CSL: Interim result 2017

‘CSL delivers exceptional performance' was the opening line of the results announcement. We have to agree.

Revenue increased 18% in constant currency terms to US$3.7bn due to strong demand for the company's antibody, albumin and specialty products. Underlying net profit was even more impressive, rising 36% to US$806m thanks to the brilliant economics of blood fractionation – which we'll get to in a moment – while underlying earnings per share rose 39% to US$1.77 due to CSL's ongoing share buyback.

But let's put the juicy numbers aside for a moment and get the bad news out of the way. The company's haemophilia products continue to disappoint with sales rising just 2% to US$514m.

Haemophilia is an extremely rare and expensive disease to treat. The cost of treating a 50kg child with a blood-clotting protein known as Factor VIII, for example, can run as high as $300,000 per year.

It's common for governments to use a tender system whereby they purchase large batches of Factor protein via a reverse auction. This introduces an incentive to make medicines more affordable but, as the auctions happen at irregular intervals, it also causes CSL's sales to be lumpier than when it supplies individual organisations with a steady stream of product. CSL won a lower share of a large tender in Poland this half which, among other things, led to a 6% decline in plasma-derived haemophilia products.

Thankfully, man-made haemophilia products (known as recombinant coagulation proteins) picked up most of the slack with sales increasing 15%. This was mainly down to strong sales of Idelvion, a Factor IX protein, following its launch in the US and Europe earlier in the year. Management noted that Idelvion has been extremely popular among patients with strong conversions from the company's older Factor IX products, despite patients tending to be loyal to products that have been successful for them in the past. Haemophilia is potentially life threatening, so the decision to try something new isn't taken lightly.

Behring powerhouse

Haemophilia results aside, there really wasn't anything to dislike about CSL's half-yearly report.

CSL's main division, CSL Behring, increased sales 18% to US$3.0bn, helped by strong demand for plasma-derived antibody products (known as immunoglobulins), which help to prevent infections when a patient's immune system isn't functioning properly. Immunodeficiency disorders affect around one in 10,000 people.

The main drivers of Behring's result were Hizentra, which allows patients to use a portable pump to self-administer their dose by injection under the skin, and Privigen, an intravenous antibody treatment. Sales of Privigen – already the company's top-selling product – increased an astonishing 34% in constant currency terms. The product was also introduced to Australia for the first time following a successful national tender.   

‘Privigen and Hizentra together accomplished over $2bn of combined sales for the very first time. There is significant scope and opportunity to continue to grow both of these products as we focus on gaining approvals for new indications, such as CIDP, as I mentioned in the US for Hizentra, and the expansion of our geographic footprint', said management.

CSL's performance in antibodies has been stellar in recent years. The overall antibody market has grown at 11% a year since 2011, with CSL's sales of antibody products growing at 13% a year. This suggests the company has consistently increased market share.

A major reason for this has been CSL Plasma, the company's network of 160 plasma collection centres. CSL has consistently stayed one step ahead of demand – since 2011, the company has increased the number of US collection centres by 18% a year, compared to only 6% for the rest of the industry.

CSL's deep, reliable source of plasma – a significant competitive advantage – meant that manufacturing could keep up with the sharp increase in demand for antibodies over the past six months, whereas competitors Baxalta and Grifols experienced supply constraints. 

The albumin egg special, please

Revenue from albumin increased a healthy 19% in constant currency terms. Albumin is a concentrate of plasma proteins extracted from blood and used to treat burns, severe blood loss and in various surgeries. Chinese sales led the result, rising 35% thanks to increasing sales to small-city hospitals. Management also singled out Brazil and Turkey as having particularly strong sales growth.

Sales of specialty products – which often have ‘orphan drug status' and get special government incentives – grew 25% thanks to Kcentra and Beriplex. Sales of Berinert, which treats a rare disorder that causes swelling of the face and extremities, were also strong thanks to supply disruptions at competitors.

In July 2015, CSL bought the influenza vaccine operations of Swiss healthcare company Novartis and combined it with CSL's own vaccine business, bioCSL. Seqirus, as the new division is known, is the second largest flu vaccine maker in the world and had a solid second year, with revenue up 14% in constant currency terms. The result was underpinned by the introduction of a seasonal flu vaccine that offers protection against four strains of influenza, rather than three, which garners higher prices.

As we explained in CSL solves chicken and egg problem, the division shows promise despite losing money under Novartis and since CSL bought it. Management said ‘the integration of the Novartis acquisition with our existing bioCSL business is substantially completed and the turnaround in performance is on track for what we expected'. The division broke even for the six months to December, though this is also the strongest financial half due to the Northern Hemisphere flu season. It's unlikely that the division will turn a full-year profit until 2018.

Economies of scale

A large proportion of CSL's costs are fixed, including blood collection centre infrastructure and manufacturing plants. This means that as volumes increase, the fixed cost can be spread across a higher number of sales, giving CSL significant operating leverage. As CSL grows, its margins improve, and it now has higher operating margins than almost all its competitors.

No result in recent years has showed the benefit of these economies of scale more than this one. The company's earnings before interest, tax, depreicaiton and amortization (EBITDA) margin increased 5.25 percentage points to 34.5% due to that delightful combination of fixed costs and strong sales growth. The turnaround of Seqirus was also a contributor and management said margins should continue to expand as the company transitions to the use of more man-made proteins in the haemophilia division and expected growth in high-margin specialty products.

Management expects net profit to rise 18–20% in 2017 and earnings per share are likely to grow slightly faster due to the company's ongoing share buy-back. The stock has more than tripled in the five years since our initial Buy recommendation on 18 Mar 11 (Long Term Buy – $33.97). CSL has a clean balance sheet, several competitive advantages, decent growth prospects and a reasonable forward price-earnings ratio of around 28. We're increasing the price guide and continue to recommend you HOLD.