Ansell: Growth Versus Costs And Currencies

This story features ANSELL LIMITED. For more info SHARE ANALYSIS: ANN

By Chris Shaw

Glove and condom group Ansell ((ANN)) recently conducted an analysts tour of its Asian manufacturing operations, one that saw BA Merrill Lynch return with the view the company is set to enjoy a step change opportunity via the bringing of new products to market.

An example is the recent launch of Ansell's new Gammex surgical glove, which BA Merrill Lynch notes protects the wearer from breaches in the glove's surface. This means protection from infections such as HIV.

Other new products have also come to market recently such as a new condom and a fire proof Power Flex Occupational glove, which highlights the company's ability to continue to improve its product range and to tap new markets.

For BA Merrill Lynch the tour also highlighted Ansell's lean cost base, which is allowing management to concentrate on not only new product development but on trying to achieve technological superiority and differentiation across its product portfolio.

As well, management has indicated Ansell will look to increase market share in developing markets where the company already has a beachhead and a brand advantage. BA Merrill Lynch sees this as supporting a solid earnings growth outlook, with its forecasts being lifted by 3% this year and 4% in 2011 to reflect a steeper growth profile.

BA Merrill Lynch is now forecasting earnings per share (EPS) of US76.2c this year and US84c in 2011, which is a little higher than the US73c and US86.2c forecast by Southern Cross Equities. Earnings risk remains to the upside according to BA Merrill Lynch as its numbers sit above guidance this year and above consensus in 2011.

Morgan Stanley, which has assumed coverage of Ansell with an Equal-Weight rating within a Cautious industry view, agrees earnings guidance for 2010 appears conservative. Its EPS forecasts stand at US72.8c and US82.2c respectively, though 2011 earnings risk is seen as to the downside.

This reflects adverse currency movements, as on Morgan Stanley's assessment if exchange rates were to remain at current levels through next year there would be a large downside risk to earnings in the second half of 2011 in particular.

As a counter to this, BA Merrill Lynch suggests the company is generating gains in areas such as cost reduction that will help offset currency impacts. On a previous tour in 2007 BA Merrill Lynch estimates wastage accounted for around 7% of the cost of goods sold, but the latest tour suggests this has fallen below 4%.

Wages have also been a key concern with respect to the cost line, though in the view of BA Merrill Lynch the company has to date been able to manage this risk fairly successfully. If pressures continue to rise it expects management would look to make additional investments in automation.

BA Merrill Lynch also suggests latex is unlikely to be a meaningful headwind to earnings going forward, particularly as Ansell appears to be having some success in extending storage life by using various additives. As well, latex prices have started to decline due to seasonal factors, with further falls expected by the second half of May.

Southern Cross also weighs in on the latex question, noting Ansell continues to look into new technologies that will improve the efficiency of its latex use. With management also looking at longer-term contracts for its latex needs, the broker expects price volatility in that market will become less of an issue.

Ansell's transition to a new CEO in Magnus Nicolin appears to be going smoothly in the view of Southern Cross. Nicolin has a good record in building businesses and is emphasising branding and a lean manufacturing approach, which Southern Cross expects will be a positive for inventory turns and cost reductions generally.

Factoring all this in sees BA Merrill Lynch suggest Ansell is transitioning from a value proposition to a growth opportunity, which implies value in the stock at current levels. On its forecasts Ansell should deliver materially higher EPS growth in 2011 than will peer companies, which suggests the current earnings multiple is too conservative.

Southern Cross is similarly positive on the growth potential for Ansell given the focus on innovation and competitive advantage. While actual spending on research and development is only around 1% of revenues, Southern Cross notes it is quite specific spending and so is valuable in terms of positioning for future growth.

Morgan Stanley is not as excited by the value equation as its discounted cash flow valuation for Ansell supports a price target of $12.95, implying the stock is fully valued around current levels. What Morgan Stanley does point out is if the Australian dollar weakened to around US83c, latex prices fell by around 10% and the company made an acquisition in the range of $250 million that generated a return on invested capital of 15%, its valuation would increase to in excess of $15.00 per share.

Morgan Stanley's price target equals its $12.95 valuation, while Southern Cross has a $13.00 price target and an Accumulate rating. BA Merrill Lynch is the most aggressive with respect to price target in the FNArena database at $13.85. The average price target is $12.48. The database shows Ansell is rated as Buy four times, Hold three times and Sell once.

Shares in Ansell today are slightly higher and as at 11.30am the stock was up 1c at $12.91, which compares to a trading range over the past year of $8.01 to $13.48. The average price target in the database implies downside of around 4% from current levels.

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