Risks and risk management

Essity is exposed to a number of risks that could exert a greater or lesser material impact on the Group. These risks are generally defined as factors that impact Essity’s ability to achieve established targets for the Group. This applies to both financial targets and targets in other areas. Essity’s objectives are outlined in the chapter Our objectives.

Many of the risks described could have a positive or negative impact on the Group. This implies that if a risk develops in a favorable manner or if risk management is successful in counteracting the risk, target fulfillment could exceed expectations. From this perspective, the risks could also entail opportunities for Essity. Examples include the GDP trend and the economic situation, the cost of input goods, customer and consumer patterns, and movements in market prices.

The description in this section relates to the structure that Essity had at year-end 2017.

Essity’s structure and value chain

Essity’s structure, value chain and operations entails in itself a certain degree of risk spread.

Essity conducts operations in hygiene and health, with sales through a variety of different channels and distribution paths, both in retail trade and business-to-business, as well as deliveries to entirely or partially different customer segments and end-users. The geographic structure includes both mature markets and emerging markets with sales in approximately 150 countries. Manufacturing is pursued at about 90 production facilities in some 30 countries. Sales are often based on local manufacturing. Essity’s operations are partly influenced by the business cycle and general economic prosperity. The competitive situations also differ.

Processes for risk management

Essity’s Board of Directors determines the Group’s strategic direction based on recommendations from the Executive Management Team. The responsibility for long-term and overall management of strategic risks follows the company’s delegation scheme, from the Board of Directors to the President, and from the President to the Business Unit Presidents. This implies that most operational risks are managed by Essity’s business units at a local level, but are coordinated when deemed relevant. The tools for this work primarily comprise continuous reporting by the business units and the annual strategy process, which includes risk assessment and risk management as part of the process. Identified risks have been classified according to the likelihood of the risk becoming a reality and the impact it can have on Essity’s target fulfillment. The standardized model also includes how risks shall be monitored and followed up. The outcome of this evaluation constitutes a part of the assessment of risks described in this section.

Essity’s financial risk management is centralized, as is the case for the corporate internal bank for financial transactions of Group companies and management of the Group’s energy risks. The financial risks are managed in accordance with the Group’s finance policy, which is set by Essity’s Board of Directors and, together with Essity’s energy risk policy, comprises a framework for management activities. The risks are grouped and followed up on a regular basis to ensure compliance with these guidelines. Essity has also centralized the management of other risks.

Essity has established a corporate internal audit unit, which ensures that Essity’s organization complies with the set policies.

Risks that impact Essity’s ability to achieve established targets

GDP trend and economic conditions

Risk

Demand for Essity’s products is driven by factors such as population growth, aging population, improvements in living standards and increased awareness of the importance of hygiene and health. Demand is to some extent related to GDP trends, where Professional Hygiene is the business most sensitive to economic movements. The institutional care and homecare segment for Incontinence Products is also relatively unaffected by the business cycle, although it can be impacted by the public budget situation in certain countries. Sales to the retail market, which accounts for the bulk of sales of hygiene products, are more dependent on established consumption patterns, innovation and distribution than the economic climate.

Policy/Action

For all businesses, it is important that Essity manages the effects of the economic movements that occur by taking actions to reduce costs and by reviewing the capacity and production structure, and creating higher customer value through product innovations. Essity also works with solutions that can reduce a customer’s total cost of use; for example in Professional Hygiene where sensors in public washrooms help to optimize work tasks in connection with emptying wastepaper baskets, refilling paper and soap, etc.

Environmental impact and climate change

Risk

Essity’s operations have an impact on air, water and land. These effects could lead to costs for restoring the environment or other kinds of negative effects. The matter of the economic impact of climate change is also growing in significance.

Policy/Action

Essity’s sustainability policy stipulates guidelines for the Group’s measures within environmental and social responsibility. The company’s targets for people and nature are an integrated part of the business strategy. Risks are minimized through preventive work in the form of certified environmental management systems, environmental risk inspections in conjunction with acquisitions, and remediation projects in connection with plant closures. The company combats climate change and reduces emissions of greenhouse gases by investing in renewable fuel and programs for energy savings. Essity is committed to developing a Science Based Targets that is based on the agreement reached at the COP21 climate meeting in Paris to take measures so the global temperature rise is kept below 2 degrees Celsius.

Through its Resource Management System (RMS), Essity monitors how the company is utilizing energy, water, transportation, production waste and raw materials. The data is used for internal control and follow-up of established targets. Essity also works to reduce the volume of production waste and to contribute to a circular society.

Impact of political decisions and related measures

Risk

Essity is affected by political decisions, new legislation and administrative regulations in the approximately 150 countries in which the Group conducts operations. These relate to general regulations, such as taxation and financial reporting. Essity is also impacted by more specific regulations, such as the granting of permits in accordance with the Environmental Code and reimbursement of expenses in the healthcare system. Even actions by third parties with the intention of influencing political decisions impact Essity, such as NGO activities. Essity’s offering in medical solutions is often encompassed by regulations that are specific to these products. Regulatory requirements have become increasingly strict in recent years.

Policy/Action

Essity’s Public Affairs unit works to monitor and evaluate changes in its external environment, amended legislation and the active players in each field. Actions are identified and implemented that lead to improvements of the policy areas/regulations for the benefit of Essity’s stakeholder groups. Essity is a member of national and international trade associations and other partnerships. The aim of this is to contribute to the current public debate and promote the improvement of relevant policy areas.

A key area for Essity is energy and environmental legislation. Since legislation in Europe is often leading within the areas of environment and energy and because Essity has large operations in Europe, the company focuses many of its Public Affairs activities on the various EU institutions. Essity monitors developments in prioritized policy areas, such as the circular economy and resource consumption in general and, more specifically, issues relating to waste and emissions to water and air.

Since the public sector is both a significant customer and stakeholder group for Essity, the health debate is important to the company, especially with regard to the development of systems for healthcare with greater patient benefit and greater cost efficiency. Essity also works actively to disseminate knowledge and solutions regarding various national systems to decision-makers in countries where new structures are being built up. Examples include the development of systems for cost-free or subsidized prescription of incontinence aids in countries where such benefits were not offered in the past.

We are also monitoring developments in regulations covering medical solutions.

Impact of substitutes

Risk

Other product solutions (substitutes) can replace products that are included in Essity’s offering and thereby reduce sales. By offering competitive products, Essity can also capture market shares from the substitute. The issue of substitutes is also linked to changes in the patterns and attitudes of customers and consumers that affect demand for certain products and thus profitability.

Policy/Action

Substitutes exist for virtually all Essity products. This may involve different products with a similar function, such as cloth diapers or cloth rags for household or industrial cleaning, or completely different solutions to meet the needs of customers and consumers, such as menstrual cups or electric hand dryers. Essity’s focus on customer and consumer insight guides its innovation activities, ensuring that new products and solutions provide competitiveness and that the company’s offering continuously evolves to meet customer and consumer needs. New technological solutions are developed through the company’s own research and development activities and in cooperation with suppliers. Development work is thus often conducted in direct cooperation with customers and suppliers of material and machinery to provide a direct link to requirements and feedback from customers, at the same time as more efficient processes and products are developed.

An increasingly important factor is greater focus on sustainability with respect to environmental, economic and social factors. The service life of products, use of renewable raw materials and the recycling of used products will be affected the most. Other demands imposed on Essity’s innovation include the desire to create profitable differentiation for Essity’s product range and create value and growth, both for customers and Essity (read more about innovation in the chapter Innovate bigger brands).

In many countries, the degree of penetration is low, meaning only a small proportion of the population uses hygiene and health products compared with more mature markets. To increase acceptance of its products, Essity focuses on matters influencing attitudes and on breaking taboos. This also applies in Europe and North America with regard to for example Incontinence Products.

Dependence on major customers and distributors

Risk

The retail trade is Essity’s single largest customer group and thus exercises considerable influence. Around 59% of Essity’s net sales are made as retailer’s brands, under both Essity’s brands and retailer’s own brands. Essity also uses distributors or retailers to reach certain markets. If these distributors or retailers are not successful in selling Essity’s products, this could have a negative impact on Essity’s earnings.

A general consolidation trend is taking place in several of Essity’s sales channels, which could increase dependence on individual customers. In the retail trade, for example, the prevailing trend is towards increased concentration, which has mainly resulted in fewer retail companies at a national and regional level. A more consolidated customer situation may mean larger volumes are concentrated to an individual customer and thereby increase dependence or sensitivity in a transaction.

Policy/Action

Essity’s customer structure is relatively dispersed, with customers in many different areas of business. In 2017, Essity’s ten largest customers accounted for about 23% of net sales. Most of these customers were retail companies. The ten largest customers also include some large distributors of professional hygiene. Essity works to successfully maintain strong and long-term customer relationships with strategic customer segments and build relationships with new customers. The strength of Essity’s customer relationships also affect the ability to obtain competitive pricing and selling terms. The processes for customer dialogue and customer follow-ups, both in economic terms and also in terms of how well we deliver on our commitments, such as service level, product complaints and availability, are important parameters for ensuring customer satisfaction and thereby long-term customer relationships.

Credit risk in accounts receivable is dealt with in the section Credit risk.

Movements in the market price of Essity’s products

Risk

Movements in the market price of Essity’s products could create major fluctuations in the profitability of the product segment unless these movements can be offset by adjusting costs for Essity.

Policy/Action

To reduce the impact of price movements on Essity, actions are taken to adapt the cost scenario to lower market prices, for example, by renegotiating purchasing agreements, implementing personnel and capacity reductions, and reviewing the business structure. In other cases, the product’s content can be adapted to the new market price level.

Risks at plants

Risk

Essity has around 90 production facilities in some 30 countries. Fires, machinery breakdowns and other types of harmful incidents could damage the plant in question and also cause delivery problems.

Policy/Action

Essity’s activities in this area are governed by its Risk Management Policy, which controls how Essity shall manage insurable operating risks. From this perspective, the aim of risk management is to effectively and cost efficiently protect the employees, the environment, the company’s assets and the business, and to minimize Essity’s risk management costs. This can be achieved by creating and retaining a balance between loss prevention and insurance coverage.

The loss-prevention work is conducted in accordance with established guidelines that include inspections by risk engineers and benchmarking with other plants, within and outside Essity. Other important elements of loss-prevention activities include maintenance of plants and machinery, staff training, and good orderliness. Every year, Essity invests in loss-prevention measures and its plants continuously work to reduce their risks. For example, new facilities are protected with sprinkler systems as standard. All wholly owned plants are insured to replacement cost and for the loss of income. Within the EU, insurance is primarily carried out by the Group’s own companies, with external reinsurance for major damages. Outside the EU, Essity cooperates with market-leading insurance companies.

Occurrence of unethical business practices and human rights violations

Risk

Essity works in some 150 countries and in environments where unethical business practices and violations of human rights may occur. Risks associated with business ethics are considered one of the most serious risks for Essity. If Essity becomes involved in these business practices, the company’s reputation in the market may be damaged and Essity may also suffer high fines and other legal sanctions.

Policy/Action

To ensure that Essity’s organization is not drawn into or tied to unethical business practices or human rights abuses, there has been a Code of Conduct established since 2004. The Code is reviewed on an annual basis to ensure that new laws and guidelines are taken into account. The Code contains principles that include business ethics, relationships to employees, respect for human rights and the environment and so forth. Training of all of Essity’s employees regarding the Code of Conduct takes place continuously. Essity’s regulatory compliance program is also assessed every year relating to anti-corruption. Training programs for managers, with a focus on various business ethics dilemmas, have been drawn up and implemented throughout the organization. To ensure that Essity’s regulatory compliance program for risks associated with business ethics is efficient, it is continuously reported to a committee that includes members from Essity’s management.

Suppliers

Risk

Essity is dependent on a large number of suppliers. The loss of key suppliers could result in costs for Essity and problems in manufacturing. Suppliers could also cause problems for Essity through non-compliance with applicable legislation and regulations or by otherwise acting in an unethical manner.

Policy/Action

To reduce this risk, Essity has supply contracts with a large number of suppliers and continuously enters into agreements with various durations. The Group has several suppliers for essentially all important input goods. These contracts ensure deliveries of a significant proportion of input goods. The Group also has more intensive cooperation with selected suppliers that covers the development of materials and processes.

Essity continuously assesses suppliers to ensure that they meet Essity’s standards in all respects in accordance with a risk-based methodology that places a special emphasis on suppliers in high-risk countries and high-risk industries, such as fiber and cotton. The assessment may take the form of a questionnaire, an on-site visit or the use of independent auditors. For essentially all important input goods, Essity assesses the following factors at current and potential suppliers:

• Quality
• Product safety
• Impact on the environment, including the issue of the origin of the input goods
• Use of chemicals
• Regulations for medical solutions
• Compliance with Essity’s Code of Conduct

See chapter Supply chain management for more information.

Cost of input goods

Risk

The market price of many of the input goods used in the manufacture of Essity’s products fluctuates over time and this could influence Essity’s earnings.

Highest/lowest market prices (annual average) 2007–2017 per product

Policy/Action

Fiber raw material constitutes a major cost item for Essity, primarily in Consumer Tissue and Professional Hygiene. Fluctuations in the price of Fiber raw material are mainly managed through long-term relationships with suppliers and by optimizing global purchasing and the fiber mix. Oil-based materials constitute a major cost item, primarily in Personal Care and as packaging material. Other oil-price related expenses comprise, for example, transportation. When possible, these and other costs are managed principally through compensation in the form of raised prices for Essity’s products, by adjusting product specifications or through streamlining of the Group’s own operation. The impact of price movements on input goods can be delayed through purchasing agreements.

Essity’s relative costs for various key input goods are described in the chapter Description of costs. The price trend for a number of input goods over the past ten years is presented in the diagram above.

Employee-related risks

Risk

Essity must have access to skilled and motivated employees and safeguard the availability of competent managers.

Policy/Action

Essity works in a structured manner to ensure the health and well-being of its employees through proactive preventative healthcare activities, such as education, exercise, special initiatives, for example, to help employees quit smoking and by offering health checks in several countries. Essity also places great importance on safety activities.

Essity’s strategic manpower planning secures access to people with the right expertise at the right time. Recruitment can take place both externally and internally, and internal recruitment and job rotation are facilitated by a job portal, where available positions are advertised both internally and externally. Salaries and other conditions are to be adapted to the market and linked to Essity’s business priorities. An established succession planning program protects the operations. Essity strives to maintain good relationships with union organizations.

Legal risks

Risk

New legislation in various countries could negatively impact Essity. Legal processes can be protracted and costly.

Policy/Action

Essity monitors the development of legislation through its corporate legal staff and external advisors. In the countries in which Essity conducts operations, local legal issues and disputes are handled through local legal advisors.

Information and IT risks

Risk

Essity relies on IT systems in its day-to-day operations. Disruptions or faults in critical systems have a direct impact on production and important business processes. Errors in the handling of financial systems can affect the company’s reporting of results. These risks grow in an increasingly technically complex and interlinked world.

Policy/Action

Essity has established a management model for IT that includes governance, standardized IT processes and an organization for information security. The IT security work includes continuous risk assessment, preventive measures and use of security technologies. Standardized processes are in place for the implementation and change of systems and IT services and for daily operations. The majority of Essity’s system landscape is based on well-proven products, such as SAP.

Energy price risk

Risk

Energy price risk is the risk that increased energy prices could adversely impact Essity’s operating profit. Essity is exposed to price movements of electricity and natural gas, but the price of other energy commodities also directly and indirectly impacts Essity’s opera-ting profit.

Policy/Action

Essity centrally manages the energy price risk related to electricity and natural gas. According to Essity’s policy, these price risks can be hedged for a period of up to 36 months. Energy price hedging is effected through financial instruments and fixed pricing in existing supply agreements.

Essity safeguards the supply of electricity and natural gas through centrally negotiated supply agreements. The portfolio of supply agreements and financial hedges shall be effectively spread to minimize Essity’s counterparty risk.

In 2017, Essity purchased about 5 TWh (5; 5) of electricity and about 8 TWh (8; 8) of natural gas.The graph displays Essity’s price hedges in relation to forecast consumption of electricity and natural gas for the next three years. The graph includes financial hedges and hedging effected via supply agreements. For further information concerning financial price hedges, see Note E6 Derivatives and hedge accounting.

Energy price hedges in relation to forecast consumption, December 31, 2017

Currency risk

Risk

Transaction exposure

Transaction exposure is the risk that exchange rate movements in export revenues and import expenses could negatively impact the Group’s operating profit and the cost of non-current assets.

Translation exposure

Translation exposure is the risk to which Essity is exposed when translating foreign subsidiaries’ balance sheets and income statements to SEK.

Long-term currency sensitivity

The table below presents a breakdown of the Group’s net sales and operating expenses by currency, which provides an overview of the Group’s long-term currency sensitivity. The largest exposures are denominated in EUR, USD, CNY and GBP. The high costs in USD is due to pulp purchases that are invoiced in USD.

Policy/Action

Transaction exposure

Transaction exposure, resulting from exports and imports, can be hedged for a period of up to 18 months. Contracted future payments for non-current assets in foreign currencies can be hedged up to the full cost.

The forecast net flow of currency against SEK amounts to SEK –1,059m (–892; –1,58). At year-end, a net flow against SEK corresponding to three months of the forecast flow for 2018 was hedged. The majority of hedges mature during the first quarter of 2018. The forecast and hedges of the 2018 flows are shown in the table to the right. For further information relating to hedging of transaction exposure, see Note E6 Derivatives and hedge accounting.

Translation exposure

Essity manages translation exposure by distributing the liability across various currencies where the Group owns assets so that key figures that are material for the company’s credit rating are protected in the long term against exchange rate effects. Translation exposure in the income statements of foreign subsidiaries is not currency-hedged. As at December 31, 2017, net debt amounted to SEK 52,467m (35,173; 19,058). Distribution by currency is shown in the table to the right. For further information relating to hedging of translation exposure, see Note E6 Derivatives and hedge accounting.

Credit risk

Risk

Credit risk refers to the risk of losses due to a failure to meet payment obligations by Essity’s counterparties in financial agreements or by customers.

Policy/Action

Credit risk in accounts receivable

Credit risk in accounts receivable is managed through credit checks of customers using credit rating companies. The credit limit is set and regularly monitored. Accounts receivable are recognized at the amount that is expected to be paid based on an individual assessment of each customer.

Financial credit risk

The objective is that counterparties must have a minimum credit rating of A– from at least two of the rating institutes Moody’s, Fitch and Standard & Poor’s.

Essity strives to enter into agreements that allow net calculation of receivables and liabilities. Credit exposure in derivative instruments is calculated as the market value of the instrument. At year-end, the total credit exposure was SEK 4,964m (5,214; 6,591). This exposure includes credit risk of SEK 4,106m (4,244; 4,828) for financial investments.

Credit exposure in derivative instruments amounted to SEK 858m (971; 753) at December 31, 2017.

Ten largest customers’ share of outstanding accounts receivable

Liquidity and refinancing risk

Risk

Liquidity and refinancing risk is the risk that Essity is unable to meet its payment obligations as a result of insufficient liquidity or difficulty in raising new loans.

Policy/Action

To ensure good access to loan financing, regardless of the economy and at attractive terms, Essity strives to maintain a solid investment grade rating.

Essity is to maintain financial flexibility in the form of a liquidity reserve consisting of cash and cash equivalents and unutilized credit facilities totaling at least 10% of the Group’s forecast annual sales. Essity limits its refinancing risk by having a good distribution in the maturity profile of its gross debt. The gross debt must have an average maturity in excess of three years, considering unutilized credit facilities that are not liquidity reserves. Surplus liquidity should primarily be used to amortize external liabilities. Essity’s policy is to not agree to terms that entitle the lender to withdraw loans or adjust inte-rest rates as a direct consequence of movements in Essity’s financial key figures or credit rating.

The Group’s financing is mainly secured by bank loans, bond issues and through issuance of commercial papers. The refinancing risk in short-term borrowing is limited through long-term credit facilities from bank syndicates and individual banks with favorable creditworthiness.

Essity’s net debt increased SEK 17,294m in 2017. At year-end, the average maturity of gross debt was 4.3 years (4.0; 3.5). If short-term loans were replaced with drawings under long-term unutilized credit facilities, the maturity would amount to 4.5 years. Unutilized credit facilities amounted to SEK 19,680m at year-end. In addition, cash and cash equivalents totaled SEK 4,107m. For further information, see Note E2 Financial assets, cash and cash equivalents, and Note E4 Financial liabilities.

Interest rate risks

Risk

Interest rate risk relates to the risk that movements in the interest rates could have a negative impact on Essity. Essity is affected by interest rate movements through its net financial income and expense.

Policy/Action

Essity seeks to achieve a good distribution of its interest maturity dates to avoid large volumes of renewals occurring at the same time. Essity’s policy is to raise loans with floating rates, since it is Essity’s understanding that this leads to lower interest expense over time. The interest rate risk and interest period are measured by currency and the average interest term shall be within the interval 3 to 36 months.

Essity’s net financial items increased in 2017, primarily a result of higher average net debt. Lower interest rates had a positive impact on financial items during the period. Essity’s largest funding currencies are EUR, SEK and USD, refer to the graph. To achieve the desired fixed interest period and currency balance, Essity uses financial derivatives. The average interest period for the gross debt, including derivatives, was 30.1 months (8.5; 9.2) at year-end. The average interest rate for the total outstanding net debt including derivatives, amounted to 1.83% (2.26; 3.11) at year-end.

Gross debt distributed by currency