QUALIPORT
SSL: Complex Condoms

By Maynard Paton (TMFMayn)
June 17, 2002

The Qualiport has been monitoring events at SSL International (LSE: SSL) since February 2001. The company is a possible "glitch investment" -- an inherently strong business that's suffering from temporary problems. SSL published its annual results last month and the statement showed the company's troubles still persist.

Here's SSL's five-year financial record:

To March 31st              1998    1999    2000    2001    2002

Turnover (£m)               118     308     648     649     592
Operating Profit (£m)        29      64     137      85      54
Pre-tax profit (£m)          24      56     120      62      29

Earnings per share (p)     32.6    37.5    49.3    20.8    17.2
Dividend per share (p)     10.0    11.0    11.0    12.3    12.3

To be frank, the above table should be taken with a large sack of salt. The figures are shown before exceptional items, but because SSL's accounts have been plagued by so many 'one-off' complications, attempting to present a meaningful financial record is a pointless task.

To recap, SSL was effectively formed in 1998/9 through the three-way merger of Scholl, Seton Healthcare and London International. Since then, exceptional charges relating to restructuring programmes, write offs and disposals have totalled some £200m. On top of that, the practice of 'trade loading' (offering incentives to customers to purchase stock over and above their normal requirement levels) was also discovered, the ceasing of which hindered the latest set of results. The accounts are simply a mess.

So with SSL, investors have to ignore the financial headache and look to the products. The company's range encompasses Durex condoms, Scholl foot care, Hibi antiseptic, Biogel surgical gloves, Marigold household gloves plus numerous over-the-counter healthcare treatments. On the face of it, they're ideal Qualiport products -- they're market leaders, repeat purchase, recession proof and have brand-loyal customers who are largely price insensitive. Combined with a fresh management team aiming to sort out the mess, SSL's robust products should underpin an operational turnaround at some point.

That said, not all of SSL's products appear to be in the dominant 'franchise' category. The following table shows that just one-third of sales are generated from areas where SSL has a 20%-plus market share:

Product                     Sales             Market Share
                             (£m)                 (%)

UK: Family planning          32.4                 80
UK: Footcare                 20.7                 50
UK: Wound management         44.5                 20
UK: Surgical gloves          21.8                 75
US: Surgical gloves          67.3                 33
Italy: Over-the-counter      18.0                 38
Italy: Family planning       20.5                 59
Total                       225.2

Other                       403.9

Latest results

Highlights from the latest results included:

* Underlying sales rising from £608m to £629m;
* Underlying operating profits falling £101m to £81m;
* Marketing spend increasing from £60m to £71m, largely causing the shortfall in operating profits;
* Exceptional charges totalling £33m;
* An expectation that the current financial year would see operating margins of between 13-14% and mid-single digit sales growth, and;
* A continuation of the company's restructure. Plans for the current year include a complete overhaul of the group's IT systems and a full review of the entire supply chain.

Valuation and summary

Turnarounds are not the ideal Qualiport type of investment. The portfolio would far prefer to invest in companies that are not undergoing operational upheavals and have proven qualities.

Furthermore, investors looking at SSL are assuming the company's products will generate enticing financial results as and when the restructuring is complete. However, there's no guarantee how the actual economic characteristics of SSL's product range will pan out in reality. Investors can't really go on past accounts for guidance and there is a genuine risk that prospective shareholders could be disappointed in the longer-run. On balance therefore, SSL are probably the weakest company on the Qualiport's watch list.

In terms of valuation, if we assume...

* Annual underlying sales grow 5% to £661m;
* Underlying operating margins are 14%;
* Net interest payments come to £22.3m (SSL had net debt of £308m at March 2002);
* Profits are taxed at 30%, and;
* Accounting earnings are reflected as free cash.

...then SSL's 'underlying' free cash flow per share comes to 26.0p. If you demanded a free cash flow yield of 7.5%, then a share price of 346p would be required. However, because of the numerous uncertainties and assumptions involved, investors should require a greater margin of safety. A free cash flow yield of 8.75%, say, would require an entry price of 297p. The shares presently stand at 376.5p.

More: SSL: Watching And Waiting | Is There Value In Health And Safety?