CSL: What the market missed

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Through reporting season, Livewire's contributors are providing exclusive insights on February results for some popular stocks. In this wire, Scott Shuttleworth from Montgomery Investment Management looks at the CSL result, to pull out some key points and identify something the market is overlooking.

What was the most important information in the report?

CSL Behring performed well in 1H17, achieving 9% revenue growth, which is a solid achievement. The Group itself beat market expectations through the outperformance of Sequirus, which provided abnormally high levels of vaccine to the US to tackle a severe strain of influenza.

We had expected more from the immunoglobulin franchise, given that US industry sales in the September and December quarters were up 17% and 33% respectively. We were pleased with the growth in uptake of Haegarda and Kcentra, which helped drive 20% growth in speciality product sales.

Our view hasn’t much changed on CSL over the last year or two. We believe it to be a high-quality company lead by an exceptional management team, but appears to be trading at an expensive valuation at circa 40x Forward guided FY18 earnings.

In terms of Seqirus, we’ve been cautiously optimistic on the outlook for this segment, and expected management’s targets to be hit, although anticipating that it may take several more years. The result today seems to suggest that whilst the outlook was correct, it’s occurred more quickly than we would have otherwise expected.

The market is overlooking the possibility of plasma oversupply

We believe that the human plasma industry is cyclical. In the years 2001-2003 the industry went into oversupply, which has significant impacts. The industry went into oversupply again after the GFC, although the impact was somewhat mitigated by Grifols’ acquisition of Talecris, reducing competitive pressures in the industry.

The supply of plasma is a function of the production capacity amongst the incumbent firms, marginal capacity from new entrants and the supply of plasma donors – primarily from the United States. Typically, when plasma prices rise, this encourages the industry to expand production capacity and alleviate prices rises.

Economic conditions also have an impact on supply – recessions typically increase the supply of donor plasma as those who are out of work or are not fully employed seek additional income. In 2001 post the collapse of the dot.com bubble, the supply of plasma exceeded demand and put downside pressure on the pricing of plasma products. During this time CSL’s share price notably fell from around $16 per share in 2001 to $4 per share in 2003.

Whilst it’s largely impossible to forecast such events, we believe that the likelihood of a recession is quite probable within at least the 15 years we’ve constructed our valuation over, and are hence cautious about the downside risk.

So, while we continue to believe that CSL is a high-quality company, its stock appears priced to perfection and doesn’t seem to incorporate a margin of safety with respect to the industry cycle.

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Guthrie Williamson

The second half guidance is extremely conservative and likely to be exceeded. The main contributor to the weak implied second half is R&D spending related to CSL112 phase 3 trial. If this trial is successful the investment will be extremely accretive. In which case , viewing the forward P/E of 40x, as expensive , will have been very misleading.

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Roger Montgomery

Thank you for sharing your view. Different views are precisely what makes a market, and indeed, we could be wrong.  You are quite right when you point out that if your scenario transpires, the P/E would not be 40 times. Thank you again for providing the counter view.

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Joseph Pang

Downside concerns to a plasma oversupply may not be warranted just yet, CSL’s own assessment of the market is “Plasma supply tightness continues” (page 13 of Half Year Results Analyst Presentation 14/2/18) Agreed. Full year guidance is way on the conservative side, would expect a further upgrade later in the year. CSL’s recent profit distribution history is weighted 60% in the first half of the year and 40% in the second half (thereabouts give or take a few percentage points). If CSL has no growth in earnings in the second half of the year ($531M – same as 2017) that would bring full year profit at $1.62B giving a weighting of 67.16% first half and 32.84% in second half. But I am betting on a second half earnings of $558M (5% growth on pcp) giving a full year profit of 1.644B (66% / 34% split), both well above guidance.

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