Ansell: Result 2015
Recommendation
In Ansell: Interim result 2015 from 10 Feb 15 (Sell – $24.06) we finished with 'as many of Ansell's customers have learnt, hope is not a strategy – you need protection … until a margin of safety returns, we're downgrading to SELL'.
We didn't know bad news was just around the corner, nor that the stock would fall 20% on the day of its release. What we did know was that the share price at the time didn't allow for anything other than a rosy future. 'You can't predict; you can prepare', as Howard Marks put it.
Management's guidance at the interim result was for underlying earnings before interest and tax (EBIT) growth in the 'high 20s', implying an EBIT figure around US$260m for 2015. However, the company ultimately delivered EBIT of US$245m – well below expectations but still an increase on the previous year of 19%.
Key Points
Industrial division slow growth
Currency and tax headwinds
Stock only offers fair value; Hold
The miss was mostly blamed on limited growth in key markets and currency fluctuations, primarily a decline in the euro and the Canadian and Australian dollars resulting in lower revenue when reported in US dollars.
If it were just a matter of accounting, we wouldn't be concerned. But the lower earnings were also due to a mismatch between currencies where the company earned revenue and expensed costs, which meant that underlying profitability was also affected. The largest contributor was European sales: around 25% of the company's revenue is received in euros, while only 13% of its cost base is in the currency.
The overall currency impact on EBIT was a decline of US$50m, with only US$20m recouped from gains on derivative contracts intended to hedge it. If current exchange rates are unchanged, management expects a further US$55m fall in sales and US$30m reduction in EBIT in 2016.
What's more, Ansell's Australian tax bill is also expected to increase in 2016 once tax losses are exhausted (see Reporting season: Ansell axed by tax). This will result in an effective tax rate of 20-21%, compared to 16% in 2015.
The combined effect of higher taxes and currency fluctuations will be a reduction in earnings per share of 22–26 US cents in 2016 – more than a 20% hit. Presumably management could see that tax losses were drying up and that hedging was inadequate long before yesterday's announcement. We've historically held Ansell's management in high regard, but communication on both issues was decidedly poor.
Industrial drag
Ansell's Industrial division, the company's largest, clocked a fall in sales of 1% to US$669m after adjusting for currency movements.
A 6% increase in sales of Ansell's HyFlex safety glove (of which Ansell makes nearly a thousand a minute) was not enough to offset weak results in the US, Russia and Brazil. US sales, in particular, were hit by a decline in spending by the energy industry after the rapid fall in the price of crude oil.
Revenue in the Single Use division jumped 30% to $312m and EBIT leapt 85% to $60m. Unfortunately, this was mostly due to the US$615m acquisition of US glove-maker BarrierSafe, which has a 20% share of the US single-use glove market (see Ansell buys US market leader from 26 Nov 13 (Hold – $19.46)).
Year to June | 2015 | 2014 | /– (%) |
---|---|---|---|
Revenue (US$m) | 1,645 | 1,590 | 4 |
EBIT (US$m) | 245 | 207 | 19 |
NPAT (US$m) | 188 | 157 | 20 |
EPS (US cents) | 123 | 110 | 11 |
Final dividend | 22 US cents, unfranked, (up 10%), ex date 13 Aug |
Excluding acquisitions and foreign exchange movements, underlying sales growth was a disappointing 2%, though underlying EBIT was up 26% due to lower costs of raw materials.
Though the EBIT margin improved from 13% to 19%, we don't expect such a large jump in future years as there's a one-off benefit from acquiring the higher margin BarrierSafe operation and rubber prices are notoriously unpredictable. But a few more years of margin improvements are certainty possible for the Single Use division as the combined Ansell-BarrierSafe operation can negotiate more aggressively with suppliers.
Sexual rebound
The Sexual Wellness division improved considerably in 2015 with a rebound in condom sales in China, India and Europe helping to increase revenue and EBIT by 2% and 4% respectively – nothing stellar, to be sure, but far better than the double-digit decline in 2014. An expanded range of flagship SKYN ultra-thin condoms increased sales of the brand by 16%. Unfortunately, the division only accounts for 13% of sales.
Overall, the company managed a 9% rise in revenue to US$1,645m after removing the effect of currency fluctuations. Underlying net profit grew 20% to US$188m, while underlying earnings per share rose 11% to US$1.10 due to the increase in shares on issue to pay for BarrierSafe.
Management expects earnings per share of between US$1.05 and US$1.20 in 2016, implying a forward price-earnings ratio of around 15.
Ansell faces currency and tax headwinds, not to mention its high exposure to global industrial activity and volatile commodity prices. But it's still a decent company with brands and scale providing some minor competitive advantages.
We'd love to own the stock at the right price but, despite the fall, today's price still offers little more than fair value. We need a wider margin of safety before buying. Nonetheless, with the stock down 10% since Ansell: Interim result 2015 from 10 Feb 15 (Sell – $24.06), we're upgrading Ansell to HOLD.