CSL tackles leading cause of death

Innovation is the cornerstone of the pharmaceutical industry. To stand still is to fail. CSL's share price has nearly ten-bagged over the past decade thanks to its research facilities consistently churning out successful products like the HPV vaccine Gardasil. But as it's the coming decade that matters now, we recently attended the company's research and development (R&D) day to see what potential blockbusters the company has in store. 

Gone are the days where R&D was a lone scientist peering into a microscope and yelling 'eureka!' – CSL has streamlined the research process using a 'hub and spoke' model built around its flagship Bio21 Institute within the University of Melbourne. This helps the company build essential relationships with academics, patients and clinicians from the nearby hospital in a similar vein to that used by Cochlear at its Macquarie facility (see Cochlear factory tour).

Nonetheless, R&D is inherently risky due to the high upfront cost, long lead times and uncertain outcomes, so CSL has a large and diversified portfolio of drugs in the pipeline. Let's analyse the most exciting prospects.

Haemophilia

CSL is known for producing treatments based on isolating certain compounds from blood plasma. However, Haemophilia treatments made artificially by modifying proteins – so called  'recombinant manufacturing' – now make up more than half of the Haemophilia segment's sales, a trend the company expects to continue.

CSL is currently seeking approval for a long-acting version of the Factor IX coagulation protein, which has been fused to albumin. The albumin-fused Factor IX is a significant improvement on existing therapies, such as Alprolix made by competitor Biogen.

It remains in the blood five times longer and comes in a more convenient 14-day dose compared to Alprolix's 10-day dosage. Phase 3 trials are now complete and the compound is awaiting registration. If granted, CSL's advantage should increase market share. 

The holy grail, however, is to develop a long-acting Factor VIII protein to treat Haemophilia A, which is the most common form of the disease. Existing treatments have already extended the life expectancy of patients from 20 years to almost that of the general population, but they need frequent doses that can cost hundreds of thousands of dollars a year. A stable, long-acting Factor VIII would dramatically improve the lives of patients and cut costs.

Chief scientific officer Andrew Cuthbertson has allocated the company's most senior researchers to the project, though it will likely take many years to get results and many more after that to bring a product to market.

Breakthrough!

What really got us excited was the potential goldmine CSL has found in the waste material from making Haemophilia products. The company realised that the blood plasma left over during the extraction process still contained 'good cholesterol' known as HDL.

Purifying the active component of HDL, dubbed 'CSL-112', and injecting it directly into patients flushes 'bad cholesterol' from the body, dissolves life-threatening plaques that clog arteries and reduces the chance of heart attack. It appears to work much faster than existing cholesterol-lowering drugs, which are slow-acting and offer little benefit in the weeks following a heart attack, right when a patient needs them most.

Cardiovascular disease is the leading cause of death worldwide, so CSL-112 could be a game changer for CSL and patients. Total sales of cholesterol-lowering drugs already top $100bn a year. The fact that CSL could produce the product at very low lost from the waste portion of plasma is remarkable, and is an example of why we've been reluctant to sell this business despite its seemingly high valuation.

CSL-112 is the company's first foray into cholesterol-lowering drugs and, as it's only at Phase 2 of the approval process, success is not guaranteed. If it is eventually approved, a commercial product won't be available before 2020.

Given the huge potential market, CSL-112 would also require a different business model to most of CSL's other products, which treat small populations suffering rare illnesses. The company may choose to license CSL-112 to a distribution partner in a similar way to CSL's Gardasil arrangement with US-based Merck.

Antibodies

The development of CSL-112 epitomises CSL's innovative culture but the company's plasma-extracted antibodies (a.k.a immunoglobulins) still generate nearly half of total revenue.

During the year, expanded approval was granted for Hizentra, a treatment administered at home for people with defective immune systems. Hizentra has been around for several years in a once-per-week dosage, but CSL received approval this year for a more convenient biweekly dosage in Europe. The company also expects approval in the US within 12 months. Modifying existing drugs and gaining expanded approval like this can add years of additional value to CSL's products.

The expanded approval couldn't have come at a better time. CSL's main competitor, US-based Baxter, experienced supply constraints in 2013 due to the temporary closure of one of its manufacturing facilities which is being upgraded. Baxter then directed its limited antibody supply away from Europe to the US where prices are higher. The hole in the market left by Baxter combined with Hizentra's more convenient dosages helped increase CSL's European market share and increase overall sales of Hizentra by 19% for the year to 30 June.

CSL's share price is up 12% since CSL buys flu vaccine maker from 29 Oct 14 (Hold – $77.38) and is currently hovering over our previous Sell price with a forward price-to-earnings ratio of 26. Normally that would be reason enough to sell, but this compnay just keeps on finding new ways to add value through new products, extending the lives of existing products and acquisitions.

We're going to take the same approach that we've adopted for other fast growing companies like Sirtex Medical, where the range of potential outcomes is wide. We're dispensing with the recommendation guide and using the portfolio limits to guide our recommendation. If CSL has become a large position in your portfolio given that the share price has nearly tripled since our original recommendation several years back, then consider taking profits as the share price increases. If we eventually get to a price that seems too much of an obstacle then we'll downgrade to Sell. Conversely, all things being equal, if the price-to-earnings ratio falls back to the mid-teens we'll consider upgrading to Buy.

We've nudged the share price risk up a notch to reflect the high valuation, but for now with the company continuing to increase its competitive position and well placed to benefit from a lower Aussie dollar, we're sticking with HOLD.