Is it time for CSL to get back on top?

Patrick Poke

Livewire Markets

In the time before COVID, CSL was one of the great market darlings. Between January 2012 and January 2020, the stock was a 10-bagger – and that’s before accounting for dividends.

But in the two years since, CSL has recorded its longest period of sideways trading in over a decade, still sitting around 10% below all-time highs.

Now with blood collection centers opening up in the US again and a recent strong showing for their flu vaccine business, is it time for CSL to get back on top? Following their half yearly report yesterday, I decided to get in touch with Michelle Lopez from abrdn to find out.

In this Q&A, she shares some of the surprises from the result, tells us about the outlook for the company and the industries it operates in, and whether she thinks CSL is a ‘buy’ today.

What were the key takeaways from CSL’s result?

CSL has a very strong first half, which beat market expectations by ~10%. However, the full year guidance has been maintained (albeit now including Vifor acquisition costs of approx. $100m, indicating a 5% operational upgrade), indicating a heavy skew in earnings to the 1H.

Plasma collections are showing signs of recovery, with volumes +18% albeit still below pre-covid levels. The market was rightly focusing on this given the operating leverage within this business, and the importance of plasma for the Behring business, which represents approx. 70% of Group earnings and is significantly higher margin.

Their vaccine business, Seqirus was much stronger than expected. Seqirus revenue increased 17% in constant currency terms and EBIT margins increased 380bps to 52.5%, driven by strength in seasonal flu vaccines in the Northern Hemisphere.

What was the market’s reaction?

The market reacted positively, which was appropriate given the result. The stock closed up 8.5%. But context is everything… the CSL share price is still off 10% since the beginning of the year, and almost 20% since November 2021 when concerns over Omicron emerged.

Given the strength of the result, I would have expected a stronger reaction, but we are in choppy territory especially for high growth/high PE stocks, which CSL falls in to.

I also think there is some digestion to be had given the outlook statement and what that implies for the business in the 2H.

Were there any major surprises to be aware of?

Yes, there were a few.

1. Skew in earnings

Management have re-affirmed FY22 guidance for Revenue growth of 2% to 5% and Net Profit After Tax of $2,150m-$2,250m. Given NPAT for the 1H was $1,722m, at the midpoint, this implies a 78%/22% split between 1H and 2H, which is significantly more skewed to the 1H than what traditionally been the case.

Putting it another way, to reach the mid-point of the guidance range assumes only a 22% earnings skew to 2H, vs ~35% historically and an 18% decline on 2H21 (which was already weak)

The Seqirus business is the main driver of this seasonality given it is highly profitable in the 1H and then loss making in the 2H. This is because most sales (approx. 80%) fall in the 1H (leading into the Northern Hemisphere winter when the population get their influenza vaccine), but the costs are more evenly split across the halves. However, this guidance implies one of two things:

  1. A significant uplift in costs within either corporate (R&D, marketing, etc) or their two main divisions: Behring or Seqirus (through higher returns of vaccines – the industry average being 11-14% returns in any particular year).
  2. Guidance will be upgraded as they get greater clarity as to how the plasma collection trend continues. However, I would put a lower probability on this given the long manufacturing lead time of 9-12 months providing solid visibility to management over that period.

2. Strength in Seqirus: Revenue growth of 17% and EBIT growth of 24%, led to solid margin expansion. What is even more noteworthy is that this division was cycling 40% growth in 1H21. Influenza sales was a key driver, specifically FLUAD (growing 48% on the prior corresponding period), which is significantly higher margin.

3. Behring margin deterioration. Of particular note was the margin deterioration within this division, given the operating leverage (high fixed cost business, dependent on volumes coming through). Whilst revenues were down 2%, EBIT was down 22% and margins contracted 800bps to 30.6%. The plasma collection trend is improving, however given the lag from collection to end product (9-12 months) we expect margins to deteriorate further, troughing in 2H22.

The question is what do FY23 margins look like? Do they recover back to pre-Covid levels or remain at these lower levels? Our current expectation is somewhere in between. Whilst we expect a recovery into FY23, it’s unlikely they get back to pre-Covid levels as we believe there has been a structural lift in collection costs (e.g. higher donor fees)

Would you buy, hold, or sell CSL?

BUY.

While in the near term they are working through the impact lower plasma volumes are having on a high fixed cost business, the trend on this has turned. We expect margins within Behring to trough in the 2H of FY22 and then incrementally improve given the operating leverage within this business and their continuous focus on driving efficiencies.

Vifor will be accretive into FY23, and we believe CSL will extract greater value from this business and its distribution network, which is not currently being priced in.

Yes, the near term will remain choppy. Particularly under these market conditions, whereby macro/policy tends to dominate, if an investor can lift their ahead and look beyond the next 12 months it’s a good buying opportunity.

What are your expectations and outlook for CSL, as well as flu vaccines and blood plasma collections more broadly?

The outlook for CSL is positive. There are many moving parts to this company, but it remains a global leader in a non-discretionary product (plasma therapies), in which demand is still strong, and likely to continue to be. They are currently facing a supply challenge, which they have managed well given the circumstances, and are transitioning though this.

Yes, there are longer-term risks on the horizon, including disruption risk from other therapies (e.g. gene therapy) but this company is well placed to capitalize on their impressive R&D portfolio (which they allocate 10-11% of revenues to and have a very high success rate) and is arguable one of the most efficiently run businesses on the ASX.

There is a lot going on in the vaccine industry. Covid has certainly shone the spotlight on it, and attracted a lot of capital. While Seqirus does not play directly into pandemic vaccines, they are a global leader in influenza vaccines. They are dedicating their fair share to R&D in this space and will soon commence on their Phase 1 trials of their “Self-amplifying mRNA” vaccine, which could be a game changer for Seqirus and the industry. The one thing I would point out though is that this is a highly cyclical and seasonal business, very different to plasma. As such inventory and cash-flow management is key to success.

Blood plasma collections: outlook from here is that collections will continue to improve, which is critical for this company. CSL has remained laser focused on this – enhanced operating and marketing initiatives to bring back lapsed donors and attracting new donors. They are paying significantly more for donor fees, and I expect this to prove stickier than initially thought. They continue to roll out collection centers with 35 planned for FY22, so continue to lead the industry in this respect.

Opportunities abound in Australian equities

Australia is home to high-quality companies with strong growth potential. Some disrupt their industries, while others benefit from structural trends that Covid-19 is accelerating. It creates compelling opportunities for investors. Learn more about abrdn's Australian equity offering here

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Patrick Poke
Managing Editor
Livewire Markets

Patrick was one of Livewire’s first employees, joining in 2015 after nearly a decade working in insurance, superannuation, and retail banking. He is passionate about investing, with a particular interest in Australian small-caps.

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