Late last year, we recommended Ansell (ASX:ANN) as a BUY in The Dynamic Investor, on the basis that the Company was in the midst of an earnings upgrade cycle. We considered this to be more structural than cyclical. The shares have re-rated strongly since that time. Accordingly, we assess whether there is scope for further upside especially after the Company, in April this year issued its 3rd upgrade to EPS guidance in six months.
Ansell operates two Global Business Units (GBUs) following the divestment of the Sexual Wellness GBU in September 2017:
i. The Healthcare GBU manufactures and markets surgical and exam gloves for healthcare and industrial applications. Its customer base in the medical vertical includes acute care hospitals, emergency services, alternate care, dentistry, and veterinary clinics. The Healthcare GBU also distributes a range of high-performance single-use gloves used in industrial applications, including chemical, food services, life sciences, electronics and automotive aftermarket. Within the Healthcare GBU, 62% of sales are generated from Exam & Single Use, 30% is generated from Surgical and 8% is generated from Life Sciences. Key brands include Gammex, Microflex and TouchNTuff.
ii. The Industrial GBU manufactures and markets hand and upper arm protective solutions for a spread of industrial applications. ANN provides gloves with three specific purposes including mechanical, chemical & liquid, and product protections across several industries. Within the Industrial GBU, 61% of sales are generated from the Mechanical category, with the remainder almost entirely comprising sales from the Chemicals category. Key brands include AlphaTec, HyFLex and Edge.
Key Fundamental Considerations
Higher Raw Material Costs Offset by Price Increases
Raw material prices have increased in recent months. In particular, natural rubber latex prices are higher, but adiene is up from trough levels recorded in 2020 and there have been further increases in outsourced supplier costs for Exam/Single Use SBUs.
However, continued increases in raw material and outsourced supplier costs for Exam/Single Use has been well managed, with ANN believed to have executed price increases over and above input cost inflation. A favourable pricing environment (i.e. demand is remaining ahead of supply) has enabled the Company to pass through higher raw material costs to customers at a better-than-expected rate.
Supply Constraints Well Navigated
At the interim results release in February, the Company flagged potential supply disruptions due to COVID-19 spikes in factories (for both ANN and for its outsourced suppliers), worsening shipping conditions/poor container availability.
Despite these challenges, the Company noted in the latest trading update that it has been able to continue to supply customers with product despite tightness in raw material supply and disruptions in ocean freight capacity, which has resulted in an increase in transportation transit times (i.e. higher transport costs). In addition, the Company is reducing reliance on 3rd party suppliers and at the same time increasing internal production volumes.
Organic Growth to Remain Well Above Trend Over the Medium Term
ANN has a medium-term organic growth target of 3-5% per annum. Prior to the trading update last month, the Company acknowledged that in the near term, organic growth over the next 1-2 years was likely to be well in excess of this range, largely due to the tailwinds from COVID-19 and that the rate of organic growth for the Healthcare GBU would outpace that of the Industrial GBU. Organic growth for the group was +22.9% in 1H21, with the Healthcare GBU reporting organic growth of ~37% supported by sustained high demand for its exam and single-use gloves and large price increases and the Industrial GBU reporting organic growth of ~7%.
Factors supporting continued strong demand in Personal Protective Equipment (PPE) & Healthcare over the medium-term outlook (i.e. beyond COVID-19) include:
i. Strengthened safety protocols are expected to be driving higher glove and suit use in many “industrial” verticals like food, janitorial-sanitation, logistics, automotive after-market, energy and government
ii. Procedures, activity and frequency of use levels in pharma, Emergency Medical Service, non-acute and medical are ramping up.
iii. Pent-up demand for elective surgical procedures will take years to satisfy.
iv. Emerging market practices are becoming more similar to mature markets and hence glove use per capita (e.g. Asia is currently 80% lower than in North America) is closing the gap to mature market levels.
Strong Balance Sheet Enables Capital Management & Pursuit of Acquisitions
Balance sheet gearing remains low (0.7x) and significantly below the target gearing ratio of 1.5-2.0x. Aside from returning excess capital to shareholders via increased dividend payments, the Company is likely to use its low gearing level and strong liquidity position in order to pursue Merger & Acquisition (M&A) opportunities.
Earnings growth should continue to be supported by favourable (and improving) structural factors underpinning continued strong demand in PPE & Healthcare over the medium-term outlook (i.e. beyond COVID-19). However, at present levels, the key risk to the shares is the extent to which some of the current tailwinds will reverse, as PPE demand and prices drop, and operating costs rise.
There is upside risk to earnings growth in FY22/23 should there be further evidence that the changes (i.e. higher use of PPE occurs in some healthcare and industrial settings) are likely to be structural, rather than cyclical
At current levels, the shares are currently trading on a 1-year forward P/E multiple of ~17.5x, which is broadly in line with the 2-year average multiple.
Up until a few weeks ago, there was strong resistance near $40. ANN then gapped above that, which was a good sign that it was ready to rally again. At the moment it is finding some obvious resistance near the old high around $43. For an entry point, a dip back here towards $40 for a retest is looking encouraging and is a sign that good buying support is coming back. If ANN jumps above $43 and breaks to a new high, then it is likely to go for a run and that momentum should be followed by adding to positions.
Michael Gable is managing director of Fairmont Equities.
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