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Essity (Hold, TP: SEK240.00) - Balancing the pulp price challenge

With pulp prices hitting new highs, Essity faces the continued challenge of raw material headwinds not yet being fully offset by price rises, looking at Q2 developments (results due 19 July at 07:00am CET) with the outlook for a better balance in H2. We still find the shares in neutral territory in terms of valuation and potential upside and we reiterate our HOLD recommendation and SEK240 target price. Q2 preview. In line with the Consumer Staples sector, Essity has not achieved much in terms of relative share price performance since its separation from SCA, and looking at the pulp price reaching new highs, creating significant raw material cost headwinds yet to be fully compensated by price adjustments, we struggle to see any potential share price catalysts in the Q2 results. We forecast Q2 organic growth of 3.6% YOY and a slightly weaker adj. EBITA margin to 11.7% (-36bp YOY). Near-term outlook still challenging. With pulp prices hitting new all-time highs (NBSK USD1,200/tonne and BHKP USD1,050/tonne), we expect the negative balance between price/mix and raw material costs to remain at least until Q4. This translates into a 2% downward adjustment to our 2018–2020 EPS forecasts, albeit with our 2018 EPS forecast benefitting from less of structural and integration costs than earlier forecast. Awaiting ‘Transformation 2.0’. In our view, SCA/Essity’s ‘Transformation 1.0’ has been successful and we still see profitability improvement potential as the best opportunity for value creation in the next phase, with a successful integration of BSN Medical and the Tissue Roadmap being good opportunities. However, with relatively high gearing (Q2e 2018 net debt to EBITDA of 2.9x), resources for a faster efficiency improvement effort and further acquired growth are limited, delaying further moves in ‘Transformation 2.0’. HOLD and SEK240 target price reiterated. We are still in neutral territory in terms of valuation and potential upside, although we note that the strong underperformance of the entire Consumer Staples segment has turned more neutral of late. Essity has clearly outperformed peers, leaving the shares at a premium valuation (currently a 11% premium to Kimberly Clark) making it hard to find the catalyst for a re-rating at present.