CSL: Interim result 2014

CSL‘s interim result produced no real surprises with revenue increasing 6% in constant currency terms from a year ago to US$2.7bn. Underlying net profit increased 8% to US$685m (which excludes a one-off litigation settlement of US$39m after-tax) and underlying earnings per share increased 12% to US$1.41 thanks to CSL’s ongoing share buyback. An interim dividend of $0.59 was also declared (unfranked, ex-date 12 Mar), up 21%.

CSL’s huge plasma products division, CSL Behring, increased sales to US$2.4bn, up 6% in constant currency terms. The result was boosted by strong demand for the company’s various antibody products (also known as immunoglobulins) which help to protect patients against infection when their own immune systems aren’t functioning properly. Intravenous treatments Carimune and Privigen, as well as the self-administered Hizentra, were among the top performers.

Albumin sales were up 7% to US$313m after a warning from the European Medicines Agency about a substitute for albumin thwarted CSL’s competition. Sales also increased 20% in China from a relatively low base. 

Haemophilia product sales fell 4% to US$550m, primarily due to an ‘uneven tender process’. We’re not exactly sure what chief executive Paul Perreault meant by this, but this division is crucial to CSL’s future as it contains several potential rock star treatments currently in clinical trials.

The much smaller BioCSL division also suffered falling sales, down 7% to US$217m, particularly due to flagging influenza vaccine sales after BioCSL’s European business partner exited the region. In contrast, sales of cervical cancer vaccine Gardasil were strong, especially in Australia, which partially offset the lost revenue.

Orphan drugs

The hero of the result was the Specialty Products unit, which increased sales 16% to US$403m following FDA approval and the successful launch of Kcentra (see Shoptalk).

Kcentra has ‘Orphan drug status’ which includes drugs developed specifically to treat rare medical conditions. Various financial incentives and more generous marketing approvals are used to incentivise companies to research drugs that would otherwise be neglected. These special conditions mean Kcentra is among CSL’s highest margin products and it’s phenomenally expensive – a single dose typically costs $5,100 for an 80kg patient. But, perhaps more importantly, CSL has the right to market Kcentra exclusively in the US for seven years, showing the benefit of CSL’s large research and development expenditure.

Litigation impact

As we explained in CSL reaches price-fixing settlement on 8 Oct 13 (Hold – $65.45), CSL settled a four-year legal battle that alleged the company conspired with its major competitor, US-listed Baxter, to restrict output and fix the price of immunoglobulin and albumin for several years. The settlement of US$64m was a relatively favourable outcome given the plaintiffs were claiming more than US$1bn.

The US Federal Court approved the settlement on 22 Jan 14 so earnings were reduced by US$39m after tax. This also prompted management to reduce its forecast full-year profit growth from 10% to 7%.

CSL’s share price has now doubled since our initial Buy recommendation on 18 Mar 11 (Long Term Buy – $33.97), and is up 152% since its low of $27.05 in September 2011. Now on a forecast price-earnings ratio of 25, CSL is a classic example of where holding a high-quality business for the long term clashes with maintaining a margin of safety.

Holding the amount of profit that the company pays out as dividends steady, we estimate that CSL would need to increase earnings per share by around 14% a year for at least another five years in order to produce a double-digit return to shareholders, assuming the price-earnings multiple remains above 18. That’s a tall order for most businesses, but we wouldn’t rule it out given CSL’s dominant market positions, pricing power, large research and development budget and pristine financials.

In the absence of a margin of safety, and the fact there have been regular opportunities over the years to pick this company up on the cheap, we’ve decided to sell our small position from the model Growth Portfolio (see below).

But we see CSL as one of the few large Australian-listed businesses that could be much bigger in the future than it is today as it expands its markets and suite of treatments, so we’re slightly increasing the Sell price in our recommendation guide to $75. However, our recommended maximum portfolio weighting remains at 6% and, if you have a large position in the stock, then you should consider taking some profits.

The share price is down 4% since CSL nudges Sell price on 20 Jan 14 (Hold – $69.95), so we’re sticking with HOLD.

Note: We’re selling 150 shares of CSL from the model Growth Portfolio at $66.98 per share, netting proceeds of $10,047.