CSL takes the fight to the flu

The company has become the second largest influenza vaccine maker in the world after its latest acquisition … but how does its value stack up?

CSL announced the $275 million acquisition of Novartis’s influenza vaccine business on October 27 which, once integrated with bioCSL’s existing influenza business, will make CSL the second largest player (20% share) in the $4 billion global influenza vaccine market behind Sonofi-Aventis (with a 30% share). This will be a strong position during influenza pandemics, when governments urgently buy vaccines.

Novartis vaccines lost $138 million in 2013-14. Forecast integration costs are around $US100 million, which is high compared with the cost of the acquisition, and synergies by 2020 of approximately $US75 million through efficiencies and greater scale.

Although the acquisition is expected to dilute earnings per share (EPS) for at least two years, management thinks it can create a global platform for bioCSL that could mirror the success of CSL Behring, its global protein science business.

The news excited investors with CSL’s share price rising 4% since the announcement. Their optimism is understandable; CSL’s acquisitions have been very successful, achieving scale and operating leverage across the group. Over the near term, however, CSL’s plasma therapeutics business CSL Behring ($4.9 billion revenues in 2013-14) will continue to drive the business.
In August, CSL announced a pleasing 2013-14 result with group revenues increasing 8% on the prior corresponding period (pcp) to $US5.5 billion. Net profit increased 8% to US$1.3 billion, which included a one-off charge of $US96 million from a US antitrust class action. Earnings per share grew 11%, benefiting from CSL’s share buyback program.

Segment results were as follows:

  • CSL Behring (91% revenue) generated revenues of $US4.9 billion, a 10% improvement on the pcp in constant currency terms (cct). Driven by demand in China, immunoglobulin (IG) and albumin were standout performers, growing sales 12% and 16% respectively. Specialty product sales grew 18%. These results were slightly offset by a 4% decline in haemophilia sales due to the conclusion of a number of treatment programs in Europe.
  • bioCSL (8% revenue) generated revenues of $US0.4 billion, a 4% fall on the pcp (cct) due to softer Euro sales, which were only partially offset by stronger demand in US.
  • CSL IP revenue (2% revenue) generated revenues of $US100 million, up 8% on the pcp (cct).  The increase was driven by royalty contributions from human papillomavirus vaccine intellectual property and a new licensing agreement with Janssen Biotech to progress CSL’s acute myeloid leukaemia product currently in development.

CSL has been an extraordinary generator of capital from a declining equity base. Earnings have grown $255 million since 2009-10 while equity decreased by $2.3 billion due to share buybacks totalling $5.558 billion (orange box). Profitability as measured by normalised return on equity (NROE, ‘normalised’ because it includes franking credits) increased substantially from 17.7% to 57.6%. Gearing as measured by net debt to equity is manageable at 40.5%.

Figure 1. CSL five-year performance


Source: StocksInValue

Outlook and risks

CSL is a defensive investment with a strong corporate reputation for quality, innovation and reliability. Its successful acquisitive strategy made it major player in the global blood plasma market. It is cost competitive due to economies of scale and its ability to make a variety of different products from a single unit of blood. Patents and licensing arrangements for its innovative products create substantial pricing power.

Growth in emerging market healthcare expenditure, greater recognition of the benefits of IG therapies, and an ageing population in developed markets should support future earnings.

Competition

The main risk is a material change in output from competitors that would affect the current supply-demand equilibrium. CSL, Baxter and Grifols dominate the IG products markets, accounting for  around 85% of supply. Industry concentration means rational supply decisions are more likely to be made to ensure industry profitability.

Diversification of earnings

Diversification of earnings provides a range of growth channels and reduces earnings volatility. CSL’s sales are geographically diversified with North America its largest market at 42% of sales in FY14. Immunoglobulin is the main product segment, generating 43% of revenues.

Figure 2. CSL FY14 group sales by (a) region and (b) major product


Source: CSL

Research and development

As sales and profit growth slows in its core business, CSL is increasing R&D investment to drive future earnings growth in developed markets. Successful licensing of innovative products will provide a competitive advantage and diversify earnings. The R&D program has been very successful, resulting in some 17 new product approvals or registrations in the last 10 years.

CSL's strategy of taking existing products to new markets has made Kcentra, a coagulation factor replacement product used in urgent surgery, the standout performer after recently gaining US FDA approval.

Figure 3. CSL R&D spend ($US million)


Source: CSL

Regulatory risk

Regulatory change to government reimbursements or contracts could affect earnings. Although the company's plasma-derived products are non-discretionary, economic conditions are challenging as governments worldwide scrutinise their healthcare budgets.

CSL is also at risk of other regulatory interventions, for example over product safety, which affect impact sales and reputation. A scare over product quality or safety is probably the most significant unforeseeable risk to intrinsic value.

Valuation

Our view of sustainable return on equity, 51%, is slightly below consensus at 53% in 2014-15 (red boxes below). CSL will continue its capital management program, having announced further on-market buybacks of up to $950 million following $882 million in buybacks in 2013-14. The dividend (D)-reinvestment (RI) split shown in the green box reflects 70% capital returns to shareholders (expected dividends buy-backs). The high proportion of capital leaving the business via buybacks biases the dividend yield lower (orange box).

We adopt a low required return of 11%, reflecting CSL’s dominant position in blood plasma therapeutics and strong operational performance. We derive an equity multiple of 10.9times and 2013-14 valuation of $72.37, rising to $73.58 in 2014-15. CSL is currently trading above intrinsic value.

Figure 4. CSL valuation and value metrics

Source: StocksInValue

By Jonathan Wilson, Analyst StocksInValue