Short Term Fever For CSL

This story features CSL LIMITED. For more info SHARE ANALYSIS: CSL

-Significant but loss making business
-Resolves CSL's sub-scale in flu
-Investor patience may be tested
 

By Eva Brocklehurst

CSL ((CSL)) has expanded its product reach, acquiring a global influenza vaccine business from Novartis for US$275m. The acquisition will strengthen the company's scale and capabilities across three plants in the US, UK and Australia. Combined with the bioCSL division it will create the second largest player in the global US$4bn influenza market, with annual sales expected to generate US$1bn in the next 3-5 years.

Sounds good. However, the business is currently unprofitable, as significant R&D investment has been required to support the commercial infrastructure and pipeline. CIMB expects synergy gains – management is targeting US$75m by FY20 – will be unlikely to offset continued investment across the current product portfolio. The three existing vaccines are Fluad, a vaccine for those over 65, Flucelvax, a cell culture based vaccine for those over 18 and Fluvax, the bio CSL vaccine for those over 5 years old. CIMB believes forecast operating margins and returns will be contingent on the competitiveness of Fluad and Flucelvax and favourable clinical results across the evolving pipeline. Goldman Sachs considers the acquisition will provide CSL with solid opportunities to scale up and drive efficiencies in its operation but, in the near term, the higher margin, higher growth plasma business, remains central to the company's prospects. 

For some time CSL has needed to boost its sub-scale Australian flu vaccine business and UBS maintains this acquisition should reconcile this need, accessing scale and state-of-the-art cell culture, along with new product registrations. Given the long-dated nature of the returns the broker acknowledges the justification for the price paid is less clear. Still, CSL has a strong history of buying low with acquisitions and outperforming so UBS gives the company the benefit of the doubt, as it would appear to resolve a strategic dilemma at a reasonable price.

Morgan Stanley is concerned about underlying earnings dilution over the two years beyond FY15. CSL may deal with the loss-making scenario by winding back R&D, increasing volumes, or lowering costs by moving from its own egg-based production to the new division's cell-based technology. Nevertheless, Morgan Stanley observes the size of the  acquisition's losses means many things need to go right before accretion occurs. CSL's core competency is in plasma products and flu vaccines are inherently more challenging, so the broker was surprised by the decision to scale up the flu vaccine division. Flu vaccine demand is volatile and there is significant seasonality.

Citi maintains a Sell rating on CSL. The broker thinks the financial metrics could disappoint initially. While the price is cheap compared with the assets acquired and the expected synergies are reasonable, it remains to be seen if investors that are attracted to CSL's steady and consistent earnings growth profile will be patient enough to look through the volatility in FY16. Citi believes competitive headwinds are building in haemophilia and immunoglobulins in FY15 and into FY16, and this will now be compounded by dilution of cash earnings in FY16 from the acquisition.

The influenza segment is changing, with Credit Suisse noting a move from traditional trivalent vaccines to quadrivalent vaccines, ie treating four strains rather than three. As the Australian business lacks scale and product differentiation this acquisition should address this issue. Credit Suisse also observes Novartis has won government pandemic preparedness contracts in both the US and UK.

Macquarie, too, is confident that the transaction will provide meaningful upside in the longer term because of the quality of products and facilities that have been acquired. The strategic benefit of moving from sub scale to number two in a large and important therapeutic segment cannot be overlooked, in the broker's opinion. JP Morgan concurs, envisaging turning around this loss-making business could be a defining moment for CSL and the company needed to either become a scale player in flu vaccines or get out of the business. Still, a lot needs to go CSL's way as the broker warns Sanofi, the number one player in flu vaccines, is a formidable competitor.

FNArena's database has five Buy ratings for CSL, two Hold and one Sell. The consensus target is $78.32, suggesting 1.3% upside to the last share price, and compares with $75.29 ahead of the acquisition announcement. Targets range from $65.01 (Morgan Stanley) to $88.00 (Credit Suisse).
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms