- Brokers split on Mesoblast
- Teva holds the cards
- Wide price target range

By Andrew Nelson

When you look at a broker report on Mesoblast ((MSB)) you’re most likely greeted with news not about the company, but rather speculation about its admittedly key partner, Teva. Brokers tend to even couch their opinions and recommendations with Teva justifications like: we’re negative on Mesoblast because Teva....., or we’re positive on Mesoblast because Teva.....

Mesoblast is a developer of biological products for regenerative medicine, with its core product being proprietary stem cell based adult mesenchymal precursor cells. The products from these cells can be used to target cardiovascular conditions, diabetes, inflammatory conditions of lungs and joints, eye diseases, bone marrow cancers, bone fractures, cartilage degeneration and musculoskeletal conditions. This is a pretty big market.

And just so we’re all on the same page here, Teva is a global generic pharmaceuticals company and is also one of the top 15 pharmaceutical companies in the world.Teva specializes in the development, production and marketing of a wide range of both generic and branded pharmaceutical products.

To get Mesoblast’s products from the laboratory to the market is an expensive process and Mesoblast has thus partnered up with Teva to commercialize their adult stem cell products. Treatments are to target degenerative conditions of the cardiovascular and central nervous systems, but will also look at developing products for augmenting bone marrow transplantation in cancer patients.

The problem brokers are having is not really about Mesoblast’s technology, as almost every broker out there agrees this is likely to be great stuff. The real issue debated by analysts is the support (or lack of) that’s being offered by Teva. Mesoblast just won’t be able to make money until Teva spends a whole lot in testing and then marketing these products. Thus, attention from Teva is crucial in trying to figure out when and how much money Mesoblast is likely to make.

Analysts at Macquarie reckon Teva isn’t all that interested in Mesoblast’s products and fear they could even fall off the plate as Teva looks to rationalise costs in the currently tough global macro environment. Analysts from Deutsche Bank see the exact opposite, with both Credit Suisse and BA-Merrill Lynch sitting somewhere in between.

Earlier this week, Teva held an R&D briefing and according to Macquarie, when asked if it was going ahead with a 1,700 patient trial with MSB, Teva offered no new commentary, simply repeating what it said a few weeks back. Phase III trials will occur, but with an early efficacy analysis. Thus, while the broker was happy to hear Teva confirm that a trial will take place, its interprets this “early efficacy analysis”  qualifier as meaning Teva does not yet have the confidence to proceed directly to a full phase III trial, and instead wants some reassurance first.

These creeping doubts saw the broker cut its valuation and lower its price target to $4.20 from $5.40 and maintain its Underperform call yesterday. This is the glass half empty scenario.

On the other hand, analysts at Deutsche remain at Buy, making no change to their $8.00 price target. The broker notes that Teva confirmed it will discontinue at least five phase II/III programs, but Mesoblast is notably not one of them. 

To the broker, this means congestive heart failure and bone marrow transplant programs remain on Teva’s agenda. In fact, the broker points out that Teva specifically said it intends to proceed with the phase III trial of Mesoblast’s Revascor for congestive heart failure, which as far as it is concerned, confirms Teva’s commitment to the project. Thus, Deutsche continues to see significant upside on offer to its price target and sees no reason to shift from its Buy rating on the stock, with additional news flow on the testing likely to provide catalysts for the share price. That’s the glass is half full argument.

The last broker to comment on Teva’s R&D day and the implications for Mesoblast was Credit Suisse, yesterday confirming Deustche’s view that Teva will proceed with a Phase III trial of MSB’s Congestive Heart Failure treatment, probably sometime in early 2013. However, the broker also flagged as being significant that Teva would be looking at interim analysis of the trial data. Thus while CS shares Deutsche’s confidence the tests will begin soon, it also shares Macquarie concerns the trial could well be discontinued if the interim results are less than favourable.

Similar to the other brokers, 50% of Credit Suisse’s valuation is based on the congestive heart failure product. Thus it has chosen to wait for further details regarding the timing and interim feedback from the FDA trial submission before its willing to update its Neutral call and $7.40 price target.

BA-Merrill Lynch didn’t cover Teva’s R&D day, last commenting on the stock towards the end of November. At that point, the broker continued to see significant positives from the trial when it is eventually undertaken. The broker did admit some uncertainty, which is why it lowered its price target to $9.31 from $10.32, but the Buy call was maintained.

The FNArena Database shows the stock is favourably regarded, with two Buy calls, one Neutral and one Sell. There is currently 20% upside to the consensus price target in the database, however a wide target range of $4.20-$9.31 undermines the value of a consensus target in this case.
 

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 - CSL surprises with earnings guidance upgrade
 - Brokers adjust forecasts and price targets
 - Signs momentum may extend into FY14
 - BA-ML upgrades to a Buy

By Chris Shaw

Blood fractionator CSL ((CSL)) surprised the market yesterday with an upgrade to FY13 earnings guidance, the company now expecting constant currency net profit after tax growth of 20%, up from 12% previously. 

As JP Morgan notes, around 50% of the upside is due to improving sales growth and a better sales mix. Given a recent 2% price increase on Privigen sales in the US had already been anticipated, the broker suggests the mix shift reflects higher priced US Privigen sales outstripping European sales. There are also signs of increased Privigen and Hizentra market share and increasing Albumin volumes into China.

For Macquarie, the upgrade to guidance from CSL is justification for the company's strategy, which is to first maximise throughput and increase market share in response to a major competitor's product recall, before turning attention to efficiencies and margins. 

The increase to guidance also underscores CSL's strong market position in Macquarie's view, as the company has the market leading sub-Q Ig product, the highest share of the Chinese albumin market and structural cost advantages relative to peers.

Macquarie suggests a number of these drivers could support margins for some time yet, which implies further margin expansion into FY14 and FY15. Given CSL is currently guiding for flat long-term margins, this suggests upside risk to earnings forecasts in coming years remains. 

To reflect the revised earnings guidance of management brokers across the market have lifted forecasts for CSL. Macquarie's net profit after tax estimates have risen 4.% this year and 5% in FY14, while UBS has increased its FY13 forecast by just over 6%. 

Consensus earnings per share (EPS) estimates for CSL according to the FNArena database now stand at 242.8c for FY13 and 276c for FY14. The increases to earnings forecasts have driven price targets higher, the consensus target in the database moving to $51.71, up from $46.65 previously. There remains a wide range of targets, spreading from CIMB Securities at $45.33 to Macquarie at $55.00.

There also remains a spread in ratings, as the database shows CSL is rated as Buy four times, Hold three times and Sell once. BA Merrill Lynch has joined the Buy ratings, upgrading from Neutral given improved valuation in the stock thanks to the stronger than previously expected earnings and some expansion in price to earnings growth multiple for the stock.

Macquarie agrees CSL is a Buy, given the view yesterday's upgrade from management may signal the beginning of a period of margin expansion for the company. This reflects the potential for further margin benefits as the company maximises the benefits from recent market share gains by improving operating efficiencies.

Competitors are also supply constrained at present according to JP Morgan, which is a positive for both margins and market share. As well, share price support is expected from a $900 million share buyback that at present is only 10% complete.

Valuation is the driver of Credit Suisse's Neutral call (CSL shares hit an all-time high price yesterday), as while the broker suggests CSL should achieve above market growth for at least the next 12 months the stock is trading on a 12-month forward earnings multiple of just over 20 times. This is a 60% premium to the ASX20 Ex Financials, well above the five-year average premium of 39%.

Citi's (Sell) concern is that CSL's current momentum won't be sustained beyond FY13, especially as competitor Baxter is likely to be back operating at full strength in FY14. This means while double-digit earnings growth should still be generated it will be down from the 20% expected this year, making it difficult to justify the current share price.

Shares in CSL today are slightly higher in a weaker overall market and as at 11.45am the stock was up 3c at $50.04. This compares to a range over the past year of $29.61 to $50.55 and implies upside of around 3% relative to the consensus price target in FNArena's database.

 
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-Agreement on pathology overspend
-Sonic sees 1.1% reduction in revenue
-Brokers generally positive on the news
-Investigation into collection centres

By Eva Brocklehurst

An agreement has been reached between the federal government and the pathology industry regarding the 'overspend' on Medicare benefits in 2012, and the outcome was generally better than expected. Sonic Healthcare ((SHL)) has stated it will affect around a 1.1% reduction in pathology revenues and Primary Health Care ((PRY)), which has not commented, is presumed by brokers to be similarly affected. Brokers had generally been penciling in around a 2% reduction so considered the news quite positive.

The funding adjustment involves price cuts to the Medicare Benefits Schedule (MBS) to bring spending under control and will be implemented from January 1, 2013. The provisions are designed to claw back the overspend, seen at around $43m, over 18 months. The price reduction will be achieved through two separate measures, firstly a 0.67% reduction in the price of pathology items on the MBS (ex Vitamin D tests) and, secondly, a reduction in the price paid for Vitamin D tests from $42.55 to $39.05. A practice that was bulk billing would see a reduction of $3.50 per test and non bulk billing practice in receipt of only 85% of the MBS price would see a reduction of $2.90 to $33.30.

Citi finds there is no impact on forecasts as its outlook for both Sonic and Primary incorporated a 2% funding cut and assumed around half to be offset by cost savings. There is modest upside risk to for earnings in the order of 1-2% if either elects to offset the cuts this way. Citi notes risks still remain for Sonic offshore, however, as this company is facing earnings pressure in its businesses in Germany and the US. The broker forecasts earnings growth of 8% in FY13, 10% in FY14 and 9% in FY15 and rates the stock a Hold. However, for Citi, Primary shares have now rallied more than 40% in the past 6 months and thereby earn a downgraded rating to Hold from Buy. The target price is $4.07.

Deutsche finds the outlook for local pathology operations has been boosted by the outcome of the negotiations but takes a different tack on its stock preferences. This broker sees valuation upside for both but Primary is preferred, given the funding uncertainty Sonic faces in Germany and the US. So, a Buy rating on Primary and a Hold for Sonic. The revisions to Deutsche's earnings estimates resulted in small upward adjustments to its price targets to $4.35 (from $4.20) for Primary and $13.55 (from $13.35) for Sonic. Goldman Sachs also took the opportunity to revisit its Australian FY13 revenue growth assumption for Sonic and has made an earnings upgrade of 1% for FY13-FY15. The $12.75 target price is unchanged and the broker notes, without material acquisitions, Sonic is likely in FY13 to deliver no more than its historical range of 6%-8% organic earnings growth.

BA-Merrill Lynch notes Primary's Australian pathology represents a higher proportion of revenue (at around 56%) than for Sonic. However, as Primary's earnings are dominated by the Medical Centre division, the impact to earnings is not as severe as the high proportion of revenue implies. BA-ML considers Primary's earnings growth has been mixed recently but the stock's outlook has now stablised. The downside risks for Sonic, where the broker has a $13.90 price objective, are further regulatory reform in pathology (in overseas markets) and increased competition from domestic competitors.

On the FNArena database the consensus target price is $13.76 for Sonic with five Holds and three Buys. For Primary the consensus target is $3.86 with one Sell, four Holds and three Buys.

The other aspect to the industry the government is looking at is the collection centres. An investigation will be undertaken into rental levels and competition associated with deregulated pathology collection. The brokers are not optimistic for anything revolutionary to come out of this review, particularly in terms of earnings for pathology operators. Deutsche said it was a positive development as it opens the door to potential reforms which could reduce the upward pressure on rental costs. BA-ML said speculation has been rife that deregulation has resulted in GPs being paid high rents to direct pathology referrals. If the review can crack down on this practice and curtail the rental impost on the pathology companies, then the broker sees out-year margin relief/upside. Again, not much is expected in the way of action as it would involve the government eating humble pie on deregulation, but it could put the brakes on any further rent rises that are still incrementally eroding margin.

UBS also notes examples of extreme rents to GP practices to secure co-located collection centres as the pathology industry continues to aggressively expand its footprint. Its recent channel checks suggest that rents for collection centres are now at levels where the work being secured through each new centre is unlikely to be profitable. UBS also identified situations where the rent being paid for the collection centre is greater than that paid for the entire premises of the GP practice. Nevertheless, most brokers expect the government will be reluctant to re-regulate the sector and hence the potential for material changes which reduce costs is modest. 
 

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