Ansell (ASX:ANN) has been a net beneficiary of the COVID pandemic. This is because of the elevated demand for hygiene and PPE products. Accordingly, a key debate is the revenue and earnings outlook for the Company as the slowdown in demand for these products continues. With this in mind, we recently researched ANN to assess the potential for a further recovery in the share price.
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. These include chemical, food services, life sciences, electronics, and automotive aftermarket. Within the Healthcare GBU, ~60% of sales are generated from Exam & Single Use, ~30% is generated from Surgical, and ~10% 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. These include 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 Drivers
Above-Trend Organic Growth Expected Over the Medium Term
The rate of organic revenue growth has already begun its trend down from COVID-induced highs of <20% in FY21, to 7.5% for the six months to 31 December 02021 (1H22). Secondly, the rate of organic growth can often vary across regions. Having said that, there are several factors supporting the view that ANN can achieve organic revenue growth above the pre-COVID-19 average (of 1.7%). In particular, ANN has rationalised non-core brands, with growth brands (i.e. those incorporating differentiated technology) accounting for >80% of group revenue.
Further, ANN has undertaken capital investments in growth initiatives. This includes capacity increases for the Single Use and Surgical business units, as well as automation and digital/IT initiatives. These factors, along with ongoing investment in new product development, are considered supportive of improved organic revenue over the medium-longer term.
Macro Conditions Moderating but Still Favourable
Given an exposure to a range to industrial-focused industries, via the Industrial GBU and Single Use business (which accounts for the majority of revenue for the Healthcare GBU), ANN’s revenue growth has historically shown a strong positive relationship with changes in industrial production growth. Between 1H14 and 2H19 (i.e. pre-COVID-19), the correlation between ANN’s organic revenue growth and global Industrial Production (IP) growth has been high.
Over the March quarter of 2022, global IP growth moderated to ~4.9% before falling to ~1.7% in April. Recent global PMI data (which has historically moved in line with industrial production growth) has exhibited similar trends. However, it remains above 50, indicating a continuation of expansionary activity.
In context, developed countries accounts for ~80% of ANN revenue, with emerging markets ~20% (where the key markets for ANN are Brazil, Russia and China). As such, when tracking PMI movements, a key focus is the US and key European countries (i.e. UK, France and Germany). To this end, PMI data in key developed economies indicates expansionary activity to June 2022. However, with declining trends relative to prior months. In the key emerging markets, data has shown improvement from weaker trends recorded earlier in 2022.
Strong Balance Sheet
Notwithstanding a recent increase in gearing, it is still below the target gearing ratio of 1.5-2.0x. This provides flexibility for growth initiatives, including both organic and acquisitive, as well as capital management. The liquidity position is strong, with ~US$550m of cash and committed undrawn facilities as at 31 December 2021. Further, there are no significant upcoming debt maturities in the next 18-30 months.
In terms of the acquisition strategy, the Company has typically focused on acquisitions that either: i) Provide revenue synergies (expanding a regionally successful product globally); ii) Have an innovative design that can be deployed to other products; or iii) Have new technology that provides entry into new market verticals for which ANN has a weak market position.
Regarding capital management, the share buyback program is expected to continue into FY23.
Earnings are Difficult to Forecast
The visibility on a recovery in earnings is uncertain and difficult to forecast. This is reflected in the wide EPS guidance range of US$1.25-1.45 provided by the Company for FY22, as well as the disparity in consensus EPS forecasts for FY23 (US$1.22-1.34) and FY24 (US$1.35-1.49). There are many factors to balance, including:
i) The prospect of slowing global GDP growth in FY24 (i.e. relative to FY23) against a degree of resilience/defensiveness during periods of slowing growth, particularly for the Healthcare business units.
ii) The likelihood that organic revenue growth (was 7.5% in 1H22) settling above the pre-COVID-19 average (of 1.7%), but not achieving the 3-5% target until FY25 (given the prospect of slowing global GDP growth in FY24).
iii) While input costs pressures are being managed well, ANN has exposure to a number of currencies in addition to the US$ (its reporting currency). A moderate currency headwind from a stronger US$ is expected. Market forecasts for FY23 indicate an appreciation of the US$ relative to key currencies, which provide a moderate headwind for revenue, with a partial offset for costs.
The shares are currently trading on a FY23 P/E multiple of ~14x and while the multiple has recovered from recent levels, we contend that the shares are likely to continue mostly trading at a discount to its 5-year average of ~16x until there is a more visibility on the likely recovery in earnings over the medium term. To this end, a key catalyst for the shares is the upcoming full year results release in August.
Ansell shares have been in a downtrend for the past year. Most recently, the share price has started to recover along with the broader market. At the moment it is coming back up towards major resistance near $28. For the short-term at least, the share price is near resistance, which means that current levels are not a good buying opportunity. If we assume that the June low can hold, then ANN needs to push beyond $28, and preferably $30 as well, for it to be back into an uptrend. For the moment, at best, it is still trading sideways to build a base.
Michael Gable is managing director of Fairmont Equities.
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