Ansell Limited (ASX: ANN), the industry leader in a number of protective glove, protective clothing, and sexual health categories, recently announced that it will buy U.K.-based protective clothing manufacturer Microgard for £59 million ($118 million).
Microgard has sales in more than 75 countries, a manufacturing facility in Xiamen, China, and about 750 employees worldwide. The company has grown rapidly, mainly in Europe, the Middle East, Africa and Asia-Pacific regions, with sales of about US$40 million ($51.83 million) during calendar year 2014, Ansell said in a recent statement.
Ansell chief executive Magnus Nicolin said the acquisition was a critical step in building the company's body protection operations, as part of its Industrial Global Business unit: "Together with our current chemical protective glove range, we now have a world-class portfolio of chemical protection solutions, leveraging our strong global footprint".
Microgard supplies customers in the industrial, chemical, oil and gas and life science sectors and Mr. Nicolin said the purchase would complement previous acquisitions that had expanded Ansell's product range.
While this acquisition may sound positive, here are six reasons why Ansell's ongoing growth-through-acquisition strategy might be a good reason to sell.
1. Poor sales and decreasing margins
Ansell's sales have only increased by 4.92% per year since 2005, from $1.1 billion in 2005 to $1.7 billion in 2014. Its operating profit margins, which are normally around 12%, have dropped to 5.35% in 2014, and its net profit margins, which are normally around 10%, have dropped to 2.63% in 2014.
2. Weak competitive advantage
Ansell has two significant competitive advantages: a portfolio of strong brands and low-cost manufacturing. Ansell's leading brands include its industrial glove range Solvex and Gammex surgical gloves.
Ansell's cost advantage is a function of the location of almost all of its manufacturing in low-cost regions, combined with higher production volumes than most competitors. Ansell manufactures in a number of countries including India, Thailand, Brazil, Mexico, Lithuania and Portugal. However, low barriers to entry and strong demand growth in emerging markets is likely to stimulate new, low-cost local supply.
In addition, Ansell spends little more than 1% of its revenue on research and development, which is unlikely to create any intellectual property advantage.
Lastly, finding well-priced acquisition opportunities is always difficult. With all acquisitions, management expects the combined entities to generate synergies through increasing sales or lowering costs or a combination of both. There is always a risk that Ansell will be unable to achieve these benefits and its acquisitions will not generate the desired outcomes.
3. Decreasing return on equityand increasing debt
Ansell's return on equity (ROE) has consistently averaged around 17% since 2005. In 2014 however, the company generated an ROE of around 11%. In the same time its debt has more than doubled from $331 million to $764 million and its debt-to-equity ratio has increased to around 37%. Recent acquisition purchases left Ansell with a funding gap in 2013 and 2014 where the company was required to borrow $268 million (2013) and an additional $184 million (2014), and sold shares to raise equity of $380 million in 2014. Equity raisings like this typically only serve to dilute shareholder wealth.
4. Decreasing free cash flows
Ansell had enjoyed strong free cash flows up until 2012, but this changed in 2013. It had negative free cash flow of $122 million that year and negative free cash flow of $479 million in 2014. At the same time, Ansell still paid dividends of $54 million in 2013 and $52 million in 2014.
5. The retained earnings test
According to Warren Buffett's Owner's Manual 1983: "We test the wisdom of retaining earnings by assessing whether retention, over time, delivers shareholders at least $1 of market value for each $1 retained."
You will notice from the analysis below that Ansell has continually failed to convert $1 of its retained earnings into at least $1 of market value for its shareholders. Since 2005, Ansell has had a total EPS of $7.75. At the same time, it paid out $2.78 per share in dividends, which should have left $4.97 per share in book value, depending on how well Ansell used its retained earnings. Ansell's book value per share only increased by $3.95, which means that it lost $1.02 per share for its shareholders.
If Ansell's growth through acquisition strategy does not generate necessary synergies, I would expect this book value per share to further decrease.
6. Overvalued share price
Even though Ansell's forecast EPS is for strong growth in the next 12 months, at the current price of around $26 and a P/E of around 30, I think Ansell's shares are too overvalued to provide any solid returns.
