Ansell Limited (ANN) Earnings Call Transcript & Summary

Good morning, everyone, and welcome to Ansell's market update. My name is Michael Evans, and I'm Head of Investor Relations at Ansell. Joining me this morning are Chief Executive Officer, Neil Salmon; and Chief Financial Officer, Zubair Javeed. This morning, we released an announcement to the Australian Stock Exchange, providing an update on our expected FY '23 results, as well as guide for FY '24. Neil will shortly provide some commentary on the announcement, after which there will be an opportunity for questions. As our results are provisional and remain subject to audit, we will not be in a position to provide significant additional detail beyond that provided in the announcement, and so answers to some questions may need to be deferred to our scheduled results call on August the 14. I will now hand over to Neil.

Thank you, Michael. In my comments today, I will start with the highlights of fiscal year '23, update you on the market conditions we see as we begin fiscal year '24, outline our business goals for this coming year and also introduce you to our new growth and productivity investment plan. Following preliminary consolidation of our full year results, we expect statutory earnings per share for fiscal year '23 to be in the range of USD 1.17 to USD 1.18. Our statutory earnings include the benefit of a successful completion of our exit from Russia, with a more favorable outcome than assumed in the provision recorded last year and disclosed in our last year accounts. Excluding this benefit of approximately $0.02 per share, our adjusted EPS are at the middle of our updated guidance range announced at the half year, and within the original guidance range announced in August last year even if at the bottom end. When I spoke to you in February, I outlined a number of focus areas for the second half, and I am pleased to say that we delivered on our goals against all of these. Our industrial business delivered continued organic growth in the second half and improved its margin versus the first half. In health care, Exam/Single Use volumes increased sequentially in the second half, and we saw pricing stabilize for these products. We had also expected that sales of Surgical and Life Science products would be affected by customer destocking and not reflective of underlying end-user demand, and this also proved to be correct. Now let me provide some comments on trends in our markets as we look to next year. Even in a climate of continued macroeconomic uncertainty, our industrial business is doing well. Strong performance with new products, effective execution of price increases and continued success in most emerging markets has contributed. Overall, we expect our industrial business to continue to grow and we do not currently see any signs of any major overall recessionary impact to the business. Turning now to health care, and I'll begin with the Exam/Single Use business. If we look at external market commentary, the focus remains on industry destocking. Major Malaysian producers are seeing low utilization rates and are starting to actively rationalize less efficient capacity. Against this backdrop, the performance of Ansell's Exam/Single Use business is encouraging and demonstrates the benefit of our consistent focus on more differentiated products and specialized market segments. The strong sequential volume growth in the second half of fiscal year '23 was driven primarily by these more differentiated and in-house produced products. And we anticipate the improving volume trajectory to continue in fiscal year '24. The annualized impact in '24 of price reductions implemented partway through '23 will act as an offset to revenue growth in '24, even though, as I mentioned, we see pricing going forward as now more stable. In contrast, our best estimate for our Surgical and Life Sciences businesses is that they are only partway through their destocking cycle. As a reminder, just 12 months ago, these products were still in widespread backorder, and distributors were seeking to build up their inventory levels. As industry product availability recovered during the first half of fiscal year '23, channel partners and some end users, particularly in Life Science, reassessed supply chain risk and began to reduce orders for low end-use demand to restore inventory to pre COVID levels. As we start fiscal year '24, we are assuming that destocking still has some months to run for Surgical and Life Sciences with orders on Ansell only expected to recover to underlying end-user consumption levels at some point during the second half. Turning to earnings now, where we are confronting several external headwinds. The first of these is a function of foreign exchange rates. As has been our policy for many years, we typically hedge our foreign exchange exposure 12 months ahead. This has provided protection in fiscal year '23 from the impact of a strong U.S. dollar. And as we have advised previously, those hedge book gains will not continue into fiscal year '24. We expect higher interest costs as rates rise. And as we've previously disclosed, we expect a higher effective tax rate in fiscal year '24. We also saw fiscal year '23 earnings supported by lower incentive outcomes in that year, and the reversal of some prior year provisions for unfit long-term incentive plans that were set in the initial phases of the pandemic, and are now not forecast to vest. This will not similarly benefit fiscal year '24, assuming we achieve incentive targets going forward. Altogether, the impact of continued customer destocking on some products together with the earnings headwinds I have just described means we do not expect to be able to get our earnings back on a positive trajectory in fiscal year '24. Even though the fundamentals of our business remain positive, underlying trends are favorable, and we are executing well against our key priorities. And so we are today issuing earnings guidance for fiscal year '24 in a range of USD 0.92 to USD 1.12. We are not satisfied with this as our earnings trajectory. So in this respect, as a management team, we have spent some time carefully considering a series of short- and long-term action plans with the goal being to respond to these external headwinds, accelerate our earnings recovery beyond this year, strengthen the business foundation and drive long-term value creation. As I will explain, we do not expect these initiatives to provide material net benefit to adjusted fiscal year '24 earnings, but we do expect them to drive earnings growth in fiscal year '25 and beyond. Our first objective is to implement a simplified and streamlined organization structure, achieving enhanced focus on the execution of our customer and market-oriented growth strategies, while also reducing cost through reducing complexity of roles and responsibilities. We expect the majority of these changes to be implemented within the next couple of months. Our second objective is to drive accelerated gains in manufacturing productivity, including realizing the efficiency benefits from upgrades already successfully completed to our manufacturing ERP systems, accelerating and building on success seen in our automation initiatives and stepping up the deployment of our active make versus buy strategic framework to achieve further cost benefits while always ensuring we preserve Ansell's IP differentiation. We estimate the cumulative cash cost of these 2 initiatives to be USD 40 million to USD 50 million to be spent over 3 years, but with the majority to be incurred in fiscal year '24. We expect to be at an annualized run rate of pretax cost savings of USD 45 million by the third year of fiscal year '26, with initial savings delivery in fiscal year '24 of USD 15 million to USD 20 million. And having excluded the expected cash cost of these initiatives from the adjusted earnings guidance I gave you earlier. In parallel with these efforts, we are also taking action to normalize our own Ansell finished goods inventory levels. Today's high levels of inventory are inefficient and costly and also tie up capital unproductively. Reducing inventory requires us to temporarily slow production for the majority of fiscal year '24, primarily for surgical and some Exam/Single Use products. We expect that the cash released from reducing inventory will fully fund the $40 million to $50 million cash cost I mentioned earlier for the productivity initiatives. However, the required slowing of production has a negative impact on earnings from loss of overhead leverage as production fixed costs are spread across lower production volumes. We expect this temporary loss of overhead leverage to fully offset the USD 15 million to USD 20 million benefit of the cost reduction initiatives I earlier mentioned, that will benefit the fiscal year '24 period. The final element to our plan is to bring forward and broaden the focus of our successful digital systems upgrade program. To include commercial units and complete the move to consistent global ERP and decision support systems investments. We expect the cash cost of these investments to be in the range of $30 million to $35 million with the majority to be spent in fiscal years '25 and '26. Based on the success we are already seeing, we are confident this program will deliver additional growth and productivity benefits in the medium term. However, we are not sharing benefit forecast today. We first need to complete the initial blueprinting and business case development phase, and then we will update our benefit expectations, including these initiatives, most likely at our half year and fiscal year '24 results. So as I already mentioned, I'm not satisfied with a short-term earnings trajectory of the company, but I am pleased with the underlying development of our business. I believe the actions we are taking as we begin fiscal year '24 are the right ones for the long-term success of the company. When we finally emerged from the long post COVID period of adjustments in our end markets, the underlying strength of our business will become apparent, and be supported by the benefit of the new initiatives I have announced to you today. I look forward to providing more details on our full year results, when I and Zubair speak to you on the 14th of August. And with that, I will now open up the call for questions.

[Operator Instructions] Your first question comes from Dan Hurren with MST Marquee.

Just so I've got this clear, sorry, a lot of numbers here. The $0.92 to $1.02 adjusted EPS guidance for FY '24, that includes the $15 million to $20 million of benefit that will be realized in year 1. Is that correct?

Yes, and it also includes a similar offsetting cost arising from that slowing of production necessary to get our inventory levels down. So the net effect of those is neutral. Of course, the loss of overhead leverage is temporary, and the cost savings from these initiatives are expected to be long term.

Sorry, Neil, I'm lost here. So it does -- the $40 million to $50 million in cost is excluded, but it does account for the $15 million to $20 million of savings. Is that right?

Yes. But what I want to -- yes, why don't you see $15 million to $20 million dropping through to the bottom line, and that's because of that second effect that I described on the loss of manufacturing overhead leverage as we slow production to reduce inventory. Is that clear now?

No, understood. Okay. And just a follow-up just on how this will be reported. The IT investments, will they be broken out separately in corporate costs or that will all be absorbed within the reported segments?

We will break them out separately, yes, and give you visibility to this entire program including the IT costs, yes.

Your next question comes from Vanessa Thomson with Jefferies.

Neil, I just wanted to ask the $39 million normalization of incentive costs, $39 million impact on EBIT. Could we get some more color on how that's achieved or how that's calculated?

Sure. I'll actually ask Zubair to comment on this one.

Yes, Neil. So at the half, Vanessa, we clearly weren't forecasting an unwind of that nearly $40 million of incentive expenses you point out. So at the half, we had already unwound a large piece of our long-term incentive plans that were on foot. So nearly half of that unwind is related to past incentive plans, again, long term in nature. What's changed in the second half was the unwind now of a large portion of our short-term incentives. This was primarily driven by our Surgical and Life Science customers destocking obviously more than anticipated. And then in turn, this affected our short-term variable compensation. So the loss of sales in that business was offset by the unwind of this variable compensation, we still land within the range. So hopefully, that's clear. Effectively, it's business. Underlying business results means your variable compensation. It obviously recedes. And just to last point on this, that's been the nature of our compensation philosophy for a long time, and it goes across a large number of employees. So obviously, we always consider that variable in setting our guidance range.

Sorry, I think -- so is that the -- when we look at the breakdown in the reports and you talk about an increase in provision for employee entitlements, is that something that we will now see reverse?

Yes, yes. So this is why it's a headwind. Now obviously, as we've unwound that expense in fiscal '23, we would reverse as long as the business performs and we bring our employees back to target variable compensation. That's an expense that we'll have to then bear in fiscal '24, hence why it's a comparative drag. So increment in fiscal '23, expense in fiscal '24.

Next question comes from Mathieu Chevrier with Citi.

I was just curious to understand what's changed in the business, I mean, aside from the excess inventory that you have to run through, it sounds like a lot of changes all of a sudden that were not kind of talked about previously. And I was just curious to understand what's changing your thinking that's brought you to do that, although it seems like it's only a temporary impact from higher inventory.

Yes, and it's a good point so let me provide some more context to these changes. These changes are not a reaction to short-term pressures, not done merely because I feel I need to respond to '24 EPS. I've been in the role for 2 years now. As I took over as CEO, as a Board, we agreed on a period of stability for 2 years. And I think it was also important during that period of time for us to get a measure of what the post COVID -- how long the post COVID period would be and what our markets would look like as we emerge from COVID. So we are at that point. And these steps that I've taken here are steps that we would have taken anyway. Some of the areas of emphasis have been adjusted to current market conditions. But the fundamentals behind these shifts are -- these are long-term strategies that I would have implemented whatever our short-term earnings trajectory. I believe for a long time that Ansell's organization structure is overly complex for the nature of our business, and it gets in the way of our effectiveness as an organization and our ability to deliver growth. We've delivered reasonably good results, but I feel there is more opportunity in the business. And that complexity also creates cost where you have a number of overlapping responsibilities. So that's the first objective I talked about to that more efficiently organized -- more efficient organization structure, better aligned to our growth strategies. And then the productivity goals are a continuation. The operations productivity goals are continuation of strategies that we've been developing for some time. The use of the make versus buy levers has been effective. Going some years back, we in-sourced as part of Project Horizon. We have also in-sourced successfully more recently as part of bringing our Careplus now at Ansell baht facility into the frame. But on other occasions, we realized that our in-house production capability is not economic versus the best outsourced producers. And if we don't feel there's an IP factor in the equation, then we'll look to outsource and rationalize any less efficient elements of Ansell production capacity. And then automation is something we've been working on for a while. We have an advantage, the slowing of production in order to draw down inventory creates some room and space within our manufacturing facilities to step forward on automation plans that otherwise often struggle for line time and activity within a site if the site is running at high utilization rates. So these are a set of strategies that are not a reaction to current issues, but the right decisions taken in any context for the long-term success of the business and with some fine-tuning that does respond to shorter-term issues. But that's at the margin rather than the fundamental to what we're doing here. And these have long been considered by myself, and I feel that the right time to execute on them is now for those reasons that I summarized.

Understood. And then just another 1 on the destocking. I mean, how do you get your confidence in where you're at in the destocking phase? Because it seems like it's been a bit less field when it came about. And all of a sudden, people have changed their behavior in ordering. How do you get comfort in where you stand in that destocking cycle?

Yes. Well, we must admit, first of all, that it is difficult because we're trying to form a picture across many geographies across the world, many different distributor partners. And even if we get a good handle on distributor partner decision-making, and we also have to consider end user decision-making. So I think we'll never have full visibility to inventory levels ahead of us. But we've set ourselves an objective to get substantially better than we were 12 months ago. We have developed a new IT system that track sell-in, sell-out data where we have that available that encourage distributors to give it to us where they haven't in the past. And that creates a model of the supply chain, either where we can verify it with reports on inventory or modeling ourselves based on behavior. So this is giving us an increased visibility of what's ahead of us and decisions that distributors are making, information that we didn't have previously. And it's those models that I'm relying on now to give a longer-term view ahead of destocking trends than I felt able to in the past. But it's work in progress. So it would be false for me to say we now have complete visibility as to decision-making ahead of us. But I think you're right to reference in your question that this shift happened very, very quickly from some months where there was still a real concern that I'm going to run out of product to then suddenly I've got plenty of product and now I can get it from several people. And now I'm concerned about economic conditions. So I'm going to switch within a short period of time between ordering to build up inventory to ordering to reduce inventory. And we've seen that play out now across several different businesses at different phases in the cycle. And the most recent 1 to be affected is the Surgical business. But it was a similar story. For example, Single Use a year ago, that business is now emerging from that phase, and that's encouraging to see. We expect Surgical to emerge from it too, but it's got another few months to run.

Your next question comes from David Low with JPM.

Just a few, some of which has been touched on. But just with the incentive payments, frankly, we were aware that they were going up, I was unaware of the magnitude. Can we talk a little bit about what they are in the normal year?

Zubair, do you want to address that?

We don't disclose the quantum in any normal year, David, but of course, the $39 million or $40 million or so, again, I've said a big piece of that is from prior long-term incentive plans. So the number is going to be smaller than the one that we just printed here in terms of the headwind. But we don't disclose that quantum.

Okay. So is this $39 million uplift a back-to-normal type of experience? I mean are we going from a year where nothing was paid to 40-odd million gives us ballpark? I mean since -- I recognize there's some sensitivities, but perhaps if you could talk to historics and whether this is indicative of what it was in previous years on average?

Yes, indeed. So there's some, as I said a couple of minutes ago, there is some unwind here of short-term incentives, but that leaves some payment to be made against short-term incentives. You'll notice we did come into the, as Neil said earlier, the bottom of the original guidance range we issued. So some short-term incentives are there but long-term incentives have been unwound. So this is a little bit higher, not too much higher than what a normal year would be in total.