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Morningstar | High Pulp Prices and Aggressive Competition Weigh on Asaleo's Fiscal 2018 Result. See Updated Analyst Note from 20 Feb 2019

Asaleo Care’s underlying net profit fell 26% to AUD 37 million, despite offloading the loss-making tissue business. Underlying EBITDA was 81 million, down 17% on the prior year, albeit in line with our expectations and at the bottom of the guided range. The main challenges the company faced were elevated pulp prices, and aggressive competition, neither of which are showing any signs of abating. The company was unable to pass the higher input cost onto customers and consequently margins came under pressure, illustrating the firm's lack of competitive advantages required to award it an economic moat rating. The remaining businesses are split into two new segments--Retail and Business to Business--both of which reported falling EBITDA. Despite declining more than 10% following the release of the results, at AUD 0.94, shares in Asaleo remain overvalued compared with our unchanged AUD 0.85 fair value estimate.

The new Retail segment represents about 45% of revenue and EBITDA. This includes the New Zealand consumer tissue business along with businesses formerly under the Personal Care segment (with the exception of incontinence healthcare). Retail sales fell 5% to AUD 190 million, with a reduction in feminine and baby care volumes as the firm struggles to recapture the lost share. EBITDA in the segment fell 21% to AUD 36 million, as the firm struggles to steady margins against elevated pulp prices and competitive pressures. Libra products grew its share of market by volume but gained little share in terms by dollar value, which highlights the deflationary pricing environment. We forecast retail revenue to grow at a modest low-single-digit pace over the next five years, on the back of increased investment into advertising, promotions, and product development. However, these additional operating costs, along with ongoing competitive pressure, will keep margins constrained at around 19% on average for the foreseeable future.

The Business to Business segment, around 55% of revenue and EBITDA, includes incontinence healthcare from the former Personal Care segment and professional hygiene from the former Tissue business. The segment grew revenue by 1.2% to AUD 218 million, but elevated pulp prices brought EBITDA down by 12% to AUD 45 million. The company was able to pass through some of the increased cost, demonstrating our view that the Business to Business segment revenue is stickier than Retail. We forecast an EBITDA CAGR of 1% to fiscal 2023, with flat margins as cost outs and a moderating pulp price help offset ongoing pricing pressure.

The Australian consumer tissue business was sold to Solaris Paper for around AUD 180 million and is due to settle by the end of the first quarter of fiscal 2019. Initially, the firm intends to use proceeds from the sale to pay down debt. We forecast net debt/EBITDA of 1.5 by end of fiscal year 2019--at the bottom end of Asaleo's target net debt/EBITDA range of 1.5 to 2.5. No dividend was declared as the board looks to review its policy after paying down debt and completing the Kawerau site upgrade. We think the firm will be able afford to reinstate dividends and forecast a fiscal 2019 dividend of AUD 3 cents per share.