Essity Continues to Feel the Bite of Inflation Despite Mammoth Pricing Efforts; Shares Fairly Valued

Cost pressures weighed heavily on no-moat Essity’s third-quarter results, leading the adjusted EBITA margin to contract by 400 basis points compared with a year earlier to 7.5% despite hefty pricing actions (price and product mix contributed 14.8% to net sales in the quarter). Profit margin deterioration was primarily driven by extraordinary raw material, energy, and distribution cost inflation, which delivered a more than 1,200-basis-point hit to gross margin in the quarter. We commend Essity’s discipline in implementing price increases and are encouraged by the positive volume development, which contributed 1.5% net sales in the quarter despite the significant price increases deployed across the portfolio. Still, we are concerned that the lack of differentiation in Essity’s portfolio limits its bargaining power with customers and is likely to further delay profit margin recovery as costs continue to surge. For this reason, we reduce slightly our operating margin forecast by 50 basis points to 7.1% for the year and expect a more prolonged margin recovery toward pre-pandemic levels. However, the valuation impact of our downgraded forecasts is largely offset by the time value of money. Consequently, our fair value estimate of SEK 232 is unchanged.