% [ EBITA ] margin, we are putting more emphasis on growth then for two reasons. One is that it's more value creating when you have good margins than when we had 10% margins, of course. But secondly, because we can see that as we utilize our remaining now very efficient supply chain, but also our go-to-market or the other strategies we put in place, we can get operating leverage. So that's what we're going for. And we never worked with operating leverage as a way to improve margins before. And we can clearly see it also in the first quarter this year.

And so when you look out over the next 3 years, 3 to 5 years, where are the biggest volume opportunities and value drivers for you? And will those businesses already be at group-level return on capital employed for you or...

Yes. Our group-level return on capital employed was now 17% for the second consecutive quarter, which has been our long-term target or target until next year, actually. But that target was helped by 1% by the divestment of Vinda, because Vinda was a drag on our ROCE target. So from the upstep perspective, we have a step-up, another percent, which will mostly come from operating margin improvement, rather because, I mean, that's quicker than capital efficiency, even though we're working with that continuously as well. But we believe, as we have rerun all our numbers after the divestment of Vinda, that our category market combinations are growing between 2% and 3%, 2.5% maybe, something like that. And of course, we believe that we can grow slightly faster than the market and take some market share, that's our ambition, which means that growing above 3% organically is something we see as achievable, which is quite attractive. And how does that break down? Typically, when we look back, we have been growing around 3%, even though it was very lumpy during, again, the pandemic. 2% has come from volume, 1% from mix. We had a very, very consistent mix component over many, many years, actually. Volume has -- over the last [ year ] as we lost volume, we were so focused on pricing. But now we see that underlying 2% volume growth should be achievable.

Okay. And you mentioned some of your financial targets, which are in place at the moment, and you said -- stated that you're going to be updating those [ relatively ], so feel free to update away now. But...

Watch [ the space ].

When you do update them, is the financial framework as it stands and -- is it like to be an update on those existing measures? Or do other measures become a little bit more relevant now that you've evolved and developed the business to the portfolio, if it is...

I can't -- I already spoke a bit about organic growth, which I think any company has an organic growth target. So that shouldn't be a surprise if we can with an organic growth target. And then if we're going to work with a ROCE target or something similar, we've done some benchmarking, we're checking what other companies are doing, of course, in our industry and other industries, and we'll get back to that. But either way, I mean, we will continue to present like we're doing today, [ EBITA ] margins, ROCE target -- ROCE development and so on. So for investors, it would be -- and I mean, the only difference between the two is the capital turnover, of course, which we also show. So this would be, I think, very transparent, going forward, also whichever we kind of work with, going forward. And then, of course, we also have the financial policies regarding our dividends and regarding our capital structure that we have today to remain solid investment grade at all times, which is more of a restriction really than a target.

Okay. And you mentioned there and in the presentation the strength of the balance sheet. What can you say perhaps at the moment in terms of the M&A valuations, perhaps of targets you've looked at? You've mentioned that before vis-a-vis your own valuation and whether perhaps buybacks...

Yes, good. I didn't -- I forgot to mention that. Of course, part of our strategy is to do acquisitions, and we have been quite acquisitive over the last number of years. It's provided 1% or 2% of growth, even though the last 2 years, we haven't done any acquisitions. We did a big review of them actually with the Board some time ago, and it turned out that all of them are actually on business plan and value creating. So very happy. Sometimes, I get questions, "Are you doing bad acquisitions?" But we did that review, and they're really, really good. What we learned, of course, it's no surprise that bolt-on acquisitions, small, medium, to existing categories and existing business, that's where you can have quick synergies and accelerate growth, do some costs -- have some cost efficiencies. Like Hydrofera, the advanced wound care company in the U.S., or ABIGO, the advanced wound care company in the Nordic markets, and so on that we acquired, that's what we're looking at. So we're looking at acquiring in Health & Medical, maybe something in Professional Hygiene, not in Tissue, in adjacent categories. Of course, in Feminine Care or incontinence care, if we find something, that's very attractive for us, but not that many targets out there. And of course, typically, these targets have high multiples, and we currently have -- or as you mentioned, are trading on a low multiple. So that's something we have to take into account. They really -- I mean we realize this. So when we look at how to allocate capital, this is something we need to think about.

Okay. Okay. Maybe if it's possible now, could we perhaps run through some parts of the business? And if you can give an update on perhaps some of the recent trading trends that you're seeing through the category lens or perhaps through the geographic lens, that would be super helpful.

Sure. If we start with Health & Medical, where our customers are then healthcare professionals, could be NHS in the U.K., could be an elderly care home, could be a hospital or anything in between; we do thousands of tenders every year. And typically, these contracts are -- have a [ 3-year ] duration. So it's a more sticky business than the other parts. This is the 20% within Health & Medical, the Inco Health Care in the medtech. What's been very positive for us is, how quickly we were able to raise prices. We were afraid, and this is also what we said, it's going to take 3 years when raw materials come up because of the contract structures. But it turned out that it was possible to achieve a bigger flexibility. Even with the NHS, we negotiated. Even though there was a 2 years left in the contract, we said, "We're just not going to deliver on these terms. You have to improve the reimbursement, one way or the other, because otherwise, we can't make this work," and we were able to do that. So that's kind of moving along quite nicely. And of course, this business area had a setback when a large portion of the users actually died away during the pandemic, and that's filling up again, and people didn't take care of their swollen legs and so on because of staying at home instead and not using compression garments and so on. So that's developing well from a market perspective. Professional Hygiene is not back to where it was before the pandemic, and that's because people are working from home. So in hotels restaurants, it's actually quite buoyant. In industrial sector, it's quite buoyant. But in commercial and public buildings, I don't think it will come back, but the new base we're at is quite good growth but from a lower level than before the pandemic. And then Consumer Goods, of course, where we work with the big retailers as our counterpart. Consumers are this kind of a subdued view of the world. So we are seeing down trading, we are seeing a move to private label. But that hasn't changed now for 12, 18 months, it's been the same trend. And in Latin America, clearly, in parts of Europe and the U.K. primarily, but to some extent in Germany also, people are switching to private label. And especially, this is limited to Consumer Tissue because in more emotional categories like Feminine Care, incontinence care, Baby Care, consumers still prefer the trust that a brand brings, that you can feel safe and secure and relaxed. So the down trading is really in Consumer Tissue. And we are mitigating that as much as we can by stretching our good, better, best tiering to keep consumers in the brand. But of course, we also have a private label offering in Europe. So it's that combination we're playing now. Our experience from previous years is that typically when things improve, the general economy, then consumers come back to the brands, so that this is temporary. So yes, that's the situation. But there's nothing new right now, and there's nothing -- no drama with any retailers to get that question sometimes, where you could say there's always the same drama. There's no change. I mean we -- but we negotiate much more frequently now, which is, I think, a good thing both for them and for us. And we can also change prices more frequently. This has been quite cumbersome, just the process, and that's something we improved over the last years significantly.

Fantastic. And you mentioned the sustainability focus that you have and how outside organizations for the sustainability and progress that you've made. To what extent is sustainability an important differentiator for consumers, now? Is it top of mind for consumer for...

It was hugely important until 1 or 2 years ago when we saw this kind of subdued view on -- in general kind of on -- in the down trading and so on. So I would say, from a consumer perspective, focus on sustainability is a bit lower. We know that claims that this is -- we have a paper packaging or recycled plastic in the packaging. We have withdrawn the products of [indiscernible] in Germany. So we know that this is very much appreciated by the consumers, but we can't say that it's a strong differentiator. Where it is a strong differentiator is primarily in Professional Hygiene, which is kind of interesting, the Tork brand, again, the dispenser systems, the soaps, not only the paper hand towels but also the napkins and so on; because this is something our distributors like Bunzl, for instance, love to bring forward to a facility management company or to a university or a hospital, and they love to use our sustainability claims in their sustainability work. So they say they work with Tork, because Tork recycles hand towels, which we do in 10 countries now in Europe. There's low 40% of our usage when you use Tork products because they have sensors in the dispensers. So they just dispense one at a time. We have 40% of our cleaning costs because of the dispenser. So the cleaning stuff, they can actually be much more efficient in refilling the dispensers. So we have real value-creating claims related to sustainability that they really like. And then in Health & Medical, it's still not such a big issue, it's not. But we're working very much, especially in Incontinence Care Health Care, where there's a lot of waste, of course, from these bulk incontinence care products from an elderly care home to convince more or less putting in the bidding criteria to focus less on those cost per piece and more of [ cost in ] use and also, of course, sustainability. If you have thinner, more efficient products, then [ they ] will be [ read ] less waste, for instance. So actually, the consumers are probably the least interested right now.

It's very interesting on the split between Professional and the Consumer. So you mentioned that your operating margin and your gross margins now give you some flexibility on A&P and give you some ability to flex your budget differently, going forward. So when we think about the A&P budget going forward, how has that breakdown between marketing and promotion changed for you? Have you optimized that? And is there a greater skew now behind the products that you see as real winners compared to history, where there have been some legacy marketing spend or so?

So this year, we are investing more in A&P than we've done for many, many years, 5.5%, I think, of sales in the first quarter. And we're doing that because we feel that we have a lot to shout about. We have fantastic innovation, fantastic brands. And of course, we want to grow volumes. So it comes together. And we expect to keep A&P on an elevated level. We have become much better in managing A&P over the last couple of years. It's part of the Essity being in better shape, than ever that we now have our global brand innovation and sustainability function. We're working with the biggest agencies. We're doing more and more ourselves because, of course, now with AI, we can do a lot of -- especially online marketing optimization and so on, ourselves. So being more efficient. We also learned over the years that it's better to have fewer bigger innovations that we drive for longer, so we can prove and see that what we launched 3 years later have a much higher sales per launch than it had 5 years ago or 10 years ago. And we continue to push those innovations. We get [ tied ] with these innovations after 3, 5 years, but the customers don't. [ They ] keep on being interested. For instance, the cordless toilet tissue or the [ for play ] we have in France called Just 1, for instance. So -- and of course, all of this makes us more efficient also in our A&P, and the trend towards investing more and more online continues, but that varies a lot between -- still, countries and markets in Latin America, there's a lot of TV commercials. For instance, in Sweden, I don't think we did a TV commercial for 10 years. It's all online. So it's big difference this year.

Okay. Well, Magnus, thank you very much indeed for running us through the business and answering those questions. And yes, thank you very much indeed for your time and come to the end of the session. Thank you very much for everybody for joining us today.

That's great.

Thank you very much.