Ansell: Result 2014

Ansell's iconic condoms business is now its smallest revenue and profit contributor following the US$615m acquisition of US medical glove-maker BarrierSafe (see Ansell buys US market leader on 26 Nov 13 (Hold – $19.46)), and that's probably a good thing.

The 'Sexual Wellness' division could hardly take a trick in 2014, with lagging condom sales, increased competition in Brazil and China and a fire at an Indian manufacturing plant causing revenue and earnings before interest and tax (EBIT) to fall 7% and 27% respectively.

Overall, the BarrierSafe acquisition combined with organic growth to deliver a 16% rise in revenue to US$1,590m and a 20% rise in EBIT to US$207m. Excluding a US$123m restructuring and impairment charge (of which more below), underlying net profit grew 13% to US$157m. Underlying earnings per share, however, rose only 3% to US$1.10 due to the increase in shares on issue to pay for BarrierSafe. The board declared an unfranked final dividend of US$0.22 (ex date 28 Aug), bringing the annual total to US$0.39, giving a yield of 2.0%.

Despite its decline, the Sexual Wellness division still has a 65% share of the local market, and the flagship SKYN brand performed well, taking market share with sales increasing 22%. However, this wasn't enough to offset a decline in other brands and management has increased advertising spending in an effort to revive the floundering business unit.

Ansell's biggest business, however, is its Industrial division, which increased sales by 10% to US$717m (45% of total revenue) and EBIT by 4% to US$94m. The company's best-selling product – the HyFlex safety glove, of which Ansell makes nearly a thousand a minute – increased sales by 5%, although overall organic growth for the division was a paltry 1% as a recovery in the US market was offset by a decline in Australia, Russia and Turkey.

Safe and sound

The Medical division, however, achieved organic growth of 5% and, combined with the impact of BarrierSafe (which was only included for half the year), revenue rose by 20% to $420m (27% of the total) and EBIT by 40% to $58m.

BarrierSafe's biggest impact was in single-use gloves, of which it is the US market leader, with a market share of over 20%. Revenue in the Single Use division leapt 68% to $241m (15% of the total) and EBIT soared 185% to $32m. The division also eked out respectable organic growth of 7%.

The BarrierSafe acquisition is particularly welcome for a number of reasons. Ansell has historically been underrepresented in North America and BarrierSafe is arguably the best in its niche with operating margins nearly twice Ansell's average. Better yet, the purchase price of 10 times earnings before interest, tax, depreciation and amortisation (EBITDA) was quite reasonable for a business of this quality (Ansell trades on an underlying multiple of 14).

The acquisition is already paying off. Ansell's administrative expenses grew less quickly than sales as the company was able to cut some fat from overlapping back office expenses. Management expects to remove around US$20m of ongoing costs as the integration of the two businesses continues.

The company also benefited from greater negotiating power with its suppliers due to the higher volumes flowing through its distribution network which, along with lower rubber prices, boosted the underlying gross profit margin from 42% a year ago to 48%. We don't expect such a large jump in future years as there is a one-off benefit from acquiring the higher margin BarrierSafe operation, but incrementally improving margins should continue.

Differentiation

So how exactly does a maker of commoditised products like gloves and condoms find the competitive advantage to earn a return on tangible assets of 15% plus?

Ansell's first and foremost advantage is economies of scale. Fixed costs, such as manufacturing machinery or the distribution network, make up a large share of Ansell's total costs. This means that the average cost per glove or condom declines as the number of units sold increases. As Ansell is the largest operator in almost all its markets, it can be profitable at a price that leaves smaller competitors, with higher average costs, losing money.

Ansell also sensibly focuses its research and development (R&D) spending on highly tailored products that fill hundreds of obscure niches, such as gloves that are impervious to a particular chemical or which offer a specialised textured grip for use on oil rigs. The company has released more than 45 new products this year and has flagged a 'major new technology' to be launched in 2015.

Restructure

Ansell is undergoing a broad restructure that includes integrating BarrierSafe, merging various business units and closing manufacturing sites. Around $100m of goodwill has been written off (non-cash), 70% of which was due to the discontinuation of 'approximately 30 brands most of which have a balance sheet value arising from 20 year old acquisitions'. This included the company selling its household gloves business due to its commoditised nature.

The restructure has reduced inventory, freeing up about US$14m of cash. The company's net debt increased to US$411m from US$251 a year earlier due to the BarrierSafe purchase, but we're not worried. The debt matures in 7-10 years and has a low fixed interest rate of 3.4%, comfortably covered 13 times by operating earnings.

Management expects earnings per share of between US$1.18 and US$1.26 in 2015, up 7-10%. Ansell's enterprise value is currently 16 times EBIT and the company has a forward price-earnings ratio of 17. Its brands, scale, and a vast, entrenched sales network mean the company has some minor competitive advantages, but given its exposure to global industrial activity and volatile commodity prices, we need a greater margin of safety than is currently on offer.

The stock is up 8% since Ansell: Interim result 2014 on 17 Feb 14 (Hold – $18.33). If the price rises much further, members should consider taking some chips off the table but, for now, we're happy to HOLD.