Ansell Limited (ANN)

CEO & CFO on FY11 Results & Outlook
15 August 2011 - CEO & CFO: Magnus Nicolin & Rustom Jilla

In this Open Briefing®, Magnus & Rustom discuss: - Drivers of F’11 sales and earnings growth - Investments in operational reorganisation and future growth - Assumptions underlying F’12 guidance
Ansell Limited today reported net profit of US$121.7 million for the year ended 30 June 2011, up 15 percent from the previous year, with EPS also up 15 percent to US$0.916. Sales increased 11 percent, Ansell’s best performance in many years. To what extent was the accelerating growth related to volume increases and to what extent to price rises? Can the momentum be maintained in the current year?

CEO Magnus Nicolin
F’11’s results were outstanding, especially as they were achieved in a year where Ansell reorganised into a global business unit matrix structure, took Project Fusion to the first stage of a global ERP roll-out (i.e. North America) and contended with sharply higher natural rubber latex (NRL) prices. Price increases were rolled out during the year, and F’11’s 11 percent sales growth came mostly from volumes (approximately 60 percent) and pricing (approximately 30 percent), with foreign exchange contributing the remainder.

We expect to continue to grow sales in F’12. Our guidance reflects uncertain economic conditions in many countries with subdued growth. However, double digit sales growth may be hard to achieve as we deliberately shed some unprofitable business.

This is the first reporting period in the last decade where organic sales growth on a constant currency basis has been double digit. This was accomplished in spite of some deliberate exits from negative or very low margin business.
Ansell’s sales were up 11 percent and profit attributable was up 15 percent, but EBIT growth was only 8 percent. What was the reason for this?

CFO Rustom Jilla
In a nutshell - sales and marketing investments and restructuring costs. Through a combination of higher selling prices, strong volume growth and a better product mix, we more than offset the raw material cost increase of approximately US$50 million, and still grew gross profit after distribution (GPADE) by almost US$22 million before restructuring costs.

We could have delivered a double digit EBIT increase. However, we spent US$4.4 million on restructuring, including ceasing manufacturing at our last European condom plant and accelerating the closure of a European warehouse. We also invested several million in SG&A, in stepped-up sales and marketing spending (with new hires and new sales offices as we expanded geographic and vertical coverage) and in the new GBU structure (people, initiatives, travel etc.). These actions will contribute to future sales growth or cost competitiveness and we believe that it was worth giving up some F’11 EBIT to do this.
For the current year ending June 2012 your EPS guidance is US$0.97 to US$1.03, up 6 to 12 percent. With input prices remaining high, particularly for key raw material latex, and the US dollar under pressure, what are expected to be the main drivers of profit growth?

CEO Magnus Nicolin
Yes, raw material prices have increased and we don’t expect them to decline, but we are also benefiting from the selling price increases from last year. We will build on our strong sales momentum and reap the benefits of the investments that Rustom talked about earlier. All four GBUs have benefited from strong emerging markets growth, China, Brazil and India in particular. We have invested in additional sales positions and increased spending on new product development with the expectation that we will get more sales growth from new products. These and other factors will drive sales going forward.

CFO Rustom Jilla
Our guidance is based on moderate global growth going forward and foreign exchange rates at approximately current levels. A weaker US dollar versus the revenue currencies helps us and a weaker US dollar versus the costs currencies hurts us. Our foreign exchange hedging program helps protect us from currency risk, and we are about 60 percent covered at this time.

A broad slow down in industrial growth will certainly impact us - but if that happened we would likely also see lower raw material costs. Remember too that Ansell enjoys the benefits of a diversified business and geographical portfolio, and we have shown time and again that we will act swiftly to meet challenges.
You have flagged that there were some problems in the US with your Fusion ERP Project implementation and that you were experiencing back orders. How will this impact earnings?

CEO Magnus Nicolin
Our ERP implementation has not gone as well as hoped, but we will work our way through this. Due to the new processes and systems, we are having difficulties fulfilling orders at one large US warehouse in particular. This is very frustrating to all of us as customer satisfaction is a critical part of Ansell’s DNA. We are working 24-7 to fix the problems and I am confident that the biggest obstacles are behind us and that we will provide normal service levels soon.

CFO Rustom Jilla
Note that we have factored in the negative financial impact of lost sales (as currently estimated) into our F’12 guidance range.
With weakening economic growth in the developed markets, how do you see Industrial demand trending in the current year? Can growth in emerging markets compensate if demand softens in Industrial’s core developed markets?

CEO Magnus Nicolin
At this stage, we have not seen any weakness in our Industrial business. Even if industrial growth slowed in the developed markets, the power of Guardian, our global presence and our outstanding product range should allow us to partially offset this by gaining market share. However, emerging markets growth cannot yet fully compensate (at the top or bottom line) for a global slowdown in developed industrial markets.
The New Verticals business, which includes household and military-use gloves, booked EBIT of US$2.5 million for 2011, down from US$10.7 million. Earnings were negatively impacted by increased input and marketing costs. What is the outlook for this business in the nearer term?

CEO Magnus Nicolin
We see great potential in this business: F’11 was severely impacted by raw material price hikes. It was also a year of investing in the future, designing a new range of construction gloves, and spending time and money on rationalising brand names and SKUs with a special focus on the food glove range. Obviously the current level of return is unacceptable but that is precisely why we created this GBU; to achieve strong focus on each of its segments in order to sort out problem children and to develop the new and exciting verticals.
Raw material costs and particularly higher NRL have been a real issue. You’ve indicated you have passed over two-thirds of these cost rises on to customers. Has this been at the expense of market share? Also, given Ansell’s significant reduction in latex consumption over recent periods, what scope is there to further lower your latex use?

CFO Rustom Jilla
We have walked away from some areas such as Medical exam gloves and Industrial disposables. It is never enjoyable to abandon certain market segments but we have been quite clear that we would not seek to retain unprofitable business. Medical exam volumes were down 19 percent while we focussed on higher value add (more differentiated) products such as surgical, where volumes were up almost 5 percent.

In terms of reducing latex consumption there is always room. We have people dedicated to this task and, as you have seen, we have accelerated this effort. We expect to continue a number of initiatives to further reduce NRL use and you should see the effect of this in the coming year. In addition, we continue to expand our synthetic range and some of these new products will almost certainly replace NRL gloves.
In the Sexual Wellness business Ansell booked EBIT of US$21.9 million, up 59 percent on sales of US$200.6 million, up 18 percent, reflecting the resolution of F’10’s issues such as Unimil profitability and manufacturing and distributor problems. EBIT margin rose to 11.0 percent from 8.1 percent. Can the sales momentum be maintained and can the business in its current form return to its past margins in the high teens?

CEO Magnus Nicolin
The sales momentum should be sustainable, but it is unlikely to remain at the recent very lofty levels. SW benefits from a large emerging markets exposure and our Chinese, Indian, Brazilian, and Polish businesses are all growing well. This business is probably the one that has benefited most from the new GBU structure, and the extensive operations restructuring of the last 18 months has positioned it well.

The SW team has been able to focus on key platforms like SKYN and increase advertising and promotion spending to not only drive sales momentum and grow market share but also to provide better EBIT margins. Our aim is to get margins to the mid teens while continuing to sustain fast growth. We could deliver mid teens today if we decided to reduce marketing and innovation spending, so the trick is to get to high growth and high profitability at the same time and this will take another couple of years.
Free cash flow fell to US$62.5 million in 2011, from US$107.0 million in the previous year, reflecting an increase in working capital of US$30.9 million versus a decrease of US$5.9 million in the previous year, and an increase in capex to US$44.5 million from US$28.1 million. What scope is there to reduce working capital given continuing volume growth and what is the outlook for free cash flow in the current year given ongoing investment in the Fusion ERP Project?

CFO Rustom Jilla
As you point out, the reduction in F’11’s free cash flow is readily explainable and attributable to supporting sales growth and investing for the future. We have said previously that there would come a time when improvements in working capital days would taper off. This is what happened in F’11.

In F’12 too, we expect to see total working capital growth as sales rise. As for capex, this will continue to be high in F’12 but not at F’11 levels. Fusion capex will continue, albeit at lower levels. Plant investment will continue as we add capacity and also invest to reduce costs. But with higher EBITDA and reduced working capital and capex needs compared with F’11 we would expect a solid increase in Ansell’s F’12 free cash flow.

Moreover, after Fusion is fully implemented in F’13, we should see a further reduction in working capital days due to better systems.
As at the end of June Ansell had net cash of US$10.2 million, versus net debt of US$53.0 million a year earlier. You’ve announced a buyback of 5 million shares (equivalent to about US$65 million at current share price levels). What is the rationale behind the quantum of the buyback and apparently prioritising the retention of capital for growth at the expense of measures such as ROE?

CEO Magnus Nicolin
We said a year ago that if we could not execute a number of attractive acquisitions in the coming year then we would recommend to the board a limited buyback and that is precisely what we are doing today. Having said this, we are working on several interesting acquisition opportunities, but don’t see ourselves making a large purchase in the next few months. As long as we have a strong balance sheet and good cash generation and can buy back shares at below intrinsic value – restarting a buyback makes perfect sense.

CFO Rustom Jilla
Given our strong cash positive/negative gearing and F’12 free cash flow expectations, we have financial flexibility and can easily fund a 5 million share opportunistic on-market buyback, and also make some acquisitions. In fact, we can increase net interest bearing debt by approximately $250 million in total while retaining investment grade financial ratios.
In July, Ansell acquired Sandel, a US based developer of medical staff and patient safety products. What is the strategy behind acquiring a business that is a “step out” from Ansell’s core glove niche and is this the likely model for future acquisitive growth?

CEO Magnus Nicolin
Sandel is an interesting and exciting business and a lot closer to what Ansell does than you may think. We are both in the patient and medical staff safety business, sell to the same customers and are used by the same end users globally. So Sandel strengthens our offering in the perioperative safety space and in addition brings to Ansell a powerful innovation engine – a model to source ideas for new safety products that has been perfected by Sandel in the last five years.

I would not like to predict future acquisitions but there is room in all our GBUs for businesses that are slightly adjacent to our current product ranges and add to our ability to deliver a more integrated solution and drive shareholder value. This is also very consistent with our Guardian solution selling program.
Ansell announced an unfranked final dividend of A$0.19 per share, up from A$0.175 last year. This brought the total dividend for 2011 to A$0.33 per share, up 8 percent. This was well below the 15 percent growth in EPS. Can you comment?

CEO Magnus Nicolin
The Board has steadily increased Ansell’s dividend each year. However, Ansell also clearly prefers returning surplus cash via share buybacks rather than dividends. One reason is that we have large Australian tax losses which removes our ability to frank dividends and therefore makes them less efficient in the hands of our Australian shareholders.
Thank you Magnus and Rustom.

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