Svenska Cellulosa

Moat: 3/5

Understandability: 3/5

Balance Sheet Health: 4/5

Svenska Cellulosa AB (SCA) is a leading global hygiene and forest products company, operating in the paper and personal care sector.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Svenska Cellulosa, or SCA, is structured around three main pillars: forest, pulp, and hygiene, these pillars make the majority of the company’s overall revenues. These operations are very integrated and give it a solid foundation in its chosen industries.

The company has a large forest holding and an integrated supply chain which gives it both economies of scale and some advantages against their competitors as they can control all the different stages of their processes.

  • Forest Products: They own and manage 2.6 million hectares of forestland in Sweden, making them the largest private forest owner in Europe. Their forest division produces sustainable wood products like solid-wood products, pulpwood, sawlogs, and pulp, creating a circular integrated system. The company is a supplier of pulp for tissue and other paper products.
  • Pulp: The company utilizes their massive forestry holdings to produce pulp for tissue. They are one of the largest producers of pulp in Europe.
  • Hygiene: Under its Essity name, SCA sells a variety of tissue paper products for both professional and consumer uses, like napkins, towels, and toilet paper; as well as personal care items such as incontinence products, feminine products, baby diapers, and soap.

SCA spun off its hygiene division as Essity to focus more heavily on forest products but still has a ~25% stake in the company.

Moat Analysis

SCA has a moderate moat, earning a 3 out of 5 rating. This is not a wide moat, that puts it within the category of truly defensible businesses, but it is also not so weak that it is easily attacked.

  • Scale-Based Advantages: SCA benefits from its massive scale in terms of owning a large forest base and having an integrated pulp supply chain. This scale enables them to produce products at low cost and take advantage of pricing pressure and also helps buffer any supply chain issues.
  • Natural Resources: As the largest private forest owner in Europe, SCA has access to a large low cost source of raw materials for their pulp supply, providing a sustainable competitive advantage. This access to low cost materials can help them lower operating costs and thus be profitable in all stages of their cycle.
  • Geographic Moats: Their large holdings in Sweden provide the company with favorable conditions for production and have a certain amount of logistical advantage due to their proximity to European markets. Additionally, some of the company’s specialized products have brand loyalty and high switching costs for customers, like the high-end medical tissue paper.
  • Distribution Network: The Company has established a solid distribution network across Europe, that has high barriers of entry.

The company’s moat isn’t especially strong, because it has a lot of competitors, but the moat helps them maintain profitability within their businesses.

Risks to the Moat and Business Resilience

Several factors can impact SCA’s moat:

  • Commodity Prices: Given that the company primarily produces commodities (pulp, lumber), SCA is very vulnerable to price fluctuations that can be very volatile. Any reduction of price will diminish the company’s revenue even if sales are the same or higher.
  • Cyclicality of Markets: Similar to the price risk, cyclical industries are prone to have ups and downs that are hard to predict. Paper and pulp demand can vary considerably and this can affect the returns in an unpredictable way.
  • Regulatory Changes: Changes to forestry and environmental regulations can affect their supply of raw materials, driving costs up.
  • Technological Shifts: New innovations that may disrupt the company’s processes can emerge or new methods of producing tissue paper could lead to erosion in the cost advantage that they currently enjoy.
  • Competition: Competitors with deeper pockets can acquire a similar amount of resources. Competitors with a large network of factories might offset SCA’s scale. New entrants could also try to compete against SCA’s low costs by developing more efficient processes.
  • Economic Slowdowns: During a recession, the demand for construction, hygiene, and other products sold by SCA can decline greatly leading to reduced revenue.

SCA possesses good financial strength (which is further evaluated below) which gives the company decent business resilience by having an ability to weather a significant downturn by managing their debt or adjusting operational plans. Their diverse end-markets, with both consumer and industrial applications, allows them to be less affected by shifts in customer demand, increasing business resilience.

Detailed Business and Financial Explanation

  • Revenue Distribution: SCA’s revenue primarily comes from Europe and its geographical distribution can be seen in Exhibit 30.1.

The Company’s largest business segment in terms of revenue is wood products.

  • Industry Trends: The European market for forestry products has been strong and has benefited SCA for a long time. Given concerns about sustainability, companies that use sustainable wood have benefited by creating value using responsible sources.

The company is facing headwinds from high inflation, geopolitical uncertainty, and an increase in costs, which has led to a price squeeze.

  • Margins: Their historical gross margin is around 10%, and has stayed fairly consistent despite rising inflation due to their cost advantages. Their Operating and Net margins, however, are much lower. These margins may vary depending on demand for specific products or fluctuations in the supply of wood.

  • Competitive Landscape: The company is in the business of providing basic products: lumber, paper pulp, tissue paper, and personal care products. These are highly competitive markets, because the products are relatively undifferentiated. For tissue paper, some brand names are able to create a premium market position, which is where they have been focusing their efforts lately.

The industry is consolidating in the tissue and pulp industry, which has driven up prices and has created an opportunity for those companies that have an ability to streamline their production to better generate profits.

  • What Makes SCA Different?: SCA’s primary difference is that the company is a fully integrated timber and pulp producer. They own vast swathes of forest, and thus have a very competitive advantage for pulp production.

Furthermore, they are pushing toward using more sustainable products for their tissue division, and also improving productivity and streamlining production in their businesses.

In-Depth Financial Analysis

  • Income Statement As of their latest quarter, July 2024, Svenska Cellulosa has done 17,233 MSEK in sales. The operating profits are ~1,300 MSEK. Their net income is around 1,000 MSEK. All of these numbers are down from previous periods due to inflation, and market demand concerns. However, even with this decline, the company still generates profits. Year-over-year sales growth has been negative during the first six months of 2024 (11%) due to weaker demand and lower prices. Gross margins also took a beating, falling by 3.5 percent.

  • Balance Sheet: SCA has a pretty solid balance sheet. The company has 2,951 MSEK in short-term debt, and 11,588 MSEK in long-term debt, which is quite high, especially relative to the equity they have. They currently have 1,603 MSEK in cash, which is down from previous periods. Despite the high debt load, their net tangible assets of around 50,000 MSEK is more than enough to easily support their debt obligations. Their current ratio (current assets to current liabilities) is at 1.7, implying a low risk of near term liquidity issues. Overall, the company seems to have a solid financial footing despite current headwinds.

It seems that the company is working on reducing their debt going forward.

  • Cash Flow: While they have been profitable, the cash flow situation has taken a hit recently. They had 1,268 MSEK in operations, and 1,056 in investing, with 1,300 in financing. Overall, the company is still able to produce cash.

Understandability: 3 / 5

SCA’s business model and supply chain are relatively straightforward, involving forestry, pulp production, and hygiene product manufacturing. The competitive landscape is easy to understand, and it is very easy to analyze its financials through income and cash statements. There are other valuation factors such as foreign currency and market cyclicality that one should take into account. Because the company has operations in multiple segments, and operates across Europe, the company requires above average understanding in order to understand how it generates profit and value. I therefore rate the understandability at 3 out of 5, not too hard to understand but will not be simple either.

Balance Sheet Health: 4 / 5

SCA has a good amount of assets, even though much of it is illiquid assets tied up in plant, property, and equipment. They have had large declines in revenue and profits recently, as well as a declining cash balance. Although the company has lots of debt, its balance sheet seems to be healthy and it will be unlikely to have a financial crisis any time soon, as they continue to produce a good amount of cash flow and have a large base of assets.

Recent Concerns/Controversies

The primary issues in SCA’s recent reports and earnings calls have been a decline in profits and revenue in their most recent quarters as they face the impact of high inflation and reduced market demand. Management has expressed confidence in their long term plans and are working to optimize their operations and reduce debt.

Overall, SCA is a company with a solid business and some real competitive advantages. However, due to exposure to commodity markets and the potential of eroding moats, this business can be volatile and is subject to market factors. It seems well positioned to deliver long term results, as long as management continues to focus on their operations and competitive advantages.