Ansell's share price – ahem – rose by 18% following management’s surprise announcement that it’s considering the sale of the company’s condom business. Blushes and giggles aside, Ansell has been making condoms since the early 1900s and its Sexual Wellness division is now one of the three largest makers of condoms in the world.
The Sexual Wellness division – whose brands include LifeStyles, SKYN and Jissbon, which inspiringly means ‘James Bond’ in Chinese – continued its turnaround over the year with condom sales increasing 8% after removing the effect of currency fluctuations, while earnings before interest and tax (EBIT) jumped 41%. The division has come a long way from the double-digit EBIT decline seen in 2014.
Potential sale of Sexual Wellness division
Emerging markets rebound
Improving outlook; Hold
When it comes to something as intimate as condoms, people usually buy familiar, trusted brands, so Ansell’s long history and strong brands are a competitive advantage. New product sales increased 40%, which was driven by new lubricants, thin latex products and the booming SKYN ultra-thin brand.
The division’s size, too, should make it a sought-after asset due to the economies of scale associated with condom manufacturing. Fixed costs, such as manufacturing equipment, make up a large proportion of Ansell’s total expenses, which means the average cost per condom declines as the company sells more of them. Being one of the largest manufacturers, Ansell’s margins are higher than smaller competitors.
With this in mind, we can think of at least a few large, potential buyers that would be happy to buy the division to increase their scale, including Malaysian-based Karex Industries and UK-based Reckitt Benckiser, maker of Durex condoms. Reckitt Benckiser, in particular, has enough cash to buy the division several times over so – assuming it thinks it can get the deal past competition regulators – we’d be surprised if it didn’t give Ansell a call.
The Sexual Wellness division is Ansell’s smallest, and only accounts for 13% of total EBIT, but – assuming Ansell does sell the business – it could still free up US$400–600m, assuming an enterprise value to EBIT multiple of 14–18 (Ansell itself trades on an EV/EBIT multiple of 16).
A sale price at the higher end of this range seems likely given Sexual Wellness is Ansell’s fastest-growing division and has the second highest operating margins. It's also less cyclical than the Industrial and Single Use divisions. The two big questions now are why would Ansell want to sell it, and what might it do with the cash?
The reason for selling sounded fair enough, with management explaining that the company overall was focused on business-to-business sales, whereas condoms are sold to customers direct. ‘If you have 80% of your sales in B2B, it is hard to have a culture in the overall company that is sufficiently adapted to what it takes to win in a B2C environment’ said management.
As for the proceeds, management cited the ‘increasing number of acquisition opportunities coming up’ and the ongoing share buyback as potential ways to use the funds.
Acquisitions make us wary at the best of times, though Ansell’s management has a better track record than most. We were all for the buyback at lower prices, but with the stock up 50% since we upgraded it in Ansell: good news, bad news from 4 Feb 16 (Buy – $15.49), the investment case is starting to shift. All up, we'd rather the company repaid its US$419m of net debt or paid a special dividend.
Ansell’s Industrial division, the company’s largest, clocked a 3% increase in sales in 2016, to US$669m, after adjusting for currency movements, while EBIT was up 10%.
Part of the improvement was due to a turn in emerging markets, which account for around a quarter of sales. The Russian and Brazilian economies were a big drag over the past year but are starting to stabilise, while sales in China, India and Mexico have been ‘very, very strong’.
|Year to June||2016||2015|| /–
|EPS (US cents)||105||123||(14)|
|Final dividend||23.5 US cents, unfranked, (up 2%),
ex date 20 Aug
‘We do expect Russia to be coming back. We obviously have adapted to the situation in Russia with appropriate pricing and sales force changes and how we go to market and various other things to make sure that we can win in the Russian marketplace‘, said chief executive Magnus Nicolin.
Around 40% of Ansell’s revenue is from cyclical industries like oil & gas, automotive and manufacturing, so there’s always an ebb and flow to industrial glove sales. The recovery in emerging markets is welcome, but we won’t get ahead of ourselves. Low single-digit organic growth is about the most we can hope for over the long term.
Revenue in the Single Use division fell 1% to $301m, although EBIT rose 14% thanks to lower prices for raw materials, such as natural rubber latex, which account for 39% of manufacturing costs.
The EBIT margin rose from 19% to 21% thanks to the lower material costs as well as various cost-cutting initiatives associated with the integration of US glove-maker BarrierSafe, which has a 20% share of the US single-use glove market (see Ansell buys US market leader).
Overall, Ansell’s revenue fell 4% to US$1.6bn, though this was unchanged from 2015 after removing the effect of currency fluctuations. Net profit fell 15% to US$159m, though this was mainly due to unfavourable currency movements and a higher tax rate. After removing currency impacts, earnings per share fell 1% to US$1.05.
In investing, it pays to believe in ‘reversion to the mean’: the extreme numbers of one period tend to move back to their long-term average given enough time. High prices encourage competition, which, in turn, lowers prices. Corporate losses spur management into action to cut costs, which improves profitability etc.
In Ansell’s case, everything about this result screams ‘average’, which is a significant improvement from last year’s experience. Ansell’s management – ever the conservative straight-shooter type – even showed some rare optimism for the year ahead, which should see the company return to growth.
Management expects revenue to increase 2–4% in 2017 and underlying earnings per share to rise by 2–17% (before taking into account the sale of Ansell’s small Onguard footwear business). That would bring 2017 earnings per share to between US$0.98 and US$1.12, which implies a forward price-earnings ratio of around 17 at the midpoint of the range. We’re increasing our price guide and continue to recommend you HOLD.
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Disclosure: The author owns shares in Ansell.