ETTYF - Essity AB (publ) (ESSYY) Q3 2023 Earnings Call Transcript

2023-10-26 22:32:07 ET

Essity AB (publ) (ESSYY)

Q3 2023 Earnings Conference Call

October 26, 2023 03:00 AM ET

Company Participants

Sandra Åberg - Head-Investor Relations

Magnus Groth - Chief Executive Officer

Fredrik Rystedt - Chief Financial Officer

Conference Call Participants

Niklas Ekman - Carnegie

Jeremy Fialko - HSBC

Linus Larsson - SEB

Oskar Lindstrom - Danske Bank

Patrick Folan - Barclays

Charles Eden - UBS

Simen Aas - DNB Markets

Victoria Nice - Société Générale

Presentation

Sandra Åberg

Good morning everyone and very welcome to Essity's Earnings Call and Webcast for Quarter 3. My name is Sandra Åberg, I'm the new Head of Investor Relations. And joining me here today are our CEO, Magnus Groth; and our CFO Fredrik Rystedt. They will soon present the highlights of the report. And after that we are very much looking forward to your questions. [Operator Instructions] And any additional questions please reach out to me after this.

With that, I'm excited to get started. Magnus, please the stage is all yours.

Magnus Groth

Thanks, Sandra. Good morning. Welcome everyone to this press conference about Essity's interim report for the third quarter. Essity and our brands take care of the health and hygiene of over one billion people in 150 countries for everybody and for every body. And we do this in three very distinct business areas, Health & Medical 16% of sales; Consumer Goods 60% of sales; and Professional Hygiene with 24% of sales with different customers, different go-to-market and different business rationale, but also significant synergies that makes all of these businesses value creating and stronger together.

Moving over then to the third quarter, we saw strong profitable growth with significant improvement in all our business areas. And we continue to deliver on our key priorities for the year. We are also on path to deliver our financial targets and our strategic review is developing according to our plan. We announced this strategic review six months ago, so we're still early into this process.

So, over to the financial summary. Sales growth, 4.6% well above our target for organic growth of 3% with organic growth being 3.8%, adjusted EBITA, up 78% to SEK 5.3 billion. It's the second highest adjusted EBITA that we've had in the group. Margin improved significantly to 12.2% and very, very strong ROCE improvement with 620 basis points to 14.6%.

Focusing in on the sales growth, the 4.6% consisted of a volume drop of 3.1%. Price and mix very strong 6.91% of which mix is 1%; and acquisitions, 0.8% primarily coming from Knix our leakproof apparel company in Canada and US that continues to grow very, very nicely.

Looking at the volume specifically development, it's partly due to lower sales and slightly lower price, but 2% out of the 3% are relating to decisions that we have taken in the group to prepare ourselves to reach our long-term financial targets. So onetime impacts that will also impact the following few quarters that we have reported in the first and second quarter already relating to Professional Hygiene very much where we have done restructuring to improve the structural margin by over 2%, but also decisions to step out of unprofitable contracts in Inco Health Care and in Baby Care. This is now done. Of course it will impact the following few quarters but it puts us in a very good spot to reach our long-term financial targets and I'll get back to that.

Moving over then to the higher adjusted EBITA margin which improved by 470 basis points to 12.2%. There's a huge uplift in the gross margin, where we see higher prices, better mix cost savings which is something that we're very happy about, because it's been difficult to work with cost savings in the past couple of years with the pandemic and ensuing bottlenecks that we had in the supply chain. But we're also helped for the first time by lower raw materials lower energy and distribution. Lower volumes and salary inflation had a negative impact.

A&P slightly up in -- and this is due to marketing investments continuing to fuel the mix improvement and the growth; and SG&A higher due to inflationary impacts. Now looking year-over-year, but on a quarterly sequential basis, net sales has continued to grow also in the fourth quarter. The very high numbers that we have seen over the last three quarters preceding are of course also related to the necessity to increase prices to manage the cost inflation that we've seen over the last 1.5 years. And to the right, the result of all the efforts that we've done not only in price management but also when it comes to innovation efficiencies and other areas; the fourth consecutive quarter of stable and rising adjusted EBITA and EBITA margin.

With that, let's look into the business area. I hand over to you Fredrik.

Fredrik Rystedt

Thank you, Magnus. I'll do that with pleasure and I'll start with Health & Medical. And we continue to have a really good quarter for Health & Medical strong organic sales growth and a significant margin uplift as you can see. And if you look at the different details specifically within Medicaln we could see that Wound Care and Compression were especially outperforming in terms of organic sales growth. And as we have talked about before the price management is very key within Health & Medical and we continue to have a strong development. So if you compare with the same quarter of last year it's plus 8% and we also had a sequential uplift in pricing. Mix as well continues to be really healthy and that's particularly the case for Inco. We had – supporting that mix both of course within this quarter but also in coming quarters we had a lot of launches both in under the Actimove or/and JOBST brand name for Medical but also for TENA. So we continue with lots of innovation to support our mix and margin development.

Now, as you can see here volumes have been negative. You can see it's roughly about a bit over 3%. And that's all attributable to Inco, and they delivered decisions to exit unprofitable positions that we have taken. We have reported about this before. This is now – this journey is now over. And of course, we have through all of these actions created a much more sustainably profitable platform of course that we will benefit from in the future. But needless to say, as Magnus already alluded to, this will have a negative impact as we proceed. All of this is basically within Inco.

And if you look at the kind of volume development without these deliberate exits it's largely flat slightly negative but largely you can say flat. So all in all, a very good development in that sense.

And I already mentioned it the margin is up by 600 basis points. That's higher price that is mix that is lower input costs but also really good cost control within Health & Medical. And of course, as I already alluded, the choices we have made there has clearly contributed to that profit.

Now if we look ahead to Q4, as now margins have improved to the levels we are at this point of time, we will refocus a bit and focus more on volume as we go forward and less on margin. So that's a bit on Q4. And now turning to Consumer Goods. As you can see we continue to grow at good levels less than previous quarters and this is because of the pricing impact now being a lot less. I'll come back to that in a second.

Organic sales growth really strong for Inco Retail and for Feminine. And especially, if you look at these positions just a couple of examples there in LatAm as just one example, we continue to grow our feminine position on the Nosotras and Saba, lots of market share gain there and we reached now over 50%. So a couple of percent market share growth. And just another example we continued to kind of manifest our leadership position in Brazil, reaching close to now 30% in market share, up by about 3%. So it continues to do really well.

And just maybe a final example, the acquisition that we did quite recently with our leakproof apparel Knix, the company continues to do super well in terms of growth and it's up by roughly about 15%. So lots of good examples on the Inco Retail and Feminine side.

If you look at the volumes, you can see it's actually negative. And if we take that one level deeper you can see that Inco – that's not a surprise that Inco and Feminine keeps on doing really well in terms of growth whilst we have a decline for Consumer Tissue and for Baby. And starting with Baby you already know the reasons. We've talked about that before. It's mainly related to the retail brand contracts that we left sometime ago and a bit of our exit of diapers in Colombia. So that's basically the main reason and that will sort itself out over time.

Consumer Tissue is clearly – has been clearly declining in Europe and Latin America up in China and through Vinda, but down in Latin America and Europe. And of course, we can see actually down trading there both in Europe and really across the categories in – well all categories in Latin America.

So if you look at the margin development all in all of course positive. Price and mix supported the development. But we do have a sequential price decline in consumer and tissue – Consumer Tissue and Baby. But all in all, the margin development on the back of course same as for the others lower input cost, a good price development, good mix and of course also here lots of efficiency. So all in all a good development for Consumer Goods.

Now looking ahead for Q4, we see that we will have lower prices sequentially and this is of course on the back of lower input cost. We also see that we will have higher promotional investments in Consumer Tissue to support the volume and that is particularly so for Europe and to some smaller degree also in Latin America.

In comparison to Q3, input costs will continue to go down. They will be slightly lower in comparison to Q3. So if I take the final area, Professional Hygiene continues to do fantastically well, as you can see so, both from an organic growth standpoint and also in terms of margin. And as you can see the strong price and mix more than compensated for the loss of volume. And as expected, the volume was down, as you can see minus 5.4% and this is all of it a consequence of the restructuring activities that Magnus alluded to and that we have reported in Q1 and Q2. So for Europe and North America, all of the decline here is related to those exits. So underlying it's roughly about flat. And of course, we continue to actually benefit from how should I put it the post-COVID hygiene standards, with kind of more wiping, with more cleaning, with more hand-wash soap and tissue all of those bringing kind of a better mix and a better margin.

And as a consequence of all of this, the operating margin increased with 650 basis points obviously, price/mix input cost and cost efficiency. So once again, for also this business area what will the future bring in terms of Q4? Well, obviously, the restructuring activities that we've had will continue to have an impact on volume and that impact will be slightly larger than what we've had in Q3.

One perhaps peculiarity in the way we have done these restructurings, is that we haven't just exited the volumes, but what we have done is raise prices a lot for those volumes. And that has had a very positive margin impact for those particular volumes. And as those volumes now have been exited in Q3 and they will be out in Q4 of course, that will have a bit of margin impact also in Q4. But overall, the performance of Professional Hygiene is really great. And finally, there on the input costs we expect them to be sequentially stable.

And that is it Magnus.

Magnus Groth

Thanks.

Fredrik Rystedt

Then let's look at how we're doing on our strategic priorities. And of course, we already touched upon it several times price management continues to be a key priority and again very successful development here with 5.9% of price in the overall result development. We continue to be number one and number two, in over 90% of our branded position. So we are taking all this price while protecting our market shares.

Innovation and brands continue to provide a very strong mix improvement of about 1% in the quarter. Of course, this is something we are almost getting used to. We had positive mix now for almost I think for as long as I can remember, and in most categories and business areas. And of course, this really builds up to our structural margin improvement and growth opportunities for the long term and the short term.

Cost efficiency SEK 224 million in the quarter. Again, this will definitely help our margin development in the short term as well as in the long-term, and our focus on our long-term financial targets. So we see big progress here in raw materials, fiber mix, sourcing negotiations, energy-saving projects and more to come in this area. Just to give some examples of another strategic priority, which is of course to grow as fast as we can in the fastest-growing channels and with the winning customers.

Inco Retail, up 15%; Feminine Care 9%; Knix, Fredrik already mentioned; but also Compression and our advanced wound care company Hydrofera growing very nicely and becoming a bigger part of the overall sales. E-commerce also continued to grow and now accounts for 14% of overall sales.

Something about sustainability where we are the leaders and we are the leaders because we're not just talking about it really taking action. And this is not only to reach our Science Based Targets that we have set ourselves for 2030 and 2050, but also because it's very good business. Value-creating innovations it was a good quarter and there's more coming this year and next in Incontinence Products, good innovation focused especially on the Health Care segment that will help us grow there.

Also in Medical Solutions, adding to our successful recent launches in JOBST and with Actimove. And in Consumer Tissue I think those two examples are quite interesting because the Tempo moist toilet tissue is very much focused on a premium offering while Plenty Everyday is a value-based offering that we are using now to manage the down trading that we've been seeing in Europe and in Latin America.

Committed to net zero, this is a recent investment that we've made a massive solar park around our plant in Suameer in Holland. It accounts for on average 26% of the energy needs of this tissue plant. And of course, it also contributes to a very stable and low-cost energy supply to this facility and contributes to the overall target that we have to 2030 of reducing our Scope one and two emissions by 35% compared to 2016.

Another example is from Hondouville in France, where we are now collecting and recycling cartonboard and using this as an alternative fiber thereby improving our fiber mix and also in addition having a very strong sustainability profile.

Then I would like to talk a little bit more about the long-term, and you know these long-term financial targets and capital allocation targets that we have. And when it comes to the annual sales growth target of over 5% looking back all the way to 2015, we can see that on average we have been growing much higher than that 6.6%. So this is something we feel very comfortable with this target and it is as important for us as the return on capital employed target

And looking at that as we already mentioned, a huge improvement year-over-year up from 8.4% a year ago to 14.6% now in the third quarter, which also gives us confidence that our journey to reach over 17% by 2025 is very solid. Capital structure with the very, very strong cash flow that we had in the quarter SEK 7.5 billion. We have really deleveraged and are in a very, very strong financial position, and dividend policy stabilizing dividends which we have been proving year-over-year.

Talking about year-over-year and I would like to have one slide showing the development looking back as far as we can see on the Hygiene business and also a slide looking forward coming next. I think this is really, really interesting. What it shows is net sales development since 2014 and we don't have the breakdown in the different quarters really before 2017, because that's when we did the split. So, that's why those are solid bars.

And as you can see here we've been on a very stable growth trajectory with the exception of the dent in the curve in 2021 and 2020 which is of course due to the pandemic. But already last year when it comes to net sales we recovered back on the path we were on before the pandemic. And as you can see after three quarters so looking into nine months of this year it's by far the highest net sales that we've seen for the group back in history.

Turning to the adjusted EBITA our operating profit and margin. Also here you can see that we have been on a very strong and positive trajectory until 2020. This is the first year of the pandemic and then the impact from lockdowns and the impact from higher costs in all areas. And again, looking at the nine months development here after three quarters in 2023 we are already before ahead with SEK 14.3 billion of the full year results of last year and the year before. And compared to our best-ever nine-quarter results in 2020 we are well ahead of that number as well. So, really back on the long-term trajectory of where we want to be. We're a young company.

So I think this is important to show that as far back as we can see we've been on a very solid trajectory with the exception then of the external shocks that we had for two years. And now we're back again with very good momentum. And that leads me to the road map to our adjusted ROCE target above 17%. And it says illustrative and of course this is exactly what we mean. What's a positive on this picture is that of course price management will still be very, very important for us. But it's back to normal. It's back to the normal discussions that we have with retailers distributors the tenders we participate in Health & Medical.

And to achieve the last steps to reach above 17% in 2025 the main bulk of the improvement will come from commercial excellence which is exactly what we've been working with over the last eight years and that has resulted in the development that we just saw on the previous slide.

In addition kind of structural efficiencies and some of the ones that we have presented like in Professional Hygiene and then a smaller part from new growth initiatives that doesn't contribute so much in the next two years but that we believe will contribute substantially if you look further into the future. So we have a plan and we know what to do.

We will continue with all the important strategic priorities that we know so well of improving efficiency launching new products doing structural improvements and of course price management going forward. With that before we move over to Q&A I'd like to welcome you to the Essity webcast for covering innovation Innovating for Profitable and Sustainable Growth on November 27 at 3:00 p.m. CET. It's a short event 1.5 hours focusing on innovation. It will be really exciting and you will meet many of my colleagues in VMT and other specialists. So very welcome to that webcast.

Let's move over to Q&A. Fredrik, do you want to join me?

Fredrik Rystedt

Yes, absolutely.

Question-and-Answer Session

Operator

[Operator Instructions] Niklas Ekman from Carnegie, please go ahead.

Niklas Ekman

Thank you. Yes. Firstly maybe a question on the last thing you touched upon here with the road map to a ROCE target of 17%. You don't mention lower raw material prices. And I'm just noting that the raw material prices have been a negative basically up until Q2 with an aggregate impact of around SEK 20 billion on your earnings. Given where raw material prices are now shouldn't they be a clear contributing factor also in the coming quarters? That's my first question.

Magnus Groth

Fredrik, our financial planning expert.

Fredrik Rystedt

Thank you. Thank you. I'm not sure about that Magnus. But thanks Niklas for a great question because what we basically had if you recall you've seen a bit of this road map before and then the price/cost gap was a very significant portion. But we also said at that point of time Niklas that we would compensate with price all the cost disadvantages that we actually have. And largely, we have actually done exactly that.

So the pricing power that we have within the organization has supported that. So we have reached a point now where we, from an absolute perspective have compensated, all that raw material headwind. And this is why we now -- and we talked about it before as an example with consumer tissue, we see to some degree that on the back of those falling input cost we will also see a price decline. So this is why this is not a major part of the road map anymore. It's more the things we control on our own so basically commercial excellence innovation mix or structural efficiencies as Magnus alluded to.

Niklas Ekman

Okay. Very clear. And can you just remind us the ROCE target at 17% what kind of margins does that translate to? In the past you've said 13.5% to 14%. Is that still valid?

Fredrik Rystedt

Yes, that is still valid. Of course, it depends on the absolute capital turnover. And so capital turnover is of course a margin or both a consequence of kind of net sales which moves to some smaller degree with price obviously. So the absolute mix on capital turnover and margin that will vary over time but it's roughly in that ballpark.

Niklas Ekman

Super. Thank you. Also sorry here but can I just ask about Vinda, where you are in that divestment process? Given that Vinda is near or has been near breakeven now for five consecutive quarters what gives you confidence that they are facing an imminent turnaround? And if not is now really the time to divest Vinda?

Magnus Groth

Yes. So of course, Vinda has to speak for themselves. What we do know is that Vinda has been consuming a very expensive pulp stock over the last three quarters. And that gradually of course that will have a much lower impact on their margins going forward. So that's what makes me confident. When it comes to M&A in general and of course, our ambition with the strategic review is to reduce our dependence on Consumer Tissue significantly.

We never comment on what's going on. We are now six months into this process. It's not a long time. It's very complex. But of course, we are combining -- we want to manage this as quickly as possible but also creating the highest possible value for shareholders. And I believe that those who could be interested in a fantastically well-managed company like Vinda with super-strong brands they look beyond the profitability of the last couple of quarters and have a much longer-term perspective on the value of the company.

Niklas Ekman

Super. Thank you for taking my question.

Operator

Our next question comes from Jeremy Fialko from HSBC. Please go ahead.

Jeremy Fialko

Hi. Good morning. Jeremy Fialko, HSBC. First of all, could you just clarify in either to SEK million what you think the approximate benefit you're getting from some of these contracts where you're kind of looking to exit but have just basically raised the prices in order to do that?

And then the second, slightly bigger-picture question, you've gone through this process of exiting a lot of the contracts. You're now I guess happy with the mix of the contracts that you've got. I guess can you talk about a little bit more about the kind of the attributes of the contracts you've kept versus the ones that you've kind of exited? And I guess maybe the other thing which is really important linked to this is how can you be confident that the good quality contracts you've kept don't move into the sort of unprofitable bucket? And so it becomes -- this becomes a sort of endless process of kind of rationalizing your volumes as contracts become less attractive and so basically the sort of sustainability of this change to the contract structure. Thanks.

Magnus Groth

Absolutely. And it's a great question. We have been very, very focused over the last number of years with many initiatives to improve the profitability on Consumer Tissue on Baby INCO, Retail, Feminine Care are developing really, really well and maybe less focus when it comes to margin enhancement on Health & Medical and on Professional Hygiene, because they are have already been doing well.

Of course, with our commitment to our long-term financial targets, we have also taken a review also in light of our new organization that we put in place at the beginning of the year of these two businesses Health & Medical and Professional Hygiene and realized that when you look at starting with Professional Hygiene, the different customers and the different assets and the different products that we have, there's a huge difference and that there is -- there was a part at the bottom that where we didn't see for the long-term an opportunity to actually improve.

We've had that concept called cure and kill where we looked very much at how we can either cure or kill underperforming parts of the business. And we realized that approximately 4% 5% of Professional Hygiene was creating cash flow but it wasn't contributing to our long-term return on capital employed journey and that's why we take it out. And that's kind of done now and the remaining part is very healthy with very good margins.

When it comes to Health & Medical and especially then INCO Healthcare, we negotiate thousands of contracts every year for typically a three-year duration. And of course, most of these contracts we keep or we win. And there is also in this area a big span of how these contracts work. Some are very, very price-oriented so cost per piece basically; others we talk about cost in use we talk about training adding other expertise that Essity can provide the quality the service levels that we provide in our products in our service. And those are the ones the contracts that we are developing. But also here we could see that there was some contracts where our estimate especially with the cost increases inflation we've seen over the last year that would never contribute to our longer-term ROCE journey.

So they weren't contributing. That's not where we want to be. So that's why I say it's not going to be an ever-ongoing journey. This is a kind of a onetime cleanup that puts us in really, really good shape to achieve our long-term ROCE target.

Fredrik Rystedt

And maybe just Jeremy to add you were asking for how can you see the benefits of it. And obviously, you see it in the profit margin enhancement, but it's also obvious from the mix. If you take the Professional Hygiene just using that as an example mix -- the mix component is 2.6%. So of course that's not a normal mix. Obviously, that's a consequence of some action. And of course this is just one piece of the evidence. We also have very good mix in Health & Medical and particularly so as I mentioned in Inco and this is another sign of the fact that this is working.

Jeremy Fialko

And just on that as the not exceptional but the profits from some of these contracts which you're going to be getting out of where you raised the price just a ballpark low -- like low hundreds of millions of SEK or not even that?

Fredrik Rystedt

Sorry, could you repeat the question?

Jeremy Fialko

Just the --you mentioned that there was some profit from the contracts where you're exiting basically by putting the prices up very high. And just what the –

Fredrik Rystedt

Yeah. No, so we have actually -- we have quantified the impact and Magnus actually mentioned it before that roughly in terms of Professional Hygiene it's roughly about 2% margin enhancement. So this is the actual benefit in Professional Hygiene. It's a bit less in Health & Medical than that, but still very profitable. We -- and it's not -- just to clarify one thing Jeremy as you said we're not about to leave. We have left already. It's actually done. So as Magnus said this is an exercise that we have executed on. And so it's -- of course, the impact will now be fully visible in Q4 but it's also very visible in Q3. So we don't expect to do more contracts. We expect to just kind of have the consequences of what has already been executed now in the coming quarters as we said.

Magnus Groth

Okay. So for those of you that can hear us the phone line is gone temporarily. So we're looking to fix it as quickly as possible if anyone can hear us right now.

Jeremy Fialko

Hello? I hope that you just had that question on the EBITA benefit in Professional.

Fredrik Rystedt

Yes I'm not sure if my answer was heard.

Jeremy Fialko

Can you repeat it please? I certainly didn't hear anything.

Fredrik Rystedt

Is that Jeremy? Or was it...

Jeremy Fialko

Yes it is it's Jeremy.

Fredrik Rystedt

Yeah. Sorry about the interruption. Jeremy, I thought my answer was so good. I'm not sure I can repeat it again, but I'll try. So as I think I mentioned there that proof of -- in terms of the evidence then we obviously have had a very good mix in both Professional and Health & Medical. And just to use Professional Hygiene as an example we had an uplift of roughly about 2.6% so really, really very, very strong. And obviously, you can see for yourself in terms of margin that this has brought a lot of benefits. So there are lots of evidence that this is actually working. And I did clarify, I'm not sure if that was heard but as Magnus already alluded to in his comments there that this is a onetime exercise. These are not contracts that we are about to leave. These are contracts that we have left and the full impact will be in Q4.

So, some of the contracts of course obviously have been left during Q3. But we have kind of completed this exercise now and we'll live with the consequences from a volume perspective in the few quarters but that is not additional coming as we go forward.

Jeremy Fialko

Sorry, sorry, apologies for this. I got all that but the only part I didn't get was this one about the -- was this bit about the EBITA benefit in Professional from some of these contracts where you jacked the prices up very high as your way of exiting the as a way of exiting the contract. You mentioned that in the prepared comments. So just an indication of what the quantum of that benefit might be...

Fredrik Rystedt

Right. I got it. Yes we haven't actually quantified that exactly. But as you can see a part of that very significant uplift of 650 basis points is clearly that. So you can say largely we have achieved you can say the benefits of these restructurings a bit early. It may not be the full kind of benefit, but we have achieved a substantial benefit.

Magnus Groth

Okay, thanks.

Operator

Thank you. We will now turn to the next question from Linus Larsson from SEB. Please go ahead.

Linus Larsson

Thank you very much and good morning to everyone. On volumes I think I heard you say that in Health & Medical you're putting increased emphasis on volume at the possible expense of margins. Whether if you could maybe expand a bit on that discussion including also the other two divisions and how you see volume development for the group as a whole going forward? We have had I think four quarters by now with negative year-on-year volume growth. When should we expect volume growth to turn positive for the group? Thank you.

Magnus Groth

Yes. And I can't give you an overall answer to that but what we're seeing is that market conditions are normalizing and that we are now looking at balancing price and volumes also depending of course the competitive pressure and on what happens now with raw materials that in some cases are actually stabilizing or even starting to move slightly up which we think is a good thing. We always say that we would like key raw materials and energy and other cost components to be stable over time. But clearly we see that we will have a higher focus on volume going forward and believe that we can manage this partly through the efforts that we already did now in actually not gaining volumes in the lower margin end of our assortment, but focusing very much on the high end. And that's where we want to grow going forward.

So in that way and together with innovation manage this and of course also with the cost efficiencies because every cost efficiency every saving we achieve makes us more competitive. We can achieve the same margin with a lower price. So it's very, very important for us and we can be more competitive and gain market share. So it's that overall volume or that overall equation that we are now back to working with. And I can't say more than that. But of course it's different than the last two years when our only message was price, price, price and price. We're beyond that now. Now it's finding this mix. And I mean that's our core business. That's what we've been doing forever. So that's something we know how to do very, very well.

Fredrik Rystedt

Maybe Linus I can just clarify one thing you specifically said there. You said we -- you will prioritize volume at the expense of margins in Health & Medical. I didn't actually say that. This was your statement. What I actually said was as we now have reached much more attractive margins, we will refocus and focus more on growth. That was the wording I used. And so it's not at the expense of...

Magnus Groth

No.

Fredrik Rystedt

Just to be clear.

Magnus Groth

We have...

Linus Larsson

Thanks for that clarification.

Fredrik Rystedt

Yes no problem.

Magnus Groth

Yes, absolutely. I think that was really, really good that you said that Fredrik. Of course I want to underline I mean it's not one day we go in one direction the other day going the other direction. It's really about now managing both our long-term financial targets so both the return on capital employed target and the growth target. And that's our ambition and we feel very confident that we can do this going forward. We have a very, very good foundation for that now.

Linus Larsson

That's great. But is it rightly understood then that this somewhat more active strategy or tactics on volume it's applicable on all three business areas? And relating to that also how do you see A&P developing or A&P to sales?

Magnus Groth

Yes this is applicable to all three business areas and we are investing in A&P. I don't see any substantial changes but it's definitely not going to be lower in relation to sales rather maybe slightly the opposite because we have so much good innovation coming in so much to talk about that we will spend more on this because it's very value creating. It really helps us with this profitable growth that we are achieving.

Linus Larsson

Great. Thanks a lot.\

Operator

We will now take our next question from Oskar Lindstrom from Danske Bank. Please go ahead.

Oskar Lindstrom

Yes. Good morning. This is Oskar Lindstrom Three questions from my side more sort of focusing on the Q4 outlook if you will. The first one is I mean for Q4 should we expect continued price/cost sort of margin expansion net of any cost declines and price erosion? But are you still seeing forward momentum in -- or expanding margins driven by improving price/cost margin? That's my first question.

I can go on with the second one is related a little bit to what Linus brought up here about the boosting volume. It's not at the expense of margin but at least at the expense of margin expansion. Is that something that will hit already in Q4, or is it more something that you're foreseeing for the full year 2024?

And then my third question is on consumer tissue. Can we expect profit per unit to remain stable going forward, or where are we in the cycle for consumer tissue? Thank you.

Magnus Groth

Okay. Of course this is getting very, very close to a forecast for the fourth quarter, which we don't provide Oskar if you add all this together. So it's really, really difficult to talk about specifically margin and volumes and so on.

Maybe specifically on volumes, I think, Fredrik made it clear that in Professional Hygiene, in INCO Health Care we've taken measures. It will take a few quarters for these volumes that we have taken out to roll over and the positive impact on volume from our renewed focus on this. And, of course, we are gaining volumes and I showed many good examples of that in INCO Care Retail in Feminine Care in some of our acquisitions. So it's -- I mean we have areas where we're growing volume very well also.

You have to assume that we will have an underlying volume focus but that the impact of these exits will have an impact also in the fourth quarter. And then when it comes to consumer tissue, I almost can't remember the question. I -- you Fredrik?

Fredrik Rystedt

I think it was price per -- or profit per unit, I think was specifically what you asked…

Magnus Groth

And I think the only -- maybe a reflection I can provide is that we have excellent margins in consumer tissue outside of Vinda currently throughout the company. And we will of course do everything we can to manage those margins, as well as we can also taking into account to manage volumes. And Vinda we spoke about earlier already coming from a situation now of very low margins.

Fredrik Rystedt

I can just maybe repeat something you've already said Magnus here, because I think it's important to note one thing, Magnus alluded to on the road to 17% road map price/cost gap was not part of that equation because we have achieved. And, of course, you can interpret that that we don't expect specifically input cost to be more beneficial than price. That's basically the overall context. And, of course, consumer tissue as we alluded to specifically with variations that we have in individual quarters, we also talked about the fact that on the back of falling costs, we will see lower sequential pricing. And we do expect also higher price promotion to support volumes.

But, of course, obviously the long-term journey and that was the question earlier what margin does it take for you to reach your target? Of course, that's a lot higher than what it is. So over the longer perspective, there is no doubt that margin will -- we strive for that margin will continue to increase. In the short-term, we are refocusing more on volume. So just to reiterate what's already been stated here Oskar. But it gives a bit of lead of course for the next few quarters maybe.

Oskar Lindstrom

All right. Thank you.

Operator

Thank you. We'll now take our next question from Patrick Folan from Barclays. Please go ahead.

Patrick Folan

Hi, good morning. Thanks. Just on the group margin point, it sounds like the 12.2% in Q3 were kind of at a normalized level. We talked about Health & Medical, which is focusing on volume. And Fredrik you just talked about there, kind of, that's going to be the focus not taking away from margin.

So how should we just think about EBITA margin in the short-term? You have input cost improving obviously as you saw in Q3 but pulp has etched up a bit, SG&A is up, A&P is up. So just trying to square that away as we look over the next couple of quarters I suppose be good to kind of understand the moving parts there.

And just secondly Magnus I know we talked a couple of months ago we talked about the Hygiene category in Europe particularly consumer tissue and you said it's one of the softest markets you've seen in a couple of years. Just wanted to get your thinking on how you're seeing Q3 play out, is there any improving trends in the market? Thanks.

Magnus Groth

Yes. So thanks Patrick. Starting with the last question, yeah, the first half was very soft and it has improved considerably now in the second half of the year. And we are more or less back to zero underlying growth in consumer tissue in Europe from a very negative development in the first half. So, of course, that will help going forward.

And then to your first question I'll soon hand over to Fredrik. But of course we are at 12.2% currently which is fantastic. We're very happy about the quarter and we need to get somewhere north of 13.5%. So that's the gap we're talking about. And again it will be a mix of -- in some areas we will even increase prices. In some markets, we will have cost savings. We will have mix improvements and we will manage day-to-day the price/cost gap. And in order to achieve the over 13.5%, we will need to improve the margins further in all three business areas. I guess that's kind of the high level without specifically talking about the fourth quarter. And Fredrik yes we don't provide...

Fredrik Rystedt

No, we really don't Patrick. Of course, I guess, what you're after here is a forecast on margin for Q4. And you alluded specifically to cost relating to SG&A or whatever. And so of course, we've seen as rightly to your point there we've seen an increase in SG&A spend. We anticipate a higher A&P in Q4 profitably so of course needless to say. But of course, these are mainly you can say a consequence of salary inflation. So just as input cost, we compensate salary inflation with price. So we manage the price/cost gap. And the long-term journey is clear. Short term, of course, we focus a bit more on volume. And over -- just to reiterate also what has been said we got two goals, right? One is the 17% and the other one is the organic sales growth of 3% plus another couple of percent in acquisition growth we focus on both. So this is just kind of balancing and that will impact in the short-term quarters. But over the long term, it is obviously -- the direction is very clear.

Patrick Folan

Thank you.

Operator

We will now move to our next question from Charles Eden from UBS. Please go ahead.

Charles Eden

Good morning. Thanks for taking my question. Just one left for me really. I just wanted to touch on the gross margin. Obviously, a very strong performance in the quarter, up sort of 630 basis points year-over-year. And now just a under 30% gross margin. Obviously, in the past, you've been north of 30% gross margins. You've got the cost savings coming through. You've obviously got at least while it's part of the portfolio an improvement in the Vinda gross margin to come still despite obviously returning to 27% in Q3. Is there any reason structurally, why the gross margin can't return back into that early 30s? I guess, because if I think about some of these profitability-focused areas you just touched on, I would have thought the underlying profitability margin at the gross margin level would be higher than it had been historically. So could you maybe talk a little bit about this? Thank you.

Magnus Groth

Yeah. But absolutely -- and thanks for just asking one question, Charles. Gross margin is our top priority and focus of course. That's how you build strong brands. And we're really, really happy about the improvement 630 basis points year-over-year. And it's definitely -- this is where we're going to see our journey to 17% return on capital employed coming from gross margin improvements from all the different areas that we mentioned. Fredrik, I don't know if you want to add there.

Fredrik Rystedt

No, no, really Charles, it's exactly as Magnus said there. Just one maybe technical thing that's worth having in mind right, so obviously price levels are a lot higher than they were in 2019. I mean, prices have gone up a lot. And so it's -- if you kind of compensate in terms of absolute profit, but with a much higher net sales then obviously gross profit margin comes down mathematically, but with the same profit. So just bear that in mind. But other than that I don't have anything to add Magnus.

Charles Eden

Great. Thanks so much.

Fredrik Rystedt

Sure.

Operator

And our next question comes from Simen Aas from DNB Markets. Please go ahead.

Simen Aas

Good morning guys. So I have a question on -- mainly related to energy costs. So can you quantify what was the energy cost in Q3? And how should we think about this going into Q4? And maybe on the same topic, I'm not sure if you said it sorry if I missed it I'm sorry, but did you say anything about the sequential improvement in SG&A going into Q4? And how should we think about that from Q3?

Magnus Groth

Maybe Fredrik you should go through raw materials and energy and SG&A the total for the group.

Fredrik Rystedt

Yeah, we've actually -- I've already done that in terms of the absolute total there. So maybe to -- that's a great point Magnus. Let's just repeat that. So if you take Health & Medical -- and I'm not talking about energy and distribution, I can do that, but it's kind of maybe more fruitful to talk about the total. So basically, if you look at input cost in general, so distribution energy and input -- and raw material for Health & Medical you will see slightly lower; the same for Consumer Goods. And when you count Professional Hygiene, we expect sequentially to be stable. If you look at it year-on-year, then they will be lower for all three of these business areas. So that's pretty much the overall context.

Now your question was specifically on energy and the question there on Q4. Let me just comment a bit on Q3 super quickly. So obviously, as you have seen in comparison to last year, the spot prices were super much lower. However, having said that, we were hedged to a fairly significant degree with much, much higher prices than the actual spot values. And of course, that had a negative impact. So, we benefit in Q3 a lot from the lower spot to the degree we weren't hedged. But of course, we also had a bit of higher cost on the back of those hedged contracts.

Now, if you look at the future, Q4 specifically, then of course, included in the total benefit then we expect energy costs to be largely stable. So, still in comparison sequentially slightly better in terms of the hedge prices hedge levels and then spot prices perhaps being slightly lower. So, overall about stable for energy costs. So, hopefully that-

Magnus Groth

And SG&A.

Fredrik Rystedt

Yes SG&A really tough to give a good comparison. It's likely to be somewhat higher than what we've seen here in Q3 for various reasons, but it shouldn't be really material.

Simen Aas

Okay, that’s very helpful. Thank you for that.

Operator

Thank you. [Operator Instructions] And the next question comes from Victoria Nice from Société Générale. Please go ahead.

Victoria Nice

Hi there. Good morning everyone. So, my question is just on pricing. I wondered if you could give us an indication on the quantum of the sequential price decline that you mentioned in Consumer Tissue. And could we assume that the pace of this decline accelerates moving forward given the move in raw materials?

And still related to that and sorry if you said this already but how does absolute price level look sequentially? Is higher pricing in other parts of the business offsetting that lower Consumer Tissue pricing please? Thank you.

Magnus Groth

I think that's very, very specific and really difficult to respond. I think that's something that -- again this is managed now. I mean this was easy to answer in the last couple of years when it was pricing, pricing, pricing.

Now, when we're kind of back to normal and managing the price/cost gap in all the different ways we've spoken about of course this is not as clear anymore. But I think you're basically on to the right parameters here.

And Fredrik spoke about kind of a little bit of some over-profitability in the third quarter in Professional Hygiene and also that increasing promotions coming in Consumer Tissue in the fourth quarter.

But we will also work in other areas to increase prices and to manage more importantly again the price/cost gap and the margin. I mean that's what we're looking at not specifically anymore just pricing but the price/cost gap. And again that's something that we know very well how to manage. And I think we've proven that again and again over the last number of years.

Fredrik Rystedt

I can repeat Victoria one thing that I've actually already said there just to maybe clarify a bit. So I mentioned that for Consumer Goods we had a sequential price decline. That was 1.3%. If you look at the individual categories we never give of course the individual components but I'll do give you some lead.

So, Inco and Feminine were both positive. And Baby -- and I already alluded to it Baby and Consumer Tissue were sequentially negative, all of that translating into an average of 1.3%. But the individual exact components of course we cannot give for commercial reasons obviously.

Operator

Thank you. And as there are no further questions, I'd like to hand the call back over to our speakers for any additional closing remarks.

Magnus Groth

Okay. Well, we are really, really happy about the development. Of course it was a super strong quarter in terms of topline and in terms of profit improvement and not least cash flow which was incredibly strong. This was the fourth consecutive quarter where we improved more or less on all metrics.

We are moving now into a situation where we are -- see a normalized market condition and we pull all the levers that we also experienced at working with. So pricing, costs, efficiencies, innovation, all the strategic priorities that we have in the short and the long-term.

And with the structural initiatives that have been now covered during this presentation we feel in a very, very good place to reach our long-term financial targets 17% return on capital employed and combining that with 5% growth.

So, thanks for calling in and talk to you next time.

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Essity AB (publ) (ESSYY) Q3 2023 Earnings Call Transcript