Is CSL Expensive?

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– CSL interim just beat expectations
– Headwinds emerging in clotting factor business
– Valuation an issue relative to earnings growth expectations

By Chris Shaw

Blood products group CSL ((CSL)) managed to just beat market expectations with its interim result, profit for the period of $500 million comparing to a consensus estimate of $491 million. The result allowed management to maintain full year earnings guidance of around $1,030 million in constant currency terms, or about $950 million assuming current spot rates.

The Immunoglobulin or IVIG business delivered impressive results by growing 22% in constant currency terms, Credit Suisse attributing this in part to stronger volumes given the Octapharma recall. The blood clotting operations lagged slightly, Citi noting this is a reflection of the fact CSL now cannot sell all the pdFVIII it can produce and what it is selling is going to lower priced markets. 

Southern Cross also picked up on this factor and the broker has indicated as much, pointing out it expects zero top-line growth for pdFVIII going forward. Macquarie notes this compares to previous estimates of around 8% growth, which cuts CSL's sales growth estimates going forward by around 2%.

To reflect the details provided in the interim result brokers have adjusted earnings forecasts, Citi lifting its earnings per share (EPS) numbers by 5-6% to factor in a lower tax rate. Deutsche Bank and Macquarie went the other way and trimmed their numbers modestly through FY13 to reflect changes to clotting factor forecasts, while UBS lifted its FY11 estimate but lowered its FY12 numbers.

Consensus EPS forecasts for CSL according to the FNArena database now stand at 179.8c this year and 206.6c in FY12, which implies solid earnings growth will continue.

But the result also highlighted some emerging issues for CSL, Southern Cross Equities taking the view the company is about to experience a tougher competitive environment given expected weaker demand for its albumin and clotting factor products.

There is also the issue of rising costs for plasma collection, which is an problem according to Southern Cross given CSL has historically operated best in a stable pricing environment. Rising plasma prices encourage product substitution, which the broker notes would eat away at market share.

The re-emergence of Octapharma in the market is also a potential issue, one that Macquarie suggests the market is not correctly factoring in at present. For one, Macquarie estimates the increase in IVIG sales recorded by CSL in the December half implies the company has only picked up around 20% of Octapharma's previous market share.

The other point for Macquarie is that while winning raw plasma supply contracts can be a positive, it only becomes one when CSL fractionates the plasma and can then sell it as end products through its existing distribution network. 

This is a more sober assessment than that of JP Morgan, who suggests the fact CSL had been able to secure some large recovered plasma contracts from Octapharma suppliers at a discount will likely be a positive for margins in FY12 and beyond.

Assuming Octapharma returns to the market before the end of FY11 there is scope for CSL to lose some market share in the view of Southern Cross, which would limit CSL's upside given the market would again become more competitive in both pricing and volumes.

This makes valuation an issue, especially given what some, Southern Cross included, regard as a relatively bare new product pipeline. While there is potentially significant upside from IVIG as a treatment for Alzheimer's Disease, Macquarie notes it remains too early to factor this into valuations for CSL.

For Macquarie this all means CSL is now relatively expensive, as EPS growth expectations of 8.4% through FY13 doesn't justify an earnings multiple of around 21 times in FY11 as implied by the current share price.

Given this Macquarie has downgraded to an Underperform rating from Neutral previously, while Southern Cross has downgraded to a Reduce rating from Buy previously. JP Morgan has gone the other way in upgrading CSL to Overweight from Neutral given a positive view on the medium-term benefits for CSL from Octapharma's issue and the ongoing strength in the IVIG operations. 

Overall the FNArena database shows CSL is rated as Buy twice, Hold five times and Sell once, with a consensus price target of $38.45, up from $37.97 previously. Targets range from Deutsche Bank at $34.00 to UBS at $44.00.

Shares in CSL today are weaker and as at 1.50pm the stock was down $1.31 or 3.5% at $35.71. Over the past year CSL shares have traded in a range of $30.45 to $38.07, the current share price implying upside to the consensus price target according to FNArena's database of about 7%. 

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