Risks and risk management
Essity is an international group with sales in approximately 150 countries and manufacturing at about 90 production facilities in some 30 countries. The geographic structure means that operations are conducted in countries and in markets with different cultures and varying degrees of maturity. Essity is exposed to a number of strategic, operational and financial risks, which could exert a negative impact on the Group’s operations. Accordingly, it is of major importance that the company has a systematic and effective process to identify, manage and mitigate the effects of these risks.
Processes for risk management
The responsibility for the management of risks follows the company’s delegation scheme, from the Board of Directors to the President, and from the President to each Business Unit President. The delegation scheme involves risks being managed primarily by Essity’s business units, but with clear central coordination and follow-up. The latter is mainly achieved through the business units’ continuous reporting and in the annual strategy process.
Risk identification and risk management are a key part of the annual strategy process, where risks are analyzed based on how they impact Essity’s opportunities to achieve established targets. Identified risks are assessed according to the likelihood of these becoming a reality and the potential impact each risk could have on the Group. This process also includes specifying who is responsible for managing the risk, and measures for how risks shall be mitigated and followed up. Responsibility and follow-up for the majority of risks are centralized at a global level.
- 1Identification and analysis
- 2Action for risk management
- 3Monitoring
Essity’s financial risk management is centralized. The Group’s internal bank handles the Group’s financial risks and energy risks. The financial risks are managed in accordance with the Group’s finance policy, which is adopted by Essity’s Board of Directors. Together with Essity’s energy risk policy, the finance policy constitutes a framework for financial risk management. The risks are compiled and continuously monitored. Responsibility for insurable operational risks is managed by the Group Risk Management & Insurance department. Risks related to ethics, human rights and other sustainability risks as well as information security are aggregated and monitored on a regular basis at Group level.
Essity has a corporate internal audit unit, which follows up that Essity’s organization complies with the adopted policies.
Based on current knowledge, the following are deemed to be the main factors that risk materially negatively impacting the operations and Essity’s ability to achieve established targets:
GDP trend and economic conditions
Risk
Demand for Essity’s products is affected by general macroeconomic fluctuations and the resulting changes to customer purchasing power and consumption patterns. For example, a tighter budget situation in the public sector or among business customers influences sales in the healthcare sector and business-to-business, respectively. Sales to the retail sector, which accounts for the bulk of sales of hygiene products, may also be affected by reduced purchasing power among consumers.
Action
Essity continuously works to manage the effect of cyclical fluctuations that arise, for example, through measures to reduce costs, increase efficiency and to create higher customer value through product innovations. Essity also works on differentiation to move toward product areas that are less sensitive to economic fluctuations.
Environmental impact and climate change
Risk
Essity’s operations and the products used in the manufacturing process have an impact on air, water and land. Essity is subject to extensive environmental regulations in all of the countries where the company conducts operations. More stringent environmental requirements, remediation of the environment in connection with plant closures or breaches of permits could incur higher costs for the Group. Risks related to climate change and the financial implications of such change, for example, increased production costs and investment requirements, have increased in importance.
Action
Essity’s strategic framework and sustainability target stipulate guidelines for the Group’s measures within the environmental area. Environmental impact and the impact of climate change are part of the annual strategy process, which includes the identification, assessment and actions for managing these types of risks. Risks are managed, for example, 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 use of energy, water, transport, production waste and raw materials is controlled using the company’s Resource Management System (RMS). The system also enables the simulation of investments on the basis of climate aspects. The data is used for internal control and follow-up of established targets. Essity also works to reduce the volume of production waste.
Essity has adopted the Science Based Targets issued by the Science Based Targets initiative (SBTi) to reduce the company’s climate impact and to support the 2015 Paris Agreement. Through clear governance and responsibility for climate targets within Essity’s management team, climate impact also constitutes a clear part of the company’s business strategies and financial planning. Essity works to reduce carbon emissions by, for example, making investments in renewable energy and energy-saving programs. In addition, Essity has adopted targets relating to packaging, which are part of Essity’s commitment to the Ellen MacArthur Foundation’s plastics initiative. The targets aim to increase the proportion of renewable or recycled material in the company’s packaging. In 2020, Essity carried out scenario analyses to evaluate in detail the effects climate change may have on Essity’s operations in the years ahead.
Read more about Essity’s reporting based on the recommendations of the framework of the Task Force on Climate-related Financial Disclosures (TCFD) in chapter Climate-related risks and opportunities.
Global health risks
Risk
Extensive outbreaks of disease entail risks for Essity’s operations, not least in terms of the risks posed to our employees’ health and safety and their ability to carry out their work. Political decisions to limit the spread of disease, such as lockdowns, more stringent border security measures or other restrictions may also cause disruptions at production facilitates, in the supply chain or for a third party’s ability to fulfill its obligations toward Essity. More extensive outbreaks of disease may also result in a temporary fall in demand for some of our products, changed consumer behavior and preferences and changes in the economic conditions in the countries where we conduct operations.
Disease outbreaks and global health risks could potentially also lead to an increase in healthcare costs. This, in turn, may result in limitations being imposed on subsidized prescription of Essity’s products in Incontinence Products and Medical Solutions and an accelerated shift toward self-management of health and self-financing of these products.
Action
The highest priority during extensive outbreaks of disease, such as the current pandemic, is to take action to safeguard the health of employees. The company implements a series of actions to adapt local operations to reduce the risk of infection. These could include remote working where possible, information disclosure about handling the risk of infection, protective equipment, new procedures for carrying out work, limited access to plants and offices, restrictions on business travel, changed forms of customer contact and so forth.
When required due to disease outbreaks, the company also adapts its solutions for sourcing raw materials and storage as well as transport solutions for raw materials and finished products.
Changes in demographics, consumer behavior and preferences
Risk
Changing demographics and lifestyle alter demand from customers and consumers. There is a risk of a decline in demand for our products if we do not successfully satisfy customer and consumer needs and adapt our innovation program, product portfolio, sales channels, brand-building activities and communication accordingly.
The global population is growing, entailing that the age structure in many countries is moving toward a larger share of the population in the category 65 years and over. At the same time, younger generations of consumers have preferences and behaviors that impact what and how they shop, for example, in the form of more stringent demands on convenience, transparency, sustainability and social responsibility. This has given rise to demand for new products, services and solutions, such as subscription services, recycling solutions and a greater emphasis on a sustainable choice of materials.
Action
Customer and consumer insights constitute the core of Essity’s innovation work. Through knowledge about people’s daily needs and challenges, we create an offering that improves quality of life for users. We continuously analyze customer and consumer data and listen to the views of consumers, customers, experts and opinion formers to improve our offering.
Political decisions and regulatory measures
Risk
Essity conducts operations in a large number of different countries. In some countries, the institutional structures are more established and developed, while the political, financial, legal and regulatory systems in other countries are less predictable. In both cases, political changes and decisions, as well as amended legislation and regulations could have a negative impact on Essity’s operations in the form of higher costs or some other obstruction. In general, the regulatory requirements imposed on Essity’s operations, products and services are intensifying.
Action
Essity works continuously to monitor, evaluate and anticipate changes in its business environment in the form of political decisions and amended regulations in the areas that are of importance for our operations.
Essity participates in various national and international industry organizations, as well as in other types of partnerships. The aim is to gain early knowledge, and also to contribute actively to the development of areas where we have expertise and that are significant to our operations. Such areas include environmental and energy issues, where the circular economy, use of resources and more specifically, issues relating to waste, plastics, chemicals, and emissions to water and air can be considered of particular importance for Essity. The public sector is both a significant customer and an important stakeholder group for Essity. The company is therefore working actively on matters relating to health and medical care, as well as care for the elderly. By complying with and contributing to the development of relevant regulations, Essity shares its experience garnered from existing systems to decision-makers in countries where new structures are being built or existing systems reformed. An example of this is the development of systems for subsidized prescription of incontinence aids in countries where such benefits were not offered in the past. Similarly, Essity monitors developments in regulations covering medical solutions.
Competition
Risk
Essity is subject to considerable competition from other producers of similar products. Essity is also exposed to the risk that alternative products and solutions with the same or similar function (substitutes) could replace the products included in Essity’s range. Substitutes exist for virtually all Essity products. This may involve such products as cloth diapers or cloth rags for household or industrial cleaning, or completely different solutions to meet the needs of consumers. In recent years, digitalization has broadened Essity’s competitive landscape in digital products and solutions, new digital business models and new players, such as start-ups and technology companies that now compete with Essity in the field of hygiene and health.
Competition, the occurrence of substitutes and the effect of digitalization present the risk of a negative effect on sales and pricing of Essity’s products and jeopardizes the company’s market position.
Action
Essity’s focus on customer and consumer insight guides its innovation activities, ensuring that new products and services are attractive and competitive. Essity develops the company’s offering to meet the needs of customers and consumers in terms of the products themselves, but also in providing these in the relevant sales channels, including digital solutions and sales models. New solutions are developed through the company’s own research and development activities in cooperation with customers, consumers, suppliers or partners. Through its processes for monitoring the business environment, Essity follows up on new players and substitutes in the market and their impact on the company.
Read more about innovation in chapter Innovate leading brands.
Dependence on major customers and sales channels
Risk
Essity’s success is attributable to its ability to offer attractive products, services and brands and to make these available to customers and consumers. Essity’s products are sold through retailers, pharmacies, e-commerce, distributors and resellers, with retail representing the single largest customer category. If these players are not successful in selling Essity’s products, this could have a negative impact on Essity’s earnings. In general, there is a consolidation trend in several of Essity’s sales channels and markets, particularly in the retail trade, through mergers and purchasing alliances, which could increase dependence on individual, large customers. Digitalization is also changing customer and consumer behavior, preferences and demand, and is leading to a gradual shift in channels toward an increased share of e-commerce.
Action
Essity’s customer structure is relatively dispersed, with customers in many different geographies and areas of business. In 2020, Essity’s ten largest customers, most of them retail companies and distributors, accounted for 22.5% of net sales. The company works to maintain strong long-term customer relationships in strategic customer segments, and to build relationships with new customers. Essity is participating through a continuous and steady increase in its e-commerce and also by aligning to the new and changing purchasing and consumption patterns. Essity also places great importance on developing processes, products and information to ensure customer satisfaction.
Production facilities
Risk
Essity has around 90 production facilities in some 30 countries. Fires, machinery breakdowns and other types of harmful incidents in plants could lead to considerable value destruction, and loss of production and income, which ultimately, could have a negative impact on Essity’s market position.
Action
From this perspective, the aim of Essity’s risk management is to protect its employees, the environment, the company’s assets and the business properly and in a cost-efficient manner. Essity strives to create and maintain a balance between loss-prevention activities and insurance coverage. The loss-prevention work is conducted in accordance with established guidelines that include repeated inspections carried out by external risk engineers. Other important elements of loss-prevention activities are maintenance of production plants and machinery, staff training, and good orderliness. Essity invests continuously in loss-prevention activities to reduce its risk of damage in various ways. For example, the sites are usually protected by sprinkler systems. All wholly owned facilities are insured at replacement cost and for the loss of income. Within the EU, insurance is primarily conducted within the company’s own insurance company, with external reinsurance for major damages. Outside the EU, Essity cooperates with market-leading insurance companies.
Unethical business practices
Risk
Essity works in a large number of countries and in environments where unethical business practices and violations of human rights may occur. The risk of such business practices is deemed to be very serious. The financial consequences of violations may be very severe in the form of various sanctions and fines. Violations also risk having a negative impact on the company’s reputation in the market.
Action
Essity has a program for regulatory compliance, which aims to minimize the risk of Essity taking part in or being associated with unlawful or unethical business practices or committing violations of human rights. The program is based on a Code of Conduct adopted by the Board of Directors. The Code contains policies for how the company and its employees are to conduct themselves in the workplace, in the community and in the market. Essity’s employees are routinely trained in the Code of Conduct. Within certain areas – corruption and competition regulations – Essity has an in-depth program for risk evaluation and various training courses for employees. The implementation of the regulatory compliance program is reported continuously to the Compliance Council, which includes parts of the Essity management team and where internal audit has an opportunity to take part in work.
Employees
Risk
To meet its targets, Essity is dependent on being able to recruit, retain and develop qualified and motivated employees. There is high competition for skilled employees.
Action
Essity ensures access to employees with relevant competence through strategic staffing and succession planning. Essity strives to build a reputation for the company as an attractive employer. This includes health and safety in the workplace, market-based and competitive forms of employment, personal development plans and the possibility to take on new challenges in the Group. In the recruitment of employees, it is important to create a modern and attractive corporate culture. Essity also works actively to build and maintain good relationships with union organizations.
Legal risks
Risk
Legal risks comprise a number of risks in, to some extent, diverse areas. Amended legislation, violations of laws in the operations or errors in any agreements signed by Essity, are some examples of legal risks that could have negative financial implications for Essity. In certain instances, they may also result in protracted and costly legal processes.
Action
Essity constantly monitors developments in a number of areas and addresses any legal risks that arise in cooperation with external advisers. Legal issues are often national by nature, which means that local experts are also often engaged by Essity in various issues.
Suppliers
Risk
Essity is dependent on a large number of suppliers. The unplanned or sudden loss of key suppliers could result in increased costs and disruptions to the company’s production. Suppliers could also cause problems for Essity through non-compliance with applicable legislation and guidelines or by otherwise acting in an unethical manner.
Action
Essity enters into supply contracts of various durations with a large number of different suppliers. These agreements ensure the supply of key input goods. The Group has several suppliers for essentially all important input goods. In-depth collaboration also occurs with specially selected suppliers in the development of materials and processes. Essity continuously evaluates its suppliers to ensure compliance with agreements entered into. Particular importance is placed on suppliers operating in countries and industries deemed to be more vulnerable to risks. The assessment of key suppliers may take the form of a questionnaire, on-site visit or independent audit.
Information and IT
Risk
Essity relies on IT systems for its operations. Disruptions or faults in critical systems, as well as the increasing prevalence of cyber-attacks, risk having a direct impact on production and other important business processes. Errors in financial systems risk affecting the company’s reporting of results.
Action
Essity has a management model for IT that contains governance, standardized IT processes and an organization for information security. The latter works with continuous risk assessment, preventive measures and the use of security technologies. Standardized procedures are in place for implementing and changing systems and IT services, as well as for daily operations.
Cost of input goods
Risk
Input goods account for a considerable part of Essity’s total operating expenses. The market price of input goods fluctuates over time and could influence Essity’s earnings positively or negatively. The price trend for a number of input goods over the past ten years is presented in the diagram below.
Highest/lowest market prices (annual average) 2010–2020 per input goods
Action
Fiber (pulp and recovered paper) is a significant cost item, mainly in Consumer Tissue and Professional Hygiene. Essity is evaluating alternative types of fiber, such as wheat straw as a means of diversifying fiber sourcing in the future. The cost of oil-based materials is driven by the trend in oil prices and represents a major cost item in Personal Care and for various packaging materials. The trend in oil prices also impacts transport costs. The impact of price movements on input goods can be delayed through purchasing agreements with fixed durations. Efficiency improvements in the company’s operations, altered product specifications and price increases are examples of measures to offset the effect of rising costs for input goods.
Essity’s costs for input goods are described on pages Description of costs.and Raw materials.
Energy price
Risk
Energy price risk is the risk that increased energy prices could adversely impact Essity’s operating profit. Essity is exposed to movements in the prices of electricity and natural gas, but the prices of other energy commodities also directly and indirectly impact Essity’s operating profit.
Action
Essity centrally manages the energy price risk related to electricity and natural gas. According to Essity’s Energy Risk Policy, these price risks can be hedged for a period of up to 36 months. Exceptions are made for regulated and non-hedgeable markets. Energy prices are hedged through financial instruments and fixed pricing in existing supply contracts.
Essity safeguards the supply of electricity and natural gas through centrally negotiated supply contracts. The portfolio of supply contracts and financial hedges is effectively spread to minimize Essity’s counterparty risk.
In 2020, Essity purchased about 5 TWh (5; 5) of electricity and about 7 TWh (8; 8) of natural gas.
The graph shows 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 contracts.
For further information concerning financial price hedges, see Note E6 Derivatives and hedge accounting.
Energy price hedges in relation to forecast consumption, December 31, 2020
Currency
Risk
Transaction exposure
Transaction exposure is the risk that exchange rate movements in export revenues as well as import expenses and other costs could negatively impact the Group’s operating profit and the cost of non-current assets.
Action
Most of Essity’s business is conducted outside Sweden and transaction exposure therefore arises primarily in currencies other than SEK. The largest exposure comprises a purchase requirement for USD and selling requirements for CNY and GBP. The significant USD exposure is a consequence of the Group’s purchase of pulp that is invoiced in USD.
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 currencies with the greatest net volume were hedged as follows: USD 1.2 months, CNY 0 months, GBP 1.2 months. During the year, there was continuous hedging of, primarily, trade receivables and payables, as well as future payments of non-current assets. The majority of hedges mature during the first quarter of 2021.
Net flows in 2020
For further information relating to hedging of transaction exposure, see Note E6 Derivatives and hedge accounting.
Risk
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.
Currency |
Sales |
Costs |
Adjusted EBITA1) |
Average rate |
||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
EUR |
38 |
37 |
8,098 |
10.4721 |
||||||||
USD |
13 |
27 |
–12,026 |
9.1749 |
||||||||
CNY |
12 |
7 |
7,430 |
1.3303 |
||||||||
GBP |
8 |
4 |
4,379 |
11.7760 |
||||||||
MXN |
5 |
4 |
2,119 |
0.4296 |
||||||||
COP |
3 |
3 |
420 |
0.0025 |
||||||||
RUB |
3 |
2 |
770 |
0.1276 |
||||||||
SEK |
2 |
4 |
–962 |
1.0000 |
||||||||
Other |
16 |
12 |
7,398 |
|
||||||||
Total |
100 |
100 |
17,626 |
|
||||||||
|
||||||||||||
Risk
Translation exposure
Translation exposure is the risk to which Essity is exposed when translating foreign Group companies’ balance sheets and income statements to SEK.
Action
Essity manages translation exposure by distributing the liability across the various currencies where the Group owns assets so that key figures that are important for the company’s credit rating are protected in the long term against exchange rate effects. Translation exposure in the income statements of foreign Group companies is not currency-hedged. As at December 31, 2020, net debt amounted to SEK 42,688m (50,940; 54,404).
|
|
Percentage of net debt |
||
|---|---|---|---|---|
Currency |
Net debt |
2020 |
2019 |
2018 |
EUR |
18,190 |
43 |
42 |
46 |
SEK |
7,652 |
18 |
19 |
11 |
USD |
7,002 |
16 |
10 |
13 |
GBP |
5,085 |
12 |
14 |
15 |
CNY |
3,262 |
8 |
5 |
7 |
MXN |
1,529 |
4 |
5 |
4 |
HKD |
654 |
2 |
4 |
3 |
Other |
–686 |
–3 |
1 |
1 |
Total |
42,688 |
100 |
100 |
100 |
For further information relating to hedging of translation exposure, see Note E6 Derivatives and hedge accounting.
Credit
Risk
Credit risk refers to the risk of losses due to a failure by Essity’s customers, or counterparties in financial agreements, to meet payment obligations.
Action
Credit risk in trade receivables
Credit risk in trade receivables is managed through credit checks of customers using credit rating companies. The credit limit is set and regularly monitored. Trade receivables are recognized at the amount that is expected to be paid based on an assessment of the expected credit losses for the remaining lifetime of all trade receivables at the balance sheet date. For further information concerning trade receivables and recognition of anticipated credit losses, see Note E3 Trade receivables.
Financial credit risk
Essity’s finance policy regulates the maximum permitted counterparty risk depending on the counterparty’s credit rating from the credit rating agencies Standard & Poor’s, Moody’s and Fitch. The objective is that counterparties must have a minimum credit rating of BBB+ or equivalent from at least two of these credit rating agencies.
Credit exposure in derivative instruments is calculated as the market value of the instrument on the balance sheet date. Credit exposure in derivative instruments amounted to SEK 1,650m (971; 1,255), gross. Taking net calculation agreements per counterparty into consideration, credit exposure of derivatives amounted to SEK 887m (551; 810). At year-end, the total credit exposure was SEK 6,208m (3,750; 4,028). This exposure includes credit risk of SEK 5,048m (2,928; 3,081) for financial investments. Refer to the table below for the distribution of credit risk by category.
Financial credit exposure
|
Category1) |
|
||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|
SEKm |
A |
B |
C |
Total |
||||||||
Financial assets measured at fair value through other comprehensive income |
– |
– |
96 |
96 |
||||||||
Financial assets measured at amortized cost |
105 |
– |
72 |
177 |
||||||||
Cash and cash equivalents |
4,188 |
353 |
441 |
4,982 |
||||||||
Current investments >3 months |
– |
66 |
– |
66 |
||||||||
Derivative assets, net |
887 |
– |
– |
887 |
||||||||
Total |
5,180 |
419 |
609 |
6,208 |
||||||||
|
||||||||||||
Liquidity and refinancing
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.
Action
To ensure good access to loan financing, regardless of economic situation and on attractive terms, Essity strives to maintain a solid investment grade rating.
Essity maintains a 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 well distributed maturity profile of its gross debt. The gross debt must have an average maturity in excess of three years, taking unutilized credit facilities which are not part of the liquidity reserves into account. Surplus liquidity should primarily be used to amortize external liabilities. Essity’s policy is to avoid terms that entitles the lender to terminate loans or adjust interest rates as a direct consequence of movements in Essity’s financial key ratios or credit rating.
The Group’s financing is mainly secured by bank loans, bond loans and through issuance of commercial papers. The refinancing risk in short-term borrowing is mitigated through long-term credit facilities from bank syndicates and individual banks with favorable creditworthiness.
Essity’s net debt decreased by SEK 8,252m in 2020. At year-end, the average maturity of gross debt was 3.1 years (3.1; 3.5). If short-term loans would be replaced with long-term unutilized credit facilities, the average maturity would amount to 3.8 years. Unutilized credit facilities amounted to SEK 20,056m at year-end. In addition, cash and cash equivalents totaled SEK 4,982m.
SEKm |
2020 |
2019 |
2018 |
|||||||
|---|---|---|---|---|---|---|---|---|---|---|
Unutilized credit facilities |
20,056 |
20,850 |
20,554 |
|||||||
Cash and cash equivalents |
4,982 |
2,928 |
3,008 |
|||||||
Total |
25,038 |
23,778 |
23,562 |
|||||||
|
|
|
|
|||||||
SEKm |
2020 |
2019 |
2018 |
|||||||
Net sales |
121,752 |
128,975 |
118,500 |
|||||||
Liquidity reserve1) |
21% |
18% |
20% |
|||||||
|
||||||||||
For further information, see Note E2 Financial assets, cash and cash equivalents, and Note E4 Financial liabilities.
Interest rate
Risk
Interest rate risk relates to the risk that changes to interest rates could have a negative impact on Essity. Essity is affected by interest rate movements through financial income and expenses, cash flow and the value of its financial assets and liabilities.
Action
Essity strives to achieve a solid distribution of its interest maturity dates to avoid large debt volumes of renewals occurring at the same time. Essity’s policy states that the average interest duration shall be a minimum of 3 months and a maximum of 36 months. Essity’s financial items decreased in 2020. Lower interest rates and lower average net debt had a positive impact. Essity’s major funding currencies are EUR, GBP and USD, refer to the graph on the right. To achieve the desired interest rate duration, Essity uses financial derivatives. The average interest rate duration for the gross debt, including derivatives, was 21.2 months (24.7; 26.7) at year-end. The average interest rate for the total outstanding net debt including derivatives, amounted to 1.61% (2.11; 2.55) at year-end.
Gross debt distributed by currency
