Ansell/ANN

Ansell did very well over the COVID period, and then found itself stuck with clients who didn’t need nearly as much PPE (personal protection equipment) when the pandemic ended.

The industry had expanded capacity in that time, and so a glut that emerged when the vaccines took hold meant price weakness, and volume collapse.

We thought that revenues would decline to trend, but instead they overshot to the downside, and that was our mistake. A period of above trend growth, given the boom and bust nature of inventory management and destocking, meant a period of below trend growth.

And so, what to do next?

And from here, with all that we see in Ansell, is a good investment opportunity. So, we are happy ex post holders, even if slightly gruding ex ante holders.

We will go through the result.

Firstly, ANN are doing quite well in the emerging markets. Not immune to the issues described above, but clearly there are pockets of growth and outperformance. Asia pac is a good illustration of “return to trend” and North America is a good example of “the overshoot required a period of undershoot to work down inventories in end user markets”.

That holds at the EBIT level, where healthcare looks very poor (we will return to that in a moment) whilst industrial (which, not being healthcare, not being related to COVID, didn’t suffer the same kind of dynamics; industrial suffered from a period of weak manufacturing, as indicated by weak global PMI data, but the point is a) it wasn’t the same as health b) it has performed relatively well).

Your eyeballs will probably tell you that the margins for industrial will look accordingly okay, and that’s what we see below, and that health probably looked quite poor, which is also what we see.

All up, that made operating income look very weak. And here is where we will start to get to the silver lining. There are cycles, and there are trends. I think it fairly clear to see what ANN’s underlying trend looks like, in the below. If destocking comes to an end, the recovery should be quite material.

Now, Ansell, having found its customers awash with inventory, cut back production, and lowered prices. Selling down discounted inventory is a big working capital unwind, it smashes your margins but also drove cashflows to very attractive levels.

That outcome, crunched margins but cash generation is the better outcome, given the poor starting point. The worst outcome is no demand for the product, and poor cashflows. That’s where things go truly pear-shaped, and this is not it.

And so, despite the fall in EBIT, we still see credit metrics looking quite robust, 1.2x ND/EBITDA is lowly geared, and absolutely fine for a stock working down its inventory.

Again, the way disasters happen is when the balance sheet is at risk, and that didn’t happen. ANN was prudently geared to begin with, and remains cash-generative.

But, let’s return to the destocking. That’s the key. When customers are ready to place orders, again, essentially, is part of the key to ANN’s earnings recovery. The second part of the key (to stretch the metaphor) is productivity.

Firms in distress (here “firms in disappointment”, but the language helps to make the point) search for productivity initiatives. And if they find them, or come up with lots of them, it can make the business emerge a lot stronger than when it went in. And that’s what we think ANN has done.

On the destocking, we have managements view that we are now through it. That’s good. If that’s right, then we can think about earnings recovery.

On the productivity initiatives, ANN put through a big structure (lots of executives out, divisions combined) and rationalised manufacturing (a lot of headcount went).

That’s been ahead of what they thought they could achieve (meaning more low-hanging fruit was on offer by culling more people, essentially, that they deemed as low productivity). Now, restructures mean redundancy packaging, and closing production lines means cost. None of it comes free, and that’s what’s indicated in the bottom line.

The thing about cost-out programs, particularly those that begin late in the reporting period, is that you get cost up front and benefit later, which can make things look worse, even if they are absolutely the right thing to do (and here, cutting production in an oversupplied market is absolutely the right thing to do).

The below are some further supportive comments that blend the “two keys” described above. Emerging with a higher quality business, a better margin business, and greenshoots on volume growth.

And below is a good set of “productivity initiatives” undertaken. ANN felt, correctly, that the market needed more transparency on what exactly they’d been up to. These are all metrics that look good to us.

All in all, I think we can be fairly confident ANN is through the worst of it and has plausibly emerged as a more efficient, productive company. Given the “about market” multiple (PE of ~16x) and the very depressed earnings, we think the future looks quite good for Ansell.

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