Ansell puts gloves up for global transition fight

Financial Journalist
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I read three company presentations this week for this column and each began with a slide on safety performance. Each company’s headline achievement was not profit growth or earnings but the fact that high safety standards were maintained.

It was just another anecdote about the culture change towards industry safety. In fact, the focus on safety from boardrooms to front-line staff, particularly in heavy industries, and constant communication about it, is a lesson for other parts of industry that need change.

I write extensively about boards and directors often talk about safety from an environmental, social and governance (ESG) perspective. Some directors chair safety committees and consider safety standards across the supply chain as part of their risk-management duties.

As the market pays more attention to ESG performance, including safety, the likelihood is steady growth in corporate investment on safety initiatives.

From an investment perspective, gaining exposure to safety trend via the ASX is hard. Some mining services companies provide safety services and plenty of technology companies engage in cybersecurity. But pure industrial safety plays on the ASX are rare.

Which brings me to Ansell (ASX: ANN), a leading global provider of safety protection solutions for industry. Ansell was once known for its sexual wellness (condoms) division, but sold that in 2017 for $800 million to a Chinese consortium.

Ansell’s sole focus now is gloves and other protective equipment in the healthcare and industrial sectors. Surgeons, doctors, dentists, vets and scientists use Ansell gloves, as do workers across a range of heavy industries in Australia and overseas.

Gloves look like a boring industry with weak barriers to entry. But the sheer scale of Ansell’s operations – it is the world’s largest dedicated player in occupational gloves – creates some barrier to entry. Replicating Ansell’s manufacturing facilities, most of which are in lower-cost developing nations, is costly for industry entrants.

Ansell’s innovation in gloves is another strength. At face value, disposable gloves look like a low-margin, commoditised product. Some are. Ansell differentiates itself by refreshing its portfolio with product innovation and higher-margin gloves for specialised industries. For example, longer gloves in medical research and special gloves for surgeries.

Ansell has economies of scale advantages in glove production, greater resources for innovation and a large, global client base. Gloves enjoy a high level of repeat sales and when industrial demand rises, workers go through more boxes of Ansell products.

Ansell’s strong balance sheet is another advantage over smaller rivals. The company has firepower to make bolt-on acquisitions and buy back its shares (a buyback program is ongoing) through capital-management initiatives.

That’s not to say Ansell is an exceptional business. Revenue is reasonably cyclical; the business does well when global economic growth and industrial production are expanding, and vice versa. Raw materials for its gloves – Ansell’s largest cost – are another factor. A jump in natural rubber latex or synthetic latex prices can crimp Ansell’s profit margins.

Solid performance

Ansell reported one of the better results in the healthcare sector in the latest reporting period. Earnings before interest and tax fell around 90% because of investment in Ansell’s transformation program for the first half of FY19. But adjustable earnings, which exclude these costs, were up slightly to US$87.6 million in a complex set of accounts.

The big news was the increase in Ansell’s guidance range from US$1 to US$1.12 in earnings per share for the full FY19, to US$1.06 to US$1.12. The market liked the upgrade, driving Ansell a little higher in March and continuing a near 20% rally from its early-2019 lows.

Management said the upgrade is due to expected higher selling prices and profit margins, cost savings from the transformation program and the benefits of the share buyback. The new guidance range continued to exclude costs from the transformation program.

Always take extra care with companies that remove “transformation costs” from restructuring initiatives and present overly complicated accounts. But the sale of Ansell’s condom business, which tripled its FY18 net profit, and the restructuring, are clearly not business as usual.

Prospective investors must be satisfied the transformation program is a creating significant benefits. The evidence so far suggests it is. Ansell said in its FY19 interim result that it expects to exceed original cost savings estimates from the program and is pleased with its implementation.

Ansell is a company in transition: it closed manufacturing facilities in Mexico and South Korea as part of the transformation program and expanded facilities in Vietnam, Malaysia and Sri Lanka. The upgrade is helping Ansell meet higher production targets and providing more manufacturing options to produce differentiated gloves at higher margins.

The context of the result is also important. Ansell’s raw materials costs rose in the first half, the global economy slowed, and there was demand uncertainty in the auto sector and some emerging markets that use its gloves. Yet the company’s organic growth and margins improved a touch, and the ongoing transformation achieved better-than-expected results.

It is a good sign when companies steadily grow when market conditions move against them, particularly during a major restructure that can distract management from daily business. The result suggests Ansell is nimble and has sufficient levers to keep earnings growing – and that management is performing.

Reasonable outlook

A weakening global economy is the main headwind for Ansell’s earning growth, given the relationship between industrial production and demand for its products. A slowdown in North America, worth about 45% of Ansell’s revenue, would crunch sales growth.

Against that, the US Federal Reserve has indicated a pause in interest rate rises and I expect other central banks, including Australia’s, to cut rates and maintain accommodative monetary policies this year. Although the focus now is on a global slowdown (and falling bond yields), next year’s story might be about efforts to reflate economies.

An easing of natural rubber latex and synthetic latex prices, in line with lower oil prices, should support Ansell’s margins in FY19. These commodities are about a third of Ansell’s raw materials exposure, so could be a swing factor in the full-year result.

The transformation program, started in 2017, had targeted annualised savings of more than US$30 million and Ansell has already increased that to US$35 million by FY20.

As always, the key is valuation. At $24.90, Ansell is on a forward price-earnings (PE) ratio of about 16 times FY20 earnings, according to consensus analyst estimates. The stock traded on an average PE of almost 18 times in FY18 and 21 times in FY17, Morningstar data shows.

The forecast PE of 16 is undemanding for a company that is a global leader in its field and is moving up the value chain through higher-margin, differentiated products, and which has a narrow economic moat (competitive advantage) because of the manufacturing scale required to compete in its market. Also, safety is a long-term growth industry.

However, an average share-price target of $19.30, based on the consensus of nine broking firms, suggest Ansell is overvalued at the current price. That target looks too bearish; Morningstar’s fair value of $27 seems reasonable and assumes a FY20 PE of 16.5 times.

Ansell is no screaming buy and does not suit conservative income investors. But if Morningstar’s fair value estimate is accurate, Ansell is about 10% undervalued. Add in a forecast dividend yield of 2.7% in FY20 and the expected total return over one year is almost 13%.

I expect the share market to weaken in the next few months, possibly creating an opportunity to buy Ansell at a lower price and a higher margin of safety. Either way, the stock deserves to be on portfolio watchlists, assuming the global economy stabilises this year.

Longer term, Ansell’s transformation strategy could unlock strategic value that the market is yet to factor in – and create a larger competitive advantage that can be exploited through innovation, differentiated products and higher margins and profits. 

Chart 1: Ansell

Source: ASX

The information in this article should not be considered personal advice. It has been prepared without considering your objectives, financial situation or needs. Before acting on information in this article consider its appropriateness and accuracy, regarding your objectives, financial situation and needs. Do further research of your own and/or seek personal financial advice from a licensed adviser before making any financial or investment decisions based on this article. All prices and analysis at 20 February 2019

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