Blood Money at CSL

On our own shores, Commonwealth Serum Laboratories operates in a related field with a biotechnology division. Since the floatation at a price of $2 by the federal government in May 1994, CSL has increased 361%. It's an astonishing story with a lot of life left in it yet.

The company develops, manufactures and markets pharmaceutical products of biological origin and is in a highly monopolistic position, with high barriers to entry to prevent easy access by competitors. Even if a competitor were to take it on, CSL's intellectual property and process abilities would be hard to replicate. In this industry set-up costs can often bleed a company dry before any financial benefits are seen so CSL's dominant position is pretty safe.

Patent protection protects R&D

As you would expect, R&D spend is high. New products undergo intensive clinical testing before a request is made for regulatory approval. The overall process can take from five to ten years before product commercialisation begins. The business works in a way where patents are established to protect a product or technology with a cap placed on the competitive forces, giving the high R&D costs plenty of recovery time. There are usually several research and development programs at various stages at any one time, focusing on advancing existing products and developing new products.

The company has five operating divisions, with profitability broadly being derived from the Bioplasma and Pharmaceutical divisions (76% of EBIT for year ended June 1997).

The Bioplasma division is the most profitable for CSL, generating EBIT margins in excess of 18%. The company is the exclusive manufacturer in Australia of products derived from human plasma. Through a project funded by the Federal Government, the Red Cross supplies plasma to CSL for manufacture of plasma derived products. The main bioplasma products include clotting factors, immunoglobulins and plasma volume expanders.

Volume growth is just as important as product growth. Between $15-18m is earmarked to upgrade and increase capacity at the existing Broadmeadows plant in Victoria with offshore expansion also under consideration. In an effort to replicate its technology overseas, Poland has been identified as a market where the government is increasing its attention to health care issues. CSL is part of a private consortium of US and Polish investors who are funding the construction of a plant in Poland using CSL technology. At no capital risk, CSL will derive royalties from sales. The company will endeavour to replicate this type of relationship across the European region where political and healthcare issues are favourable.

The Pharmaceutical division deals with child and adult vaccines and benefits from the Government focus on national immunisation programs. The major product for CSL is an influenza vaccine called Fluvax allowing CSL to hold a dominant market share in what is a fast growing market. CSL's portfolio, however, is quite diverse and includes vaccines, antibiotics and pharmaceutical products. The company has been keen to establish partnerships/allegiances the world over including supplying vaccines to UNICEF and the World Health Organisation and expanding its reach into new markets like South Africa.

Other divisions supplementing the Bioplasma and Pharmaceutical are Veterinary and Biosciences. Again these are market leaders in the development, manufacture and marketing of vaccines for the prevention of disease in farm livestock and pets. CSL is keen to license its technology in this area internationally and begin exporting products.

The Biosciences division develops, manufactures and markets blood banking, human diagnostics and cell culture products and services. The company also owns JRH Biosciences Inc. which operates in the US and Europe and is involved in similar activities to its local counterpart as well as serum products.

Strong fundamentals

With superior technology and intellectual capital, CSL has a rosy future, a view that the market has endorsed. It's able to generate substantial cashflows that amply cover R&D requirements, leaving the company debt free with the ability to grow as domestic and international markets expand. Replication of their technology on a worldwide basis is still at an infant stage but if successful the opportunities are immense. As with pharmaceutical companies, collaborations with international companies will continue to assist in product commercialisation.

Importantly, CSL has very limited exposure to Asia (contributing less than 2% of sales) and its growth is monopolistically driven, protecting the earnings base from external shocks. The recent decline in the share price provides investors with a great opportunity to purchase shares in a quality growth stock at lower levels. BUY below $10.00.