Ansell (ANN) recently upgraded guidance range for the 12 months to 30 June 2021 (FY21). This indicates an EPS growth range of 11-19%. The upgrade was driven by better-than-expected volumes and sales across all five operating segments in the first four months of FY21. It was along with: i) Better management of cost increases and ii) Movements in exchange rates that have been more favourable than originally budgeted.
Following the upgrade, we re-assessed the Company’s fundamentals to assess whether the improved operational performance is sustainable and, accordingly, support a further re-rating in the shares.
ANN 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
Organic Growth Rates Accelerating
ANN has reiterated its medium-term organic growth target of 3-5% pa. The Company also acknowledged that in the near term, organic growth was likely to be well in excess of this range for FY21 largely due to the tailwinds from COVID-19 and that the rate of organic growth for the Healthcare GBU would outpace that of the Industrials GBU.
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With COVID-19 infection rates increasing again in many countries, demand for Healthcare GBU products and certain gloves within the Industrial GBU (Alphatec) should continue to act as a buffer to any further slowdown in core Industrial glove sales (i.e Hyflex). In particular, ANN has taken advantage of very strong demand for single use/exam gloves in the pharmaceuticals, non‐acute and medical industries, as it relates to the management of the COVID-19 infection. There has also been a recovery in demand for surgical gloves as elective surgery procedures recommence and waitlists are reduced in the Western World.
Can Strong Organic Growth Rates be Maintained?
We consider that there is a strong likelihood that organic growth rates (although abating over the medium term) remain in excess of the medium-term 3-5% target range. The key reason for this is that the increase in demand currently witnessed is partly structural, which will persist post‐COVID-19 and into the medium term.
The key factors supporting continued strong demand in PPE & Healthcare post-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 is likely to 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.
Macro Conditions Remain Favourable
The Purchasing Managers’ Index (PMI) is an index of the prevailing direction of economic trends in the manufacturing and service sectors. For ANN, the PMI has historically provided a reasonable leading indicator to industrial production growth. Importantly, PMI data has recovered strongly and it is worth noting that the organic growth rate of ANN’s Industrial GBU has historically followed weighted industrial production growth in key regions.
Gearing Well Below Target Range
Having moved into a net cash position as at 30 June 2018 following the divestment of the Sexual Wellness GBU, the balance sheet reverted back into net debt as at 31 December 2018. As at 30 June 2020, gearing (on a net debt/EBITDA basis) was 0.6x and significantly below target leverage ratio of 1.5-2.0x. Gearing benefited from strong cash generation and lower share buyback activity in FY20. Further, refinancing risk is minimal, as there are no significant debt maturities until FY23.
The Company commented at the FY20 results release in August that while the balance sheet is close to net cash, given the uncertainty in the global environment, it is unlikely to buy back shares in 1H21, and will revisit this once the global economy starts to normalise.
Accordingly, with the large restructuring program complete, the Company is likely to pursue Merger & Acquisition (M&A) opportunities. To this end, it is estimated that the Company has ~US$400m balance sheet capacity to pursue M&A opportunities, or return of capital to shareholder in the absence of these.
The shares are currently trading on a 1-year forward P/E multiple of ~19x. While this represents a slight premium to the 2-year average multiple of ~17x, we consider that the premium rating is justified in light of: i) Organic growth likely to remain in excess of the 3-5% target range, which offers significant revenue upside given that the increase in demand currently witnessed is partly structural, ii) An attractive EPS growth profile (+9% from FY21 to FY23 on a CAGR basis), which may be augmented by further share buybacks and/or EPS-accretive acquisitions, iii) A diverse product portfolio and iv) Ability to weather higher input costs.
From this perspective, we consider ANN is an investment worth considering, but at weaker levels.
The chart for ANN is not looking as good as the fundamentals at this point in time. The sell-off since the November peak has been quite sharp and there appears to be a lack of buying support. The shares are also making lower highs and lower lows. This means that for the short term at least we are likely to see the share price get cheaper so ANN is one to keep on the watchlist. For an entry point, we will need to see this decline start to slow down and ANN put in a higher low.
Michael Gable is managing director of Fairmont Equities.
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