Ansell: Interim result 2019

This time last year, we warned that Ansell's sales to emerging markets 'can evaporate just as quickly as they materialise', and unfortunately that's exactly what has happened. 

The breadth of the company's exposure to emerging markets is impressive, and they now account for 20% of sales. What's more, the company is spread across dozens of markets, rather than being focused on just one or two big ones, as in the case of Blackmores, for example. This evens out some political and currency risks, but because developing economies tend to have more volatile industrial growth, Ansell still struggles when global economic growth slows. 

In the six months to December, organic sales were flat for the company's Industrial division due to strong growth of 6% in North America being offset by lacklustre numbers in emerging markets. The main culprits were sharp sales declines in Brazil and Russia, China 'weakening rapidly', as well as a slowdown for European emerging markets. While management didn't sound particularly optimistic, it noted that a rebound is expected over the next two years in Europe, at least.

There's no getting around the fact that Ansell's exposure to emerging markets means more volatile revenue, but happy to take the rough with the smooth. Ansell is one of only two truly global glove makers that can provide its multinational customers with a supply of gloves on every continent at a consistent level of quality. In the industrial segment, Ansell is the only option and, in healthcare, the choice is between Ansell and Malaysian Top Glove. 

The market power and economies of scale mean Ansell can command slightly higher average selling prices and earn better margins than its competitors. Despite Ansell's slowdown in sales this half, the company improved operating margins in its Industrial division from 11% to 13% due to the sale of more high-margin products and various cost-cutting initiatives.

Raw material pain

Overall, Ansell had sales of US$725m for the six months to December, which was up 2% after removing the effect of currency fluctuations and acquisitions. 

In an interesting twist, the company's Healthcare division was both the biggest contributor to revenue growth and the biggest detractor from profit growth. Organic revenue growth was 4% after removing the effect of currency fluctuations, driven by a 15% increase in sales of new product releases. 

Earnings before interest and tax (EBIT), however, fell 8% due to a significant increase in the cost of raw materials. Nitrile prices rose 15% over the year, though this was partially offset by a decline in natural rubber latex. Thankfully, prices have come down since the middle of last year, so the higher costs will roll off over the next six months. 

'The mix of raw materials continues to move in our favour. Nitrile and natural rubber latex, as you're very aware, are the most volatile categories, but those are also steadily becoming less important in the total mix of raw materials,' said Ansell's chief financial officer during the investor call.

Management said it had increased product prices in response to the higher material costs and this should result in an improved margin in the second half. While an improved margin is generally welcome, raising prices can also curb sales, though Ansell's dominant market position and wider margins should mean it has an easier time raising prices than competitors. Rising raw material prices may even benefit the company over the long term if it knocks out a few of Ansell's smaller, less profitable competitors. 

Free cash flow

Net profit rose only 1% to US$64m, but we were pleased to see an improvement in free cash flow from US$36m to US$55m due to the company more efficiently collecting cash from customers and maintaining a steady rate of capital expenditure. 

Management increased its profit guidance for 2019, with underlying earnings per share now expected to be US$1.06-1.12, up from US$1.00-1.12. Management said that market conditions continue to be tough but that it is targeting 3-5% organic sales growth in the second half of the financial year. 

Using the mid-point of the expected earnings range, the stock trades on a forward price-earnings ratio of around 16 at today's exchange rate. The stock is up 62% since we upgraded it in Ansell: good news, bad news on 4 Feb 16 (Buy -  $15.49). We're raising the price guide slightly and sticking with HOLD.