Is CSL Good Buying Now?

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

The company is included in ASX20, ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

Global blood products producer CSL Ltd ((CSL)) has had a very good run of late, seeing its share price rise from around $31.50 at the February result release to around $37.50 last week (19%). But after a big drop on Friday and further selling today, CSL is now back at $32.50 at the time of writing (down 13% from the top).

The big drop was sparked by Thursday night's release of quarterly earnings from US blood competitor Baxter International. While the weak sales result was in line with guidance, it was management's downgrade of full-year 2010 forecasts which spooked the market. CSL investors have rushed to cash in on this news and jumped over each other to do so. But the question is: Was Baxter's guidance more about Baxter and less about the IVIG industry overall and if so, should investors be taking advantage of this weakness to pick up some cheap CSL?

Having previously expected single-digit sales growth in 2010 in the US IVIG market in which CSL competes, Baxter now expects sales to be 0-2% lower. Management nevertheless suggests sales growth will return to 5% or higher down the track but that a “transitory period” of oversupply was now impacting. Baxter cited loss of market share and the impact of the new healthcare reform bill in the US, which means bigger rebates to patients, as reasons for its downgrade.

So while suggestions of oversupply and softness in pricing is not good news for the blood market, Baxter's claim of loss of market share may simply imply market share was picked up elsewhere and that the market as a whole was not particularly impacted. CSL may well have been a recipient of that market share gain, and last week management reaffirmed its FY10 profit guidance in response to the share price dump. This could well be a big overreaction on profit-taking.

Analysts will wait to learn more from other US blood company earnings results next month, including Talecris and Grifols, to confirm whether or not sales are looking soft across the industry or not. In the meantime, analysts point out that changes to US health laws will impact more substantially on Baxter than they will on CSL. Citi estimates the bill will reduce CSL's profit by less than $10m.

The share price drop has nevertheless provided a chance to reflect on why CSL had been so highly sought after of late.

With a large proportion of its sales coming from the US, CSL's earnings are forced to fight the stronger Aussie dollar, and that has risen from around US$0.89 to US$0.93 in the time CSL shares rose 19%. But as a globally recognisable brand, CSL has no doubt attracted US investors who have looked to cash in on both a share price rising on sentiment and an Aussie running in the offshore investor's favour.

CSL had previously attempted to take over competitor Talecris but was knocked back by US authorities on anti-trust concerns. While a successful takeover was seen as a positive catalyst for CSL, concern over the outcome did weigh on the stock. Once rejected, CSL announced a share buyback instead and that has provided share price support in lieu.

But possibly most influential of late has been early trial results which have shown IVIG to potentially be a successful treatment for Alzheimer's disease. This disease is coming to be recognised globally as widespread and thus a whole new world of potential is being offered to CSL if ultimate testing leads to the approval of CSL products for treatment of Alzheimer's.

Citi (Buy) is one broker who finds this “free option” attractive. But the reality is medical approval is a very long-winded business and any success from a positive result will still be two or three years away. Investors will have to wait a long time to see actual sales among the earnings numbers.

In the meantime, CSL's earnings growth is actually on a downward trajectory. Sales of the company's swine flu antivirus – quite possibly one-off albeit we can't be ultimately sure – catapulted CSL's earnings growth to 34.5% in FY09. Thereafter, the FNArena database shows consensus earnings growth forecasts in FY10 of 11.1% and in FY11 of only 7.6%, clearly a softening trend.

JP Morgan (Overweight) has those numbers at 15% and 5% but the analysts see a turnaround thereafter with a 20% forecast for FY12. JPM is happy to assume the Baxter result was only about market share until it hears otherwise from later reports.

The other concern analysts have in general also relates back to the Baxter result. Management hinted that it would have to do something about that market share loss and analysts are concerned this will spark another round of discounting, as was the case in 2002-03, that will impact on all industry players. This will not be helpful when the industry is already expecting slower sales growth in the next year or two.

And while CSL may have accepted the umpire's decision on Talecris, the anti-trust issue is not yet dead and buried. Rumblings from drug-makers such as Glaxo have meant an ongoing investigation by US authorities into the blood products market to see whether claims of oligopoly can be justified. CSL is not yet out of the woods.

On the currency front, bulk commodity prices and interest rate rises threaten to see the Aussie moving higher still, but the reality is such expectations may now be baked in. The Aussie is actually potentially more vulnerable to the downside if the Fed comes under more and more pressure to raise its cash rate and sovereign debt issues continue to send the euro lower. While CSL earnings would benefit from a weaker Aussie, US investors may prefer to stay away.

So let's recap: Baxter's poor result might just be a market share issue but perhaps there is more widespread sales weakness in the US; CSL has now completed its buyback and there are still concerns of anti-trust ramifications hanging over the company; Alzheimer's may prove a big bonus down the track but not for some time, and in the meantime analysts are forecasting slowing sales growth; and potential US dollar strength may have US investors looking closer to home. And if Baxter does start a discount war, no one will benefit.

What this all adds up to is possible justification for why the otherwise seemingly innocuous Baxter result was enough to spark a more major exit from CSL shares. If that's the case, this heavy selling is not necessarily a good entry point for the contrarian but rather a de-rating of CSL's near term potential.

Credit Suisse this morning downgraded CSL from Outperform to Neutral citing as its main concern the potential for price discounting.

GSJB Were (Hold) notes the low earnings growth forecast figure has CSL trading an FY11 price/earnings of 17x which is a premium to the market. Price performance from here, say the analysts will likely be subdued at least until FY11 begins to play out. Morgan Stanley (Equal-Weight) believes downside risk is still prevalent and that CSL shares were looking fairly priced.

BA-Merrill Lynch previously had CSL as a member of its Australia Focus One portfolio, meaning not only did the analysts have a Buy rating on the stock but it was among the more compelling Buy stories. But all that came to an end when the analysts actually downgraded CSL to Neutral, meaning it can't really be much of a compelling Buy among the Buys anymore. The downgrade came about given CSL's recent share price run, lack of near term earnings upside and full pricing.

There are three Holds and two Buys among the brokers who have not updated their CSL opinions on the back of Baxter, leading to a Buy/Hold/Sell ratio in the FNArena database of 4/6/0. Today's reports drew some target price downgrades as analysts took the opportunity to adjust for the Aussie and other factors, leading the average target down from $38.56 to $38.17.

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