Why the glove fits at Ansell

One of many fascinating findings in Daniel Kahneman's book Thinking, Fast and Slow is that we make judgments too quickly, seeking information that confirms beliefs we already hold.

It's a dangerous tendency, especially when it comes to investing.

When Ansell piqued my colleague's interest, I struggled to see how a glove and condom maker could be profitable over the long term. It should be a commoditised industry where sub-par returns are the norm. Turns out I was wrong and my colleagues and Kahneman right.

Innovations

Everyone knows Ansell's consumer gloves and condoms businesses. These are but a fraction of this century-old company's operations. Ansell operates four inter-related but distinctly different businesses.

The industrial division produces hand and upper arm protective gear for industrial applications, including tradespeople and chemical plant workers. It's Ansell's most profitable business, generating 52 per cent of earnings before interest and tax (EBIT).

The medical gloves business produces disposable gloves for surgical and general medical use.

Tough competition ensures consistently lower EBIT margins than the industrial division. ''Sexual Wellness'' produces condoms and accessories, an area of growing demand and low price sensitivity. The fourth division houses the consumer gloves business, poorer performing product lines and new ventures, including military gloves and chemical suits. It's enjoying improving returns with potential for further margin expansion.

None of these businesses is wildly attractive on its own. Together, they're far more compelling. Having all four operations under a single roof leads to manufacturing efficiencies. Ansell can produce higher quality products at a price lower than its competitors.

Product innovation is also more efficient. The process that allows for the manufacture of extremely thin synthetic-latex condoms was easily transferable to new premium surgical gloves, for example.

Then there are the sales and distribution benefits. With a large sales force cross-selling each division's products, Ansell can reach more customers.

Together, these divisions also offer an in-built hedge. The more volatile, higher return, industrial business is offset by the steadier medical business and demand for condoms isn't affected by economic cycles. Still, Ansell's operations are beholden to latex pricing (and, to a lesser extent, cotton and butadiene), which can swing wildly depending on Malaysia's weather.

Expansion

Management is launching new products that use less or no latex. This year, Ansell's latex consumption fell 18 per cent, despite increasing sales. The industrial division is exposed in another way. In 2008-09, US automotive companies laid off workers, which affected demand for Ansell products. A deep and enduring recession in Europe would have a similar effect.

A few years ago, chief executive Magnus Nicolin was making noises about rapid expansion, raising the spectre of ill-conceived and over-priced acquisitions. Thus far, those fears have proven unfounded.

The latest purchase of European industrial glove maker Comasec for €102 million ($127 million), on a valuation of about one times sales, appears shrewd. It should lift earnings by $5 million a year. If latex prices remained flat (let alone fell), earnings would increase by another $5 million, while a lower Aussie dollar would offer another boost.

Net debt-to-equity, however, has jumped to about 25 per cent and we wouldn't like to see it creep much above 30 per cent.

Currently, Ansell trades on a price-to-earnings ratio of nearly 16 and offers an unfranked yield of 2.3 per cent. If we assume earnings grow by 5 per cent over the next five years and the company continues to recycle its spare cash into share buybacks, a price of about $15 a share would be reasonable - not far from the current price. It's not hard to imagine total returns reaching 10 per cent a year, in which case, at current prices, Ansell would be a reasonable business available at a reasonable price.

In this market, buying well is critical. I can't recommend a stock like this without a decent margin of safety. Right now, there isn't one.

If the share price fell below $14 then this stock could make a nice addition to an investor focused on growth; income investors might need to wait for a much lower share price for the yield to become attractive, particularly since dividends are unfranked.

Until then, I'd bide my time. There's a good chance you'll get an opportunity eventually.

Nathan Bell is the research director at Intelligent Investor, intelligentinvestor.com.au. This article contains general investment advice only (under AFSL 282288).

The story Why the glove fits at Ansell first appeared on The Sydney Morning Herald.

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