Essity Earnings: Commoditized Consumer Tissue Business Is Hindering Margin Improvement

No-moat Essity’s ESSITY B second-quarter results disappointed investors, with the share price falling by around 10% in early trading. The adjusted EBIT of SEK 4.4 billion reported for the second quarter was below FactSet consensus of SEK 4.8 billion, hit by salary inflation and higher marketing costs in the consumer goods segment. Our full-year forecast was already lower than consensus; therefore, the update does not affect our fair value estimate of SEK 260. We view shares as fairly valued at this time.

The volume development was more negative than expected in the second quarter (with group volumes falling by 3.6%) as Essity prioritized price increases and margin improvement ahead of volume gains. Management claimed to have exited some low-margin contracts during this time, especially in professional hygiene, to support margins.

The consumer goods segment (61% of net sales) delivered the most disappointing performance in the quarter, with a 9.5% adjusted EBITA margin—roughly in line with the first quarter and not improving sequentially as expected. Management said salary inflation and higher marketing costs were the main reasons for the slower-than-expected recovery. We believe Essity is struggling to pass on cost inflation through pricing, especially in the commoditized consumer tissue subsegment. To that end, management indicated that promotional intensity increased for consumer tissue. The 8.8% pricing contribution to growth was materially below the 18.8% reported in the first quarter.

Essity completed the divestment of its business operations in Russia in July for SEK 1.2 billion on a cash and debt-free basis. Russia accounted for around 2% of net sales. Essity expects to report a hit to earnings of negative SEK 500 million in the third quarter (in addition to the SEK 1.7 billion impairment recorded last year). All in all, the transaction is largely neutral to our valuation.