CSL Feels The Currency Pain

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

Blood products producer CSL ((CSL)) has experienced mixed fortunes since the GFC. Pre-GFC the company was quietly conquering the US market, picking up market share as demand increased, such that in the period between the US sub-prime crisis becoming apparent in late 2007 through to Lehman a year later, CSL shares doubled in value. Post-Lehman, and despite the medical (albeit discretionary) nature of CSL offerings, demand dried up.

Demand has since begun to return, slowly, but again CSL has been seeing market share wins as US competitors have run into difficulties. The latest is the product recall forced upon Octapharma.

Those stumblings from competitors have been somewhat of a two-edged sword given market share losers have resorted to discounting, putting pressure on pricing when demand is still fragile. But analysts have been assuming for a while now that the pendulum will swing given an expected return to better demand, both in the US and other regions, along with a tightening of supply. Realistically, CSL should be sitting pretty.

To top things off, from the shareholders point of view, the company itself has been supporting the share price via a buyback as a means to apply the excess cash the company had accumulated which could not be used when CSL's attempted takeover of Talecris failed to gain approval.

But CSL suffers from one very big exogenous problem – that of currency. Some 65% of CSL's blood product revenues come from the US and with a manufacturing base in Switzerland, further currency risks are generated. In the latter case, analysts have admitted they hadn't actually thought that one through.

CSL was able to weather the GFC storm relatively well but the fact the Aussie dollar fell to US60c in 2008 was a big help. But what the financial markets giveth, they also taketh away. The Aussie's recent parity push has proven the offset to repatriated revenues and as such the stock has been trading largely sideways for the past 12 months.

While revenues are undermined by AUD/USD “translation”, there has also been a “transaction” impact from the stronger Swiss franc against the US dollar (USD/CHF). The numbers were revealed at the CSL annual general meeting held yesterday.

Stronger recent trading numbers in plasma have allowed CSL to maintain its “constant currency” FY11 profit guidance of $980-1030m. The “constant currency” measure is a means of comparing apples to apples in the simple business of sales and profits before impacts from currency movements are factored in. But applying AUD/USD and USD/CHF spot exchange rates as at October 8 (about US96c for the Aussie), CSL calculates an FY11 currency impact of $90-110m or about 9%.

Here we can see why CSL provides constant currency guidance given who knows what the Aussie will average through to June next year? CSL has picked the spot rate at the time of calculation but we are now pushing toward parity. Stock analysts, on the other hand, tend to play their forecasts rather conservatively. To that end, analysts' share price valuations are based on numbers around US91-94c, at least until the next round of currency forecast updates. On that basis, and assuming Fed QE2 does finally manifest, forecast earnings for CSL remain at at significant currency risk.

That's the bad news. But the good news, apart from demand for product quietly rising and supply slipping, is the question of market share. Whenever a competitor has run into difficulty with its products the robust CSL has incrementally picked up the crumbs, both in specific market share and in reliability perceptions. Which brings us to Octopharma.

Octopharma was recently forced by the regulators to withdraw its IVIG product, leaving the door open for CSL to pick up further market share. Having examined the market data post the recall, UBS estimates a 15-20% increase in CSL's sales volume in September. This new share could be held well into 2011, suggests UBS.

The problem is, no one knows exactly how long it will take Octa to sort out its problems and return to market with an approved product. Current assumptions are six months but it's really only a guess. A longer period would obviously be beneficial for CSL but there is little doubt that when Octa does return, it will return with steep discounts in an attempt to recapture lost share. Baxter has already tried this on as it struggles to compete.

On a back of the envelope calculation, what CSL is currently losing on the swings of currency impact it is gaining on the roundabout of increased market share. Octa will return to market at some point, but the longer it takes the more likely an improving demand/supply equation will already be working to the advantage of all producers.

So what does CSL management think? Short answer – it doesn't.

Management stopped short of considering any “Octa factor” in its guidance at the AGM, either quantitatively or anecdotally. While analysts would have preferred to hear an opinion from the “inside” as it were, they also appreciate that sheer uncertainty surrounding the timing of Octa's return renders guidance-based assumptions potentially misleading. But what analysts are assuming is that in maintaining its constant currency guidance, which is in itself a good result, CSL is being conservative, and maybe dramatically so.

It is notable that the market's first impressions of AGM guidance was that of a “downgrade” once the currency impact numbers had been revealed. CSL shares plunged about $1.50 in early trade yesterday. But the sell-off was short-lived and a decent recovery followed, probably after stock analysts rushed to tell their institutional clients things weren't really as bad as they seemed.

It then comes down to a matter of value. Here we see a distinct currency risk, as even CSL's US96c “mark to market” is threatening to prove understated and stock analysts are so far working off numbers which are lower still. Mind you, all we need is some US disappointment over QE2, or lack thereof, and the Aussie could be back at US90c before you can blink. Clear uncertainty.

Then there's the Octa factor, and the simple uncertainty on timing. Here most brokers are assuming upside risk, meaning they think Octa will likely be back in the market later rather than sooner. The two brokers most keen on this upside are UBS and Citi, and they are the only two in the FNArena database with Buy ratings on the stock. Everyone else is on Hold, with no changes forthcoming post the AGM, which largely suggests one uncertainty offsets the other.

And it also suggests CSL is currently pretty well valued. The consensus target of $35.32 (down from $35.41 pre-AGM on greater than expected currency losses) is 10% above today's trading price but targets range from $30.33 (RBS) to $40.30 (UBS).

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