Ansell Limited (ANN)

CEO & CFO on H1 11 Result
09 February 2011 - CEO & CFO: Magnus Nicolin & Rustom Jilla

In this Open Briefing®, Magnus and Rustom discuss: - Ansell’s strong operating results - The business environment in general, and cost pressures in particular - Ansell’s prospects
Ansell Limited today reported net profit of US$61.0 million for the first half ended December 2010, up 12 percent from the previous corresponding period. EPS was US$0.46, up 14 percent. Sales increased 9 percent, Ansell’s strongest top-line growth for some time. To what extent did this reflect external factors such as demand recovery post GFC, and to what extent did internal factors such as your restructure of the company accelerate growth?

CEO Magnus Nicolin
Our excellent H1 sales growth came partly from a resurgence of manufacturing globally after the GFC but primarily from our ability to leverage our global leadership positions, our excellent product range, our strong global reach and value adding customer programs such as Guardian. In addition recent targeted investments in attractive geographies, e.g. Brazil, and verticals, e.g. construction, are proving successful.

CFO Rustom Jilla
This is the first reporting period in at least the last decade where organic sales growth on a constant currency basis has been double digit. This is despite some deliberate transitioning away from negative or very low margin business.
The earnings result was primarily driven by the strong performance in the Industrial business unit, which accounted for 57 percent of operating EBIT. Is such a skewed earnings growth profile sustainable? Where do you expect growth to come from in the medium term?

CEO Magnus Nicolin
Industrial is an outstanding business. It is the global leader in its category and we have the largest range of high quality products in the industry. Add to this the continuing innovation we are renowned for and our Guardian program, and there is no reason we cannot grow further. In both developed and emerging markets, ever increasing health & safety regulations support greater growth as more sophisticated products are required. I might add that although we are making great strides in emerging markets there is still a huge opportunity out there; so we have been investing in new offices, sales people and warehouses.
You’ve maintained your EPS guidance for the current full year ending June 2011 in the range of US$0.86 to US$0.91, up from US$0.797 last year. Given the guidance was originally framed before recent adverse movements in input prices, particularly latex, what counter-balancing factors are you assuming in the guidance?

CFO Rustom Jilla
When we provided the initial guidance last August, we said that there were some cost pressures around raw materials built into our expectations and that year on year forex was another negative. Offsetting this, we also expected EBIT gains to come from growth in our Industrial business, the benefits of our post GFC restructuring actions and a better product mix in Medical.

CEO Magnus Nicolin
The positives and negatives have largely offset each other. The Natural rubber latex (NRL) price has risen much higher than we ever thought possible and other costs, e.g. cotton, have also increased dramatically. The reorganisation into global business units (GBUs) has added to our SG&A with many new initiatives and an increase in people costs and travel. However, the organisation has responded well to these changes, activity levels and energy levels are high, Industrial growth has been more robust than we expected and our forex hedging program is also making a contribution.
The Medical business booked EBIT of US$20.9 million, down 20 percent, on sales of US$170.2 million, down 3 percent, with the decline in earnings reflecting the impact of increased latex prices. How are you positioned to pass continuing latex cost rises on to customers and how quickly can you realistically expect to shift to synthetics from latex in examination gloves?

CEO Magnus Nicolin
The unprecedented increase in NRL is forcing the entire industry to consider its options. We have already put prices up and will continue to do so if NRL costs rise further. Every manufacturer of NRL-based gloves is facing these same pressures. Meanwhile, the shift towards synthetics in exam and surgical gloves continues, and we have recently released two new polyisoprene surgical gloves.
Ansell’s Industrial business booked EBIT of US$42.7 million, up 52 percent, on sales of US$233.2 million, up 23 percent. EBIT margin was 18.4 percent, up from 14.8 percent. To what extent have your Industrial markets fully recovered from the GFC and are margins sustainable given increasing exposure to emerging markets?

CEO Magnus Nicolin
We believe that most Industrial markets have now fully recovered from the GFC. The resurgence of the automotive industry in particular and industrial growth in general are major factors. However, Ansell’s strong Industrial GBU sales growth worldwide would not be possible without us being a global leader and having great products or without all the drivers I have already mentioned. Our growing exposure to emerging markets is a positive. We intend to be present and a leader in the fastest growing parts of the world.

CFO Rustom Jilla
Industrial margins are quite robust right now and we have worked hard to get here. However, as we have said several times before, we can live with slightly lower margins as well. The priority in this business is growth.
The New Verticals business, which includes household and military-use gloves, booked EBIT of US$0.7 million, down 90 percent, on sales of US$82.6 million, up 1 percent. How are you seeking to address the profit challenge in New Verticals, will significant investment be required and what is the time line to recovery?

CEO Magnus Nicolin
This GBU was established to put the spotlight on a number of smaller verticals. Some of these offer significant opportunities to profitably grow new channels such as DIY, construction and the military. Other verticals like consumer household gloves and food require dedicated action to improve profitability levels, neither of which are easy tasks. NV’s H1 EBIT was negatively affected by product mix, NRL prices which hit household gloves hard, a slowdown in military contracts and lower manufacturing yields. We are working on all these challenges.

We are not seeing the need for significant investment in manufacturing but are focusing on new product development and marketing. We have some really exciting new products in the pipeline and will streamline our product offerings and pay for SG&A increases with higher margins.
In the Sexual Health & Well Being business Ansell booked EBIT of US$10.9 million, up 30 percent on sales of US$97.7 million, up 13 percent. The earnings increase reflected strong performances in government tenders and emerging markets and in the SKYN condom brand. How likely is this performance to continue and can Ansell return to the higher profit levels of past years?

CEO Magnus Nicolin
As we said last August, many of SHWB’s F’10 EBIT challenges were not expected to carry through to F’11 and this has largely been the case. We carried out a major plant restructuring in the first half as planned and you’ve just noted the main drivers of profit growth.

There is no reason the SHWB business should not continue to deliver sales and profit growth. We are present in most of the world’s largest condom markets and have seen particularly strong performances from our Chinese, Brazilian and Indian businesses. The success of our SKYN condom has helped Ansell to grow market share but it is necessary to continue to invest in new products and marketing to maintain recent gains. We are also investing to further improve our production footprint and in packaging efficiencies so there will continue to be capital spending at a higher level and some restructuring expenses.
Reported SG&A grew by only 2.5 percent, well below sales growth of 9 percent. However when the restructuring costs of the two halves are backed out, underlying SG&A has grown at nearly the same rate as sales. Why has SG&A grown at such a rate?

CFO Rustom Jilla
The recent reorganisation brought with it one-off and ongoing expenses including recruitment costs, relocation costs, new office set-up costs and of course higher salaries and stepped up travel. The benefits of GBU focus should be seen in faster new product development, SKU rationalisation, increased margins, marketing campaign synergies, etc. but it will probably be F’12 before we see them.

CEO Magnus Nicolin
These expenditures should be seen as investing in future growth. We are measuring deliverables business by business and will be ready to act if we don’t see sufficient payback on a timely basis.
Ansell’s free cash flow fell to US$13.8 million in the first half, from US$67.2 million, reflecting an increase in working capital of US$32.7 million versus a decrease of US$6.7 million in the previous corresponding period, and an increase in capex to US$23.2 million from US$5.3 million. You’ve indicated that working capital was higher due to inventory build. What is the outlook for future free cash flow?

CFO Rustom Jilla
The increase in capex was expected. Fusion is running at the level forecast in August 2010 and will continue to incur costs for another two years as the new Oracle ERP system is installed. Plant capex also was much higher than F’10’s GFC-depressed level as surging demand necessitated additional capacity: a good situation to be in.

The working capital increase was solely due to high inventories. Part of this increase is easily rationalised: as sales are up 9 percent, the raw material cost component has risen, and it made economic sense to produce more NRL-based gloves before wintering commences in H2, and allow a build-up of inventory in preparation for our big ERP go-live. However, we have also struggled with our Sales & Operations planning process.

We expect to be able to reduce inventories to some extent in the second half and free cash flow will recover. However, you should expect full year F’11 free cash flow to be lower than in recent years.
Net debt totalled US$46.0 million as at the end of December, down from US$53.0 million six months earlier. Net debt to net debt plus equity was 6.5 percent, down from 8.6 percent. With gearing at this level and in the absence of acquisitions, are you actively considering a further buyback program?

CEO Magnus Nicolin
M&A remains our preference. However we previously informed the market that if we are unable to consummate sufficient acquisitions by the middle of this calendar year it is likely that we will, after Board discussion, resume buying back shares. We see this as the low risk way of improving shareholder value.

CFO Rustom Jilla
Without acquisitions, Ansell could end H2 with no net debt – which is not in the best interest of shareholders. We continue to actively work on M&A opportunities in a disciplined manner and have several at various stages in the pipeline.
Ansell announced an unfranked interim dividend of A$0.14 per share, up 8 percent from A$0.13 last year. Given the strength of the balance sheet, and relatively strong EPS growth of 14 percent, why was the dividend increase not more in line with the increase in earnings?

CEO Magnus Nicolin
Ansell has a track record of steadily increasing dividends for shareholders. As an Australian company with large tax losses we have no franking capacity for these dividends in any case. We believe that consistent dividend payments accompanied by share buybacks, if there are surplus funds, is a better course of action. Of course, value creating acquisitions could provide shareholders with an even better return on their investment!
Thank you Magnus and Rustom.

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