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Why size matters: Ansell’s profit advantage

 Key statistics: ASX: ANN
Closing share price 08.11.16: $22.29
52-week high: $24.90
52-week low: $14.76
Most recent dividend: 30.965c
Annual dividend yield: 2.64%
Franking: 0%

The glove and condom maker’s success depends on two competitive advantages.

It’s easy for investors to fixate on a company’s numbers: its margins, profit growth or price-earnings ratio, for example. However, it’s usually on the more touchy-feely level of competitive factors that we can truly separate the good companies from the bad.

For a business to earn outsized profits over the long term, it needs what Warren Buffett calls a “moat” – a sustainable competitive advantage.

Ansell manufactures industrial, medical and single-use gloves as well as condoms and a few other protective clothing products. The company has dozens of brands and sub-brands, many of which  may be familiar to you. A household name is one thing but when it comes to Ansell’s “moat”, economies of scale are the crocodiles and piranha.

In analyst-speak, making gloves and condoms is known as a “capital intensive” industry because of its heavy reliance on manufacturing equipment and factories, rather than labour.

The benefit of this is that a significant proportion of Ansell’s costs are fixed – only 15% of the total cost to produce a condom, for example, is variable (such as raw materials and latex). This means that as more condoms are made, the average cost per “unit” decreases because the fixed expenses are shared across higher volumes of output. Sales, therefore, can grow at a faster rate than costs.

In the gloves segment, Ansell is more than twice the size of its nearest competitor, Malaysian-based Top Glove, and it’s the second largest condom manufacturer (albeit a distant second). Chief executive Magnus Nicolin would be the first to tell you that size matters.

More sales and lower average fixed costs ensure Ansell earns above-average margins. More importantly, perhaps, is that the company can remain profitable at prices that would leave smaller competitors losing money, which is a significant barrier to new operators trying to enter the market.

The top three condom makers – Ansell (Lifestyles), Church & Dwight (Trojan) and Reckitt Benckiser (Durex) – account for 90% of the condom market. And in 10  years you can bet your boots that those three manufacturers will still be on top.

With a collection of well-recognised brands, a large and entrenched distribution network  and significant economies of scale – not to mention a reasonable price-earnings ratio of 15 – Ansell is one stock we’re happy to hold.

The Intelligent Investor Growth Portfolio and Equity Income portfolios own shares in Ansell. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking hereDisclosure: The author owns shares in Ansell.

Written by Graham Witcomb

Graham Witcomb

Graham Witcomb is a senior analyst at Intelligent Investor, owned by InvestSMART Group.

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