What's CSL really worth?

No upside from here for this market favourite as the buoyant share price leaves no room for error.

CSL is a high-quality company that has consistently delivered strong earnings and dividend growth for its shareholders for a very long time. It has a positive growth outlook and the research and development pipeline will support future earnings growth.

Unfortunately the stock is priced for perfection and not of consideration at current levels near $65. At current prices there is no margin of safety for any downside risk to earnings. 

CSL has an excellent track record. Dividends have compounded at an annual growth rate (CAGR) of over 20 per cent since 2000, and earnings per share at a CAGR of over 24 per cent. Net profit margins widened from 12.07 per cent to 23.71 per cent in 2013.  
CSL has been remarkably successful at deriving value from its significant acquisitions, achieving economies of scale and operating leverage across the group as it has grown to a $31 billion company. The last financial year was no exception. CSL delivered a strong result which saw sales increase 7 per cent to US$5 billion and net profit and earnings before interest and tax both increase 19 per cent to US$1.216 billion and US$1.486 billion respectively.

Strong margin growth underpinned the result and highlighted its operating leverage. Its EBIT margin expanded from 26.6 per cent to 29.1 per cent due to an improved sales mix, and improved efficiency in plasma collection and manufacturing.

Research and development is CSL’s growth engine, successfully resulting in about 17 new product approvals or registrations over the last decade. In fiscal 2013, CSL ramped up its R&D spend; expenses were up 16 per cent on the year earlier to US$427 million and are forecast to grow 13 per cent in fiscal 2014.

The key drivers of the lift in R&D spend are the later stage trials of recombinant coagulant products as they approach commercialisation to target the $7 billion haemophilia market. Its strong research and development pipeline will support future earnings, as sales and profit growth slows in its core business.

CSL’s leadership position in the industry enables wider new market entry and a greater benefit from new indications, given it produces the largest portfolio of plasma products.

The high stock price reflects investor enthusiasm for CSL and the lack of alternative quality growth plays on the ASX. However, buying stocks trading substantially above intrinsic value incurs the risk of capital loss if earnings disappoint.

As per the below chart, CSL is trading significantly above our valuation (orange) and the consensus mean valuation (black) of the company.
Graph for What's CSL really worth?

Figure: CSL Limited Price vs. Value Chart

Source: www.StocksInValue.com.au hyperlink www.StocksInValue.com.au

Our fiscal 2014 valuation of $51.13 is derived from our adopted normalised return on equity (NROE) of 40 per cent and required return of 12.2 per cent. Even in a bullish scenario using an adopted NROE of 45 per cent, we derive a valuation of $62.39 which is still below current prices, reinforcing our view the stock is overvalued.

So where is the risk?

CSL has grown market share in recent years as it benefited from competitor difficulties and exploited the strengths of its portfolio. Baxter International and Octapharma both suffered supply constraints, however these will ease in fiscal 2014, challenging CSL’s market share.

Baxter’s return to the market, in particular in Europe, is a key risk to CSL’s second half sales, margins and market share. Another risk is further price discounting from Octapharma, which is trying to win back market share following its 2010-11 recall. 

Regulatory change to government reimbursements or contracts could affect earnings, or at worst a ‘scare’ over product quality or safety is probably the most significant unforeseeable risk to intrinsic value.

Its core business Immunoglobulin sales were solid at up 9 per cent year-on-year in fiscal 2013, but showed a clear trend of declining growth -  highlighting the importance of success in its R&D pipeline. The R&D pipeline is strong, however at the mercy of regulatory approval so there is some uncertainty to the future earnings of these products.

CSL has enjoyed 30 per cent CAGR in Chinese albumin sales in the past four years but there is a risk of market share losses to domestic suppliers in the long term. China is increasing its own plasma collection and fractionation facilities and will be able to price lower than global players.

Emerging market volume growth (Latin America, Poland) in Albumin is expected to remain strong, however lower price points in emerging markets will begin to impinge on margins.

Amelia Bott is an Equities Analyst at StocksInValue, a joint venture between Clime Investment Management, a boutique value fund manager, and the Eureka Report. StocksInValue provides valuations of 400 ASX-listed companies by Clime and equities research, insights and strategy that you won’t find elsewhere, by the StocksInValue analyst team. For a free trial please visitwww.stocksinvalue.com.au or call 1300 136 225.

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