We recently reviewed Ansell (ASX:ANN) in The Dynamic Investor after the Company entered into an agreement to acquire KCPPE. While the announcement was well received by the market, it is worth considering whether the inclusion of KCPPE can lead to a step-change in ANN’s earnings. Alternatively, does KCPPE have the potential to mitigate challenges in Ansell’s underlying business?
About Ansell
Ansell operates two divisions following the divestment of the Sexual Wellness division in September 2017:
i. The Healthcare division 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.
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.
On 8 April 2024, ANN announced that it has entered into a binding agreement to acquire 100% of Kimberly-Clark’s Personal Protective Equipment business (KCPPE) for US$640m. The proposed acquisition of KCPPE is the first major acquisition in over 10 years in terms of the quantum of both price paid and revenue contribution.
Key Fundamental Drivers
Improvement in Underlying Business Reliant on External Factors
For the 1H24 period, customer destocking in the Healthcare division continued to impact EBIT margin to a larger extent that initially thought. Notwithstanding the consensus view that destocking was close to ending, EBIT margin for the Healthcare division in 1H24 (6.8%) was significantly lower than expected. The Company attributed this to higher cost-of-goods-sold from reducing inventory, and lower sales in Surgical and Life Sciences.
ANN commented that a reduced impact from destocking was expected in 2H24, with management guiding to an improved EBIT margin in 2H24. In addition, market conditions appear to support the Industrial division. The latter reported a stronger-than-expected EBIT margin in 1H24.
Notwithstanding these factors, the organic growth profile for ANN’s underlying business is enhanced by cost savings. In addition, organic earnings growth for ANN’s underlying business is also reliant on external factors. These include expansionary PMI, limited customer destocking and no further supply chain disruptions.
KCPPE is a Strategically Sound Acquisition
The acquisition of KCPPE will be funded with a A$400m fully underwritten institutional placement and a US$377m debt facility. Completion of the acquisition is expected in 1Q25.
One of the key factors supporting the view that the strategic rationale for the acquisition is strong is that KCPPE’s Scientific business is highly complementary to Ansell. ANN’s Life Sciences business unit has generated organic growth of >6% from FY19-23 on a constant currency CAGR basis. It is also the highest margin business unit within the Ansell portfolio.
ANN expects the transaction to be mid-to-high single digit EPS accretive (on a ‘pre-synergies’ basis) and low-teen digit EPS accretive. There are also opportunities for margin expansion from cost rationalisation.
Strong Cashflow to Reduce Gearing Post Completion of Acquisition
Gearing (on a net debt/EBITDA basis) was 1.3x as at 31 December 2023 and was below the target gearing ratio of 1.5-2.0x. Adjusting for the KCPPE acquisition, gearing as at 31 December 2023 is expected to rise to 2.3x on a Pro Forma basis.
Following completion of the KCPPE acquisition in FY25E, we expect net debt/EBITDA of 1.6x, providing ample headroom below estimated covenant (~2.5x).
Gearing is expected to fall below 2.0x within 12 months post completion of the KCPPE acquisition from strong cash flow generation from both ANN’s underlying business and KCPPE. In particular, KCPPE has minimal CAPEX requirements.
Fundamental View
Following the announcement of the KCPPE acquisition, ANN shares re-rated. This was due to expectations for EPS accretion & margin expansion in FY25. In addition, the KCPPE transaction has the potential to lead to stronger organic growth in ANN’s broader Life Sciences portfolio.
Although ANN’s 1-year forward P/E multiple increased to >16x, the most recent retracement sees the multiple currently at ~15x. This is the same multiple as that prior to the announcement of the KCPPE acquisition.
With the current multiple is now broadly in line with the 5-year average of ~16x, we would look for lower levels as a more attractive entry point, given:
i. The risk to ANN’s underlying business where destocking continues to overhang on the recovery of the underlying businesses, and
ii. Short-term execution risks associated with the KCPPE acquisition. Notably, the Company has not undertaken an acquisition of KCPPE’s magnitude in over 10 years.
Charting View
ANN broke above a clear resistance line a few weeks ago on good volumes. However, it is finding some selling pressure at the moment and is unable to continue higher. If ANN is to continue higher, we don’t want to see it trading under $24.50 again. If so, then the breakout would have failed and the stock could then just drift sideways for a while longer. Otherwise, if it can hold on here, then we can be confident that it will make another run higher towards resistance near $28.
Michael Gable is managing director of Fairmont Equities.
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