Narrow-moat Ansell’s (ASX: ANN) first-half fiscal 2024 underlying earnings per share fell 13% to $0.41 US but were close to our expectations. Our fiscal 2024 underlying earnings per share (“EPS”) forecast of $1.00 US is within management’s narrowed guidance range of $0.94-$1.10 US. The firm did lower its guidance for statutory EPS by 7% at the midpoint to $0.57-$0.77 US, largely due to roughly $10 million US in additional one-off costs associated with its productivity program.

We think the shares are undervalued. Ansell’s productivity program is progressing well, with an annualized $0.13 EPS benefit expected by fiscal 2024 year-end. As such, the program is expected to deliver at least $50 million US in annualized cost savings by fiscal 2026, up from $45 million US prior, and doesn’t yet factor in likely productivity gains from digital investment.

We forecast earnings before interest and taxes (“EBIT”) margin to better prepandemic levels and expand to 15% by fiscal 2028 from 10% in first-half fiscal 2024. We maintain our $30 fair value estimate and leave our earnings forecast broadly unchanged.

Ansell declared an unfranked interim dividend of $0.165 US per share, representing a 40% dividend payout ratio. Given the conservative balance sheet with net debt/EBITDA at 1.3, we see no issues with the board targeting a 40%-50% payout ratio and leave our 45% expectation for the five-year forecast period broadly unchanged.

Ansell’s industrial segment, which contributed 49% of first-half group revenue, increased sales by 2% to $384 US million on improving product mix. Segment EBIT was up 47% to $58 US million on strong growth in higher-margin chemical products. We have lowered our forecast five-year revenue compound annual growth rate to 2% from 3%, with the company intending to exit less differentiated low-margin chemical products in fiscal 2025. However, our midcycle segment EBIT margin slightly increases to 16% from 15% as a result.

Business strategy and outlook

Ansell’s focus is on its key brands across industrial and healthcare settings. Each market is quite fragmented and Ansell’s market share varies by subsegment, but the firm has consistently held the highest or second-highest global market share in its key verticals.

Competitors differ between the two segments but are either divisions of large global players or regional companies. Key industrial competitors are Honeywell, Globus, a private U.K. company, and ATG Gloves in the U.S. In the healthcare segment, Halyard Health (spun out of Kimberly Clark in 2014) and Cardinal Health are major players.

Ansell’s revenue is split approximately 40% industrial and 60% healthcare products. The industrial segment is exposed to global manufacturing cycles and the purchasing managers indexes, or PMIs, are key leading indicators of Ansell’s industrial revenue growth. Revenue from the healthcare segment demonstrates far lower cyclicality and we expect will typically outgrow industrial revenue similar to historical trends.

We estimate the global protectivewear market to grow in the low-single digits, driven by the positive trends toward improved workplace safety, but partially offset by increasing automation. The largest growth opportunity is industrial emerging markets where a large proportion of workers still do not use protective gloves. Ansell has specifically designed an entry level range, Edge, to gain traction in these price sensitive markets where products are typically more commoditized.

Ansell’s margins are sensitive to key input prices being yarns, butadiene for nitrile rubber gloves, and natural rubber for latex gloves. The five-month lead time from raw material procurement to product sale provides Ansell with a window in which to manage customer pricing and pass through increases in input costs if necessary. Only a small proportion of group sales, mostly in European healthcare, are made on a price-driven tender basis. Ansell is also shifting to more neoprene usage, as well as furthering its internal manufacturing efforts to limit the impact of external cost pressures.

Moat rating

Read more about how identifying a company with a moat impacts investment results.

We award Ansell a narrow moat rating based on intangible assets stemming predominantly from its brand equity, which allows it to successfully compete in the more specialized protective glove markets. We believe the strategy to rationalize its portfolio, divest the sexual wellness business in fiscal 2017 where it was not competitive, and reinvest in innovation in a narrower portfolio of key brands, was the right path.

This has allowed the company to grow the proportion of sales under its five key brands to over 80% in fiscal 2021 from 45% in fiscal 2012. This not only highlights the increasing traction and captivity driven by its key brands, but it also simultaneously reduces Ansell’s exposure to its most commoditized products, such as single-use medical exam gloves, where it’s neither the market leader nor has a competitive advantage. Despite pandemic-induced demand, undifferentiated lighter-weight single-use exam gloves made up just 30% of Ansell’s single-use sales in fiscal 2021, or less than 10% of group sales.

Ansell holds several of the largest and most highly reputable brands in the industries it services, which are prominently displayed on its products, consistently holding the highest or second-highest global market share in each of its key verticals. For example, the company has roughly 20% global market share for both surgical and mechanical gloves and continues to build on its leading market positions. In highly skilled industries where wearing the right brand is the difference between being protected from injury or not, and employee satisfaction is dependent on fit and preference of gloves, we think this makes it inherently challenging for less reputable competitors to compete with brands that have proven product safety and quality.

Although there are likely many available substitute products and Ansell’s leading innovation may well be replicable over the next decade, when safety or employee satisfaction is at stake there is very little incentive for clients to switch manufacturers from an established brand to save on what is likely a sliver of their cost base. For example, this has allowed Ansell to command a 15% price premium in the mechanical subsegment with its Hyflex product range, where customers have responded with loyalty and willingness to pay a premium.

Ansell follows a business-to-business sales model and distributes through key partners, such as Grainger in the industrial segment, or directly. The company’s primary sales tool, Ansell Guardian, is a trademarked workplace safety assessment which aims to help the customer reduce workplace accidents. Ansell reports that customers on average have a 65% reduction in hand injuries following an Ansell Guardian assessment and it reports that 70% of customers undertaking a Guardian assessment ultimately buy Ansell products.

Ansell’s strong brand equity and differentiated product lines have helped maintain its leading market positions and led to the company reliably posting an average return on invested capital, or ROIC, including goodwill of 11.3% over the last five years. All peers face raw material variability and pricing challenges, but Ansell’s ability to pass through costs given its trusted brands is also seen in its fairly consistent gross margins of at least 39% since fiscal 2016. We estimate the company should continue generating economic profits and forecast

Ansell to earn a ROIC including goodwill of 10.1% on average over our five-year explicit forecast period, exceeding its weighted average cost of capital, or WACC, of 8.4%.
Strengthening Ansell’s intangible assets is its in-house research and development, or R&D, conducted at 19 specialized facilities worldwide. R&D mostly revolves around product design and manufacturing processes and results in Ansell’s leading innovation.

Ansell was the first company to patent a glove-in-glove system in which a healthcare worker can double-glove in one don. Ansell has also engineered touch-screen compatibility with little compromise in safety or quality. Leading innovation has proven critical in the past. The U.S. FDA banned the use of powdered surgical gloves in December 2016, which was a boost to higher-end players such as Ansell. In addition, the trends toward higher price point nitrile gloves and away from natural rubber latex for allergy reasons, as well as double-gloving for safety reasons, have been a tailwind for the company.