Should Ansell (ASX: ANN) Shares Be Trading At Just 12.6 Times Earnings?

Ansell (ASX: ANN) is an industrial manufacturing company that manufactures medical equipment. Ansell manufactures a wide range of personal safety products, from single-use plastic gloves to full-body PPE suits. Ansell has come a long way since it was founded as a condom business in 1905, as it has since divested its condom business and is now more focussed on industrial and medical Personal Protective Equipment (PPE).

Ansell could be considered a stalwart stock given it has 117 years of operating history, demonstrating its ability to survive any macroeconomic environment, such as inflation, deflation, stagflation, multiple recessions, and a depression. Indeed, the Ansell business has also survived different management styles and structures.

The ability of the company to survive for so long stems from its international reputation for providing high-quality, low-cost products in a market where safety is paramount.

Ansell’s management team has pivoted away from low margin single-use gloves to higher-margin multiuse gloves to boost the bottom line, in recent years. This is also better for the environment. Ansell’s management attempts to position the company to secure new business from emerging markets, by closely following regulatory requirements within relevant industries.

One disadvantage of investing in Ansell, relative to many other companies, is that it does not have fully franked dividends. When comparing Ansell to other similar companies based on its yield, Australian investors should adjust for the lack of franking credits. On the bright side, Ansell’s dividends are very well covered by earnings, with only 40% of their earnings being paid out to shareholders. At the current Ansell share price of $23.51, the company has a trailing dividend yield of around 3.7% (though of course this may fluctuate going forward).

Ansell’s relatively low payout ratio gives the management team room to allocate capital to grow earnings and grow shareholder value, rather than surrendering the company’s future growth by paying large yearly dividends that shareholders come to expect.

How Commodity Price Inflation Impacts Ansell (ASX: ANN)

As a manufacturing company, Ansell is at the mercy of highly volatile commodity prices. Volatile commodity prices can reduce Ansell’s margins. Raw material costs make up over half of Ansell’s yearly expenses, meaning the price of commodities like oil and rubber can have a big impact on Ansell’s profits. So far in 2022 both oil and rubber have increased in price, and this may have fuelled negative market sentiment about Ansell.

Ansell reports its results in USD and makes its profits in USD. It has a very international business, and so it is possible that USD strength could actually increase Ansell’s profits in AUD terms. Being an International company Ansell offers diversification away from the Australian economy. This could provide some diversification for Aussie small-cap investors strongly exposed to the Australian economy through their investment portfolio.

Is Ansell’s Balance Sheet Strong?

Ansell is a capital intensive business. In USD, it has $504.1 million in debt and $289.1m in payables. Offsetting that it has $179.8 million dollars in short term cash and $225.1m in short term receivables. The balance sheet held over $575m in inventories at 30 December, so you could argue it is essentially using debt to fund its inventory. As variable interest rates increase, this will see Ansell obliged to pay higher interest costs.

Margin Pressure Causing Concern

Ansell’s single-use plastic gloves are outsourced and repackaged, resulting in lower profit margins for this product. Coupled with an oversaturated single-use glove market due to COVID 19, Ansell has seen margin compression through higher than expected costs and lower than expected revenue. This caused the company to downgrade its FY 2022 guidance in January this year from 175¢ – 195¢ as provided on 11 November 2021 to a range of range of 125¢ – 145¢ per share.

Ultimately, Ansell’s supply chains do contain some risk. For example, China is still using lockdowns to manage covid. Though Ansell’s facility in Xiamen has escaped the lockdowns thus far, this could change in the future.

Longer term, this kind of business can reduce staffing costs by spending on automation. This would require capital investment but should result in higher margins over time.

Ultimately, the Covid 19 pandemic has increased, not decreased, global demand for healthcare PPE. In the past three years, Ansell has also opened five new manufacturing facilities, and in 2020 Ansell went into a joint venture with Careplus. Ansell thinks the joint venture will help them enter the realm of surgical gloves, and with the planned investment, they can provide differentiated, high-value products.

These investments should benefit from the ongoing importance of healthcare PPE, arising from the persistence of Covid-19 as a major killer.

What Is Ansell’s P/E Ratio?

Even at the low end of Ansell’s downgraded guidance, the business will make US$1.25 per share in net profit after tax, for FY 2022. That is about $1.86 Australian. At the current share price of AUD$23.51, that puts Ansell on a multiple of just 12.64 times earnings. That estimate is subject to currency fluctuations and the actual results, but it seems to me to under-appreciate Ansell’s long term potential. Therefore, I have purchased Ansell shares.

Ansell’s durable track record has me looking through the mist of the here and now and into the future, as more normalised business conditions might lead to a brighter future for Ansell. In any event, the ongoing Ansell share buyback should reduce the number of shares on issue, leading to EPS growth, all else being equal.

Please remember that these are personal reflections about stocks by an author, and this article is not intended as a recommendation. The author, Aleck Arena, owns shares in Ansell. This article is not intended form the basis of an investment decision. It is an investment diary valuable only for the cognitive process it demonstrates. To the extent that this article is advice under the law, it is general advice only. It has not considered your investment objectives. To the extent that this article is financial advice, it is authorised by Claude Walker (AR 1297632), Authorised Representative of Equity Story Pty Ltd (ABN 94 127 714 998) (AFSL 343937). Claude Walker does not own shares in Ansell.

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