ANN (Ansell) makes protective equipment (chemical body protection, gloves [mechanical, surgical, electrical protection], and single use gloves).

COVID, and the need for protective personal equipment, meant a large boost to demand, resulting in 3 earnings upgrades over 2021, and accordingly the stock did quite well over the COVID crisis period.

Firstly, revenues, below.

Secondly, the share price, which went from ~$30 to ~$42 over 2020-2021.

We’ll get to the share price fall of the last few months in just a moment.

Fast forward to the August 2021 result, with COVID case rates falling over that time frame, and the vaccine rollout progressing well, demand for chemical body protection and single use gloves had already begun to waiver.

The drop in demand, and supply chain kinks (freight costs, freight delays) led to a sizeable inventory build…


…which ate all the cash flow ($49m, vs $191m in 2020).

The fear is that the inventory build will be unwound through slashing margins, and that price recoveries are not enough to offset raw material input price increases, leading to profit downgrades.

The market, however, is neither forgiving nor likes taking chances, and hence fully unwound all of the gains accrued over COVID.

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Still, overall, it is important to note that operating cashflows are generally quite good, and capex needs relatively modest (shown below, on an annual basis).

Which leads to generally quite good free cashflows.

So although the inventory build looks like a miscalculation on management’s behalf (extrapolated production to a demand level that turned out to be lower than expected, and management of raw material input costs relative to finished product prices), it isn’t a regular occurrence, and perhaps excusable, given the complexities of global supply chains, at present.

There are also some good reasons to be less worried about this drop in demand, as noted at the AGM speech, which points to the broader product mix within SU and chemical, which (by implication) are doing quite a bit better.

And there’s also the observation that we are not in fact quite clear of COVID just yet. There has been a meaningful recent uptick in worldwide case rates, which would continue to lend support to elevated personal protection equipment demand, at least for a little while longer.

Nonetheless, these earnings based concerns makes the balance sheet of special interest.

The good news is that leverage is modest. An unexpected downgrade isn’t going to have a feedback loop to solvency.

With credit metrics looking strong, we’d argue that the balance sheet that is in fact under-geared.

ANN have also had a periodic buyback, over the years…

…to drive earnings per share via a reduced share count.

In the event of a more material sell-off, the buyback option can be deployed / dialled up.

Margins are over-earning, and the question is just how much.

14-15% looks much more reasonable to us, for sustainable earnings.

Which is predicated on the Healthcare segment returning to normal.

There may be some modest upside to that forecast, given the AGM commentary below, which notes that the strong performance isn’t solely attributable to COVID, and potentially even acted as a headwind, and the resurgent case rates mentioned above.

However, it remains the case that this margin uncertainty is being felt in the consensus estimates, which have rolled over.

The stocks screens favourably-to-fair-value on Damodaran regression to fundamentals.

Using average value metrics, the stock looks favourably compared to peers.

And has an implied earnings trajectory that strikes us a reasonable on 16-17x.

Were ANN to be “forever” valued at 13x, it would be a much tougher slope.

Hence a long thesis would be a function of a) earnings growth and b) the “true” earnings multiple being higher than the market expected.

To conclude, the near term outlook is mixed, some positive, some negative, some outright contradictory, but perhaps the key message is that not all the COVID gains should be treated as one-offs.

We think that’s a plausibly fair balance of risks to rewards, for a stock that screens quite favourably on Quality, in an otherwise quite expensive operating environment for QGARP stocks.

And provides us with offshore dollar diversification (meaning a weaker AUD is a net positive to return).

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