Ansell: Flowers in the desert?

When it comes to sharemarket investment, the ideas generation process is a fluid one. The simplest of leads—even a reference that subsequently proves incorrect—can be the catalyst for further investigation of a discarded stock.

Take Ansell, a manufacturer of medical, industrial and household gloves as well as condoms. Most Australians who have washed dishes would be familiar with the consumer brand name.

We ceased coverage on the company in 2010 due to concerns about its ability to manage latex costs, and the apparently aggressive growth strategy of the chief executive. Our last full review—this company has always been a source of puns—was Ansell offers slim protection on 14 Oct 10 (Hold - $11.88).

But a few days ago, Ansell announced the $118m acquisition of Comasec, a European glove manufacturer. What attracted my interest was that Comasec apparently owned Marigold, a brand of rubber glove that's a household name in the UK.

I've since discovered that the consumer brand Marigold is owned by Reckitt Benckiser. Comasec owns the rights to the industrial version of the Marigold brand. My mental shortcut led me up the garden path (a risk investors need to beware, but that's a story for another day).

What the acquisition announcement did do, though, was cause me to take another look at Ansell. The share price fall from $15.00 also piqued my interest.

Here are some of the things that make me interested:

1. Ansell's free cash flow has been excellent. Over the past five years, Ansell has generated average annual free cash flow of $124m. That puts it on an average free cash flow yield of just under 7%.

2. Even after the Comasec acquisition, Ansell won't be highly geared. On my initial rough estimates, net debt will be less than $250m and the net debt-to-equity ratio will be under 35%. This should fall quickly given high free cash flow and the puny dividend payout (a result of Ansell's mainly international earnings and inability to pay franked dividends).

3. Ansell strikes me as a classic takeover target. Competitor SSL International was taken over by Reckitt Benckiser in 2010 and defensive, strong cash flow businesses are attractive acquisitions in a difficult economic environment. I'm slightly surprised Ansell is still listed.

4. There's some evidence of shareholder friendly behaviour. During the August 2011 mini-crash, Ansell announced a share buyback. I also like seeing that management highlights both the positives and negatives in their announcements (see page 5 of the 2012 half yearly results).

5. On the face of it, the stock doesn't seem overly expensive. Consensus earnings per share expectations are around $1.10 for 2013, putting the stock on a prospective PER of 12.6. Not super-cheap perhaps, but it might be if the market is under-estimating the potential growth.

There's much more work to do, but I'll be watching Ansell's 2012 results when they're released in a few days. It's a company that one of our analysts might do further work on once reporting season has concluded in September.

Of course, most potential buy candidates fall at one of the numerous hurdles we make them jump. Our 'Dragon's Den' review process is designed to test all new ideas thoroughly and perhaps the original reason for ceasing coverage on Ansell will remain valid.

But my point is this. While you should never fall in love with a stock, you should never write one off either. Things change over time, and new buy ideas can emerge from the unlikeliest of places. Sometimes, they're even the result of mistaken identity.

What do you know about Ansell? How does your ideas generation process work? Have you found stock ideas in unlikely places?