Ansell (ASX:ANN) shares have continued to de-rate after the Company issued a negative trading update in July. We recently researched the Company in The Dynamic Investor following the release of financial results for the 12 months to 30 June 2023 (FY23). FY24 guidance point to an earnings decline of around 15%. With earnings expected to recover in FY25, are there enough green shoots to support a re-rating in the shares over the short term?
About Ansell
Ansell operates two divisions following the divestment of the Sexual Wellness division in September 2017:
i. The Healthcare division, which manufactures and markets surgical and exam gloves for healthcare and industrial applications. The division also distributes a range of high-performance single-use gloves used in industrial applications. Around 60% of sales are generated from Exam & Single Use, ~30% is generated from Surgical and ~10% is generated from Life Sciences.
ii. The Industrial division 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 division, 61% of sales are generated from the Mechanical category. The remaining portion is comprised almost entirely from the Chemicals category.
Key Fundamental Drivers
Revenue & Earnings Growth Largely Reliant on Industrial Division
The Healthcare division experienced significant customer destocking through FY23. This resulted from channel partners and end users reducing inventory. Sales declined by 20.7% as a result of customer destocking in all business units and planned price reductions in Exam & Single Use. Destocking is expected to continue in FY24. However, this may be partially mitigated by more differentiated, in-house products and stable pricing.
As such, the group outlook largely relies on conditions in the Industrial division. The latter reported impressive sales and profit growth in FY23 despite continued macroeconomic uncertainties. Notably, the implementation of pricing increases and cost control initiatives resulted in significant margin expansion. Further growth is expected in FY24. This is expected to be driven by the Mechanical business unit, prior price increases and new products.
Productivity Program to Support Return in Group Operating Leverage
For FY23, Ansell reported flat EBIT margin and a significant decline in Return on Invested Capital (ROIC). The latter was due to reduced EBIT and higher capital employed.
In an effort to improve both EPS growth ROIC, the Company has commenced an ‘Accelerated Productivity Investment Program’. This program will focus on: i) Simplifying the group’s organisational structure, ii) Reducing employee numbers in response to elevated customer inventories/de-stocking, iii) Improving manufacturing productivity and iv) Accelerating the digitisation strategy.
The productivity program is expected to deliver a minimum of US$45m in annual cost savings out to FY26. This figure equates to approximately 1/5th of group EBIT in FY23. However, operating leverage is not expected to return in FY25, as this is when benefits from the productivity program flow through.
Balance Sheet Flexibility to Pursue Growth Opportunities
Gearing (on a net debt to equity basis) as at 30 June 2023 was 1.2x. This compares to the average of ~0.9x over the period from 31 December 2020 to 31 December 2022.
Gearing likely to remain stable in FY24. In context, it is still below the target gearing ratio of 1.5-2.0x. As such, there is flexibility to undertake further capital management. As well, the Company has scope to pursue growth initiatives (both organic and acquisitive).
Fundamental View
Notwithstanding the recent de-rating in the shares, the current 1-year forward P/E multiple (~12.5x) appears unappealing for two reasons.
Firstly, the EPS growth profile (~3% over FY23-26 on a CAGR basis) is modest.
Secondly, Ansell is presenting as more of a FY25 turnaround story. This is because the benefits from the productivity improvement program, as well as the reversal of destocking in the Healthcare division, are not likely to become evident until FY25.
Charting View
The prior uptrend was broken in mid-February and the shares have been struggling ever since. In July it fell on heavy volume and once again the shares have struggled to make any headway. Price action from the past couple of weeks also suggests that risk for now is to the downside. ANN is likely to head towards the 2022 low near $21 – $22. From there, we will then need to reassess.
Michael Gable is managing director of Fairmont Equities.
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