How CSL got golden shot in the arm

CSL and CBA are great Australian companies, with different but similarly powerful customer franchises.

Bank customers in CBA's case, of course. CBA boss Ian Narev said on Wednesday that he was still cautious about the outlook, but the 10 per cent higher $7.8 billion June-year cash profit he unveiled showed that he can work the franchise and add productivity gains to produce results that easily outstrip lacklustre system-wide credit growth.

CSL has a network of supplier "customers" in the United States that it services through 80 blood-collecting centres, and a global hospital and health industry customer franchise that consumes plasma and other high-tech pharmaceutical products derived from the blood that CSL collects. It created a powerful global presence by spending more than $2 billion to acquire two other blood plasma processors, ZLB of Switzerland in 2000 and Aventis Behring of Germany in 2004, and has never looked back.

The Behring acquisition in particular was brilliant, and brave. Founding chief executive Brian McNamee watched CSL's shares get slaughtered after the ZLB takeover as investors decided that a global oversupply of plasma products was developing.

The shares fell by 75 per cent between February 2002 and May 2003, but in September of that year McNamee doubled down, and agreed to buy Aventis Behring from the giant Aventis pharma group for just under $1 billion.

CSL's shares were still 68 per cent below their February 2002 high when he announced the Behring deal. But after he completed the acquisition in April 2004 he was in charge of one of the world's two big plasma processors, alongside the United States-based group Baxter. Over time Baxter and CSL brought supply and demand back into equilibrium (totally independently, of course) and CSL's profits soared.

The group earned $219 million in the year to June 2004 as it was tucking Behring under its wing. McNamee's successor, Paul Perreault, announced on Wednesday that earnings in the year to June 2013 had risen by 19 per cent, to $US1.2 billion.

CSL shares slipped by $2.01 or 3 per cent to $65.79 on the profit news, but CSL's track record like CBA's suggests that short-term gyrations should be ignored. Since the turn of the century the S&P/ASX 200 share index has produced a total return - share price gains plus dividends - of 181 per cent. CBA's total return over the same period is 483 per cent, and CSL's TSR is a whopping 1023 per cent. If you measure the TSR from CSL's share price low point in 2003 after the ZLB acquisition, it is even better, at 1892 per cent: anyone who bought then and did not yield to the temptation to sell is very happy indeed.

One of the keys to CSL's relentless improvement is that it has a tailored strategy for the small slice of the global pharmaceutical market it has captured.

The standard "big pharma" model over the years has been to pour money into research and development in the hope of finding the next Big Thing, and then pour money into production and marketing to maximise returns while the Big Thing is protected by patents. The machine needs to be constantly fed, and pharma giants typically run R&D budgets that suck up between 15 per cent and 20 per cent of sales revenue, and marketing budgets that are even bigger.

CSL on the other hand is a manufacturer with an R&D overlay. About 70 per cent of its spending goes on the raw materials it needs, beginning of course with the blood it collects, and pays for. Its R&D budget is not insignificant, but it is smaller than the ones the global pharma giants run. At $US427 million in the latest year to June it was 8.5 per cent of revenue, and it will be about $US480 million or 9 per cent of revenue in the current year.

CSL's R&D spending is, however, tightly focused on its plasma production line, and because of that it has a higher success rate than the more wide-ranging and exploratory R&D programs that the pharma giants run. It has won 17 product approvals in the past decade, 85 per cent of them on its first attempt. Big Pharma's first-up application success rate is about 30 per cent.

There's no guarantee CSL will continue to generate new products that supplement sales and earnings on its mainline plasma products including immunoglobulin, but the history is instructive, and Perreault seems very confident there's enough new product coming through to maintain positive profit momentum. Earnings per share are also being leveraged by share buybacks: a $US900 million one is almost complete, and another of much the same size is being considered.

CSL hasn't entirely backed up its latest 19 per cent profit rise in its new guidance and that's one reason its shares fell. It is pointing to a 10 per cent rise in net profit this year, and a 14 per cent rise in earnings before interest and tax. The Melbourne-headquartered group does, however, appear to have a strategy that makes double-digit earnings growth sustainable: for long-term investors, that's golden.

mmaiden@fairfaxmedia.com.au