Essity’s Profitability Remains Hampered by Cost Pressures in 4Q, Despite Solid Top-Line Growth

No-moat Essity ended its fiscal year on largely solid footing, as strengthened pricing drove solid sales growth in the fourth quarter (up 3.3%, with more than three fourths of these gains driven by price/mix), while ongoing raw material cost pressures weighed on adjusted EBITA margin, which contracted 150 basis points to 11.1%. On a full-year basis, 8.5% top-line growth outpaced our expectations by around 100 basis points, but adjusted EBITA margins of 10.9% (140 basis points below the prior-year period) fell 70 basis points short of our estimate. These effects largely offset one another, with full-year earnings per share amounting to SEK 11.23, comparable to our SEK 11.26 estimate. As a result, we’re not anticipating a significant revision to our SEK 222 fair value estimate, outside of adjustments for the time value of money, and are reiterating our longer-term outlook, which calls for slightly below 4% organic sales growth and low-teens adjusted EBITA margin on average over the next five years. With shares up by a high-single-digit percentage on the announcement, we’d suggest investors wait for a more attractive entry point.Raw material cost headwinds had the most pronounced effect on the consumer tissue segment (38% of sales), with the market price for pulp increasing around 20% in the fourth quarter. However, we were pleased to see the firm’s efforts to improve pricing by reducing sales of its lower-margin offerings (with price/mix up 5.1%, versus a 0.5% decline in volume) help stabilize margin erosion in this segment. As evidence, adjusted EBITA margin of 6.9% (falling 130 basis points) marked a sequential improvement from the 5.8% posted in the third quarter (which had represented a contraction of 440 basis points). Although we maintain that a lack of differentiation in the commodified tissue business will constrain pricing power over the long run, we think positive mix effects and cost-saving initiatives will help Essity restore its margins over time.