Ansell: A quality business in challenging times

One of the stocks selected for our inaugural NAPS Australia and New Zealand portfolio was Ansell (ASX:ANN). Since the start of the year it has risen 1.7% which compares with 6.5% for the S&P/ASX 200 index.

To recap, Ansell is classified as a Health Care stock based on the fact that the majority (61%) of its revenue is derived from the sale of personal protective equipment (PPE) into the health care sector. The balance comes from the sale of safety equipment, gloves and other protective wear, into industrial applications.

Ansell’s revenue and profits surged in 2021 as demand for personal protective equipment (PPE) surged, but retracted in 2022 as the COVID emergency began to abate.

Ansell has long been considered a well run business that operates in a challenging environment. This is reflected in its Quality score of 93. The Health Trend, Bankruptcy Risk and Earnings Manipulation Risk are all key contributors to the Quality score, and as you can see they are all in the green.

The quality of the franchise is strong as demonstrated by the profitability ratios, margins and cash flow.

Long term return on capital employed is above 10% and the five year average net profit margin is above 9%. Gross margins average in the mid to high 30s. These are good results in an industry that is highly commoditised. Some of the products Ansell produce are differentiated based on their quality but there is less room for differentiation in products like surgical gloves, so competition keeps margins tight.

The balance sheet is strong with a net debt to assets ratio of only 11.3%. They built up excess inventory during the pandemic which with the benefit of hindsight was too much. It will take a little while to run that down which will have a short-term impact on profitability.

The Stockopedia quality score is designed to be more predictive than descriptive. A business that scores well on the quality metrics has the underlying strength to push through difficult times and prevail where competitors may fall by the wayside.

Perhaps surprisingly, the last 12 months have indeed been a difficult time for Ansell. Some of the investment decisions made during 2021 were based on the assumption that the impact of the pandemic would be more significant and longer lasting than it turned out to be. For example, a large investment in gloves inventory made early in the year when prices were high, turned into a big drag on profitability as those same gloves were subsequently sold at lower prices.

Ansell had to deal with a range of supply chain issues during the year. Many of these were attributable to COVID such as delays to shipping as well as supply shortages. They also had periods where they had their own staff shortages and had to close some of their factories for short periods due to government lockdowns. They source some of their gloves from other manufacturers, and two of those suppliers were banned from exporting into the USA due to forced labour issues.

And then there was the war in Ukraine. Ansell had manufacturing operations in Russia and took the decision to close them down. This resulted in a US$17.0m one-off expense, equivalent to EPS of -US13.4c.

Which leads us to the other components of the StockRank. Value and Momentum. They are not as strong as the Quality rank for Ansell, and indeed have declined over the last 30 days. The price has been rising, which creates a drag on the Value score. Whilst this would normally be a positive for the Momentum score, it has been counteracted by declining market forecasts for earnings and revenue.

12 months ago they issued a disappointing earnings downgrade. Whilst revenue had tracked roughly in line with expectations, earnings were forecast to be considerably lower due to the cost pressures described above. EPS guidance was downgraded by 27%. When the results were released in June, EPS had declined by 35% from the previous year but was within the revised guidance range. Revenue in 2022 fell by 4% from the record level in 2021.

Analysts are forecasting this downward trend to continue with revenue forecast to drop a further 5% in FY23 and EPS (after adjusting for the one-off Russian exit expense) to fall by 12%. They are then expecting things to start rebounding in FY24. The half year results are due to be released on Valentine’s Day and will shed some light on how they are tracking this year.

At the AGM held last November, the Chairman cautioned that the PPE sector along with the global economy were yet to return to normal and that significant uncertainty remained as to the outlook. Despite that they continue to invest in growth, building new manufacturing capability in India and Thailand which is consistent with their long term approach and looking beyond the current uncertainties.

Ansell is a conservative, mid cap stock. It is unlikely to provide the thrills of some other health care hopefuls, but it also usually avoids the spills as well. People who invested in mid 2021 may disagree with that assessment when it was trading as high as $43.51, only to fall 50% over the next 12 months, but they were very unusual times. Over the last 10 years it has returned about 8.2% p.a. including both capital appreciation and dividends. It generally provides a steady return and if purchased at the right point in the cycle, those returns may receive a boost.

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The author holds interests in the following stocks mentioned in this article: ANN. This position can and will change at any time without notice.