Ansell: Result 2017

A few years ago, Ansell had a condom problem. Not only was the company selling fewer condoms, but the cost to produce them was increasing. Operating profits fell by more than a quarter in 2014. Jokes about things shrinking are a given in the condom business, but this time was different. Rising competition, particularly from Chinese firms, meant that customers were spoilt for choice – and, in 2014, they weren't choosing Ansell.

Thankfully, improvements to marketing of the flagship SKYN brand of condoms has worked wonders in the three years since. In fact, the ‘Sexual Wellness' division was Ansell's best performer – by far – this year with underlying earnings before interest and tax (EBIT) up 10%. Sales rose 4% after excluding the effect of currency fluctuations.

With Ansell's other divisions idling – which we'll get to in a moment – it makes you wonder whether management's decision to offload Sexual Wellness is a bit like selling your car's engine to pay for fuel.

Nonetheless, with China-based Humanwell Healthcare willing to pay US$600m for the division – a lofty 15 times EBIT – we can understand the attraction. A couple of good years doesn't change the big picture: competition is still on the rise, the division has barely grown in five years, and management can now focus more on the money-spinning glove divisions. Management saw an opportunity to offload the struggling division during a cyclical high and it rightfully seized it. 

Industrial slows

Revenue for the company's biggest division – Industrial, which accounts for 41% of sales – was flat at $656m but things look better under the hood. Organic sales grew 5%, which was offset by the sale of the Onguard footwear business in the statutory result. Underlying EBIT grew 4%, before including the Onguard sale.  

The company's Single Use glove segment had a tougher time, with organic sales up 3% – mainly due to an 18% jump in sales to emerging markets being offset by slowing growth in developed regions.

Underlying EBIT fell 2% due to higher raw material costs and lower average selling prices. However, management said price increases were pushed through to distributors in July, so margins should hopefully improve in the year ahead.

Volatile commodity prices and Ansell's exposure to industrial demand mean profits are prone to boom and bust. This result is a case in point. Cyclical industries – such as chemical, oil and gas, automotive, and mining – account for just under half of sales, with the balance being from stable industries such as food processing and medical supplies. We expect sales to increase in line with the general economy over the long term, so we aren't concerned by this year's lack of sparkling figures.

Powder keg

Ansell's Medical division was arguably the biggest let-down, with sales growing a paltry 1% and rising raw material costs causing EBIT to be unchanged from the year before. Surgical gloves, however, were a bright spot, with sales up 6% thanks to a big jump in synthetics. Management expects these markets to continue to do well and the company is scaling up its surgical and powder-free glove manufacturing capacity, with boosts of 35% and 15% respectively over the past two years.

Sales of powder-free gloves, in particular, should have a nice tailwind in the year ahead. In January, the Food & Drug Administration (FDA) banned the sale of powdered gloves in the US due to an ‘unreasonable and substantial risk of illness' when internal body tissue is exposed to the powder coating, should someone inhale it. Ansell is already one of the largest manufacturers of powder-free gloves and said extra capacity is being added to take advantage of the regulatory change.

Turning to cash flow and the balance sheet, net debt fell slightly to US$407m while free cash flow was flat at US$165m. Ansell will use the US$600m of cash received from the sale of the Sexual Wellness division (due to close in September) to make acquisitions and buy back stock, with board approval to buy up to 14.75m shares, or roughly 10% of the total. That's worth around $300m at today's share price and Ansell has already bought back 500,000 shares.

Management expects revenue to increase 3–5% in 2018 and underlying earnings per share to rise by 10–22%. That would bring 2018 earnings per share to between US$0.91 and US$1.01, which implies a forward price-earnings ratio of around 17 at the midpoint of the range. This wasn't a result to write home about but, with economies of scale, a dominant market share in most segments, and decent long term growth prospects, we continue to recommend you HOLD.

Note: The Intelligent Investor Growth and Equity Income portfolios own shares in Ansell. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.

Disclosure: The author owns shares in Ansell.