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Livewire Markets article – 28 April 2020
In times of crisis, top quality management is more important than ever. There is no script to follow and few parallels to draw from history for these unprecedented times. So now more than ever it is important to have companies in the portfolio which not only have sound business models but also have exceptional management teams. CSL is one such company.
Despite the amazing run the share price has had, CSL remains a solid long term investment proposition. It operates in a global growing industry and occupies a strong position within it. It is well managed, earns a high return on capital due to its numerous competitive advantages and has plenty of opportunities to reinvest which should drive growth for many years to come.
Whilst not excessively cheap based on near term earnings, high-quality companies like CSL have the propensity to surprise on the upside - time and time again.
Two-year chart of the CSL share price
CSL provides lifesaving and largely non-discretionary treatments to seriously ill patients as well as manufacturing the seasonal flu vaccine. The current pandemic has seen increased demand for CSL’s core IVIG products and flu vaccine. It is a credit to CSL’s execution it has been able to maintain consistent supply to all countries, despite country lockdowns and border closures.
However, CSL is not completely immune to some temporary disruption and is currently experiencing a reduction in collected plasma volumes as fewer people visit collection centres and stay home. The impact of this won’t be seen for another 6-9 months due to CSL’s long manufacturing cycle, which provides it with time to work on mitigation strategies to reduce the impact.
In the US donors are paid to give plasma so donation tends to increase in times of high unemployment. As a result, it is likely CSL will see a particularly strong rebound in collected plasma as social distancing measures are relaxed. This will help offset the reduction being experienced right now and may well see CSL gain further market share as it has invested more heavily in its collection network than other fractionators.
1. Working on a vaccine with University of Queensland;
2. Collaborating with several other fractionators to develop a hyperimmune IG (taking antibodies from those who have recovered from COVID-19 to treat high-risk infected individuals); and
3. Polyclonal antibodies and working on some of its existing early-stage biotech products that may be effective as part of a treatment.
These will be ongoing studies, none of which is expected to impact earnings in the short term, but may provide longer-term opportunities.
CSL is exceptionally well managed and has earned a reputation of focussing on patients, investing in its staff, being a reliable supplier of lifesaving products and a consistent executor of a sound business strategy.
It occupies a strong position within its industry and has built up numerous sustainable competitive advantages that have allowed it to consistently earn a high return on invested capital, which should drive shareholder value for many years to come.
The global plasma product market is growing at a healthy 8-10% pa and demand is outstripping supply. Demand for key products such as IG (Immunoglobulins) is being driven by increased diagnosis and awareness of conditions that benefit from IG treatment and supply is constrained due to the fact that CSL has been the only plasma fractionator that has continued to invest and open plasma collection centres over the past decade.
Opening a plasma collection centre requires both financial investment and time – time to get the centre approved and time to draw in sufficient donors to collect enough plasma for the centre to reach scale. CSL had the foresight to continue investing in these centres while its competitors stopped, resulting in today having access to much more raw material (plasma) than its competitors. This has allowed it to gain market share and importantly, consistently supply its lifesaving treatments to patients.
CSL has also continuously invested in best in class manufacturing facilities. The amount of capital required to reach scale and meet the regulatory requirements of plasma fractionation is in itself a barrier to new entrants to this industry.
CSL’s efficiency in manufacturing enables it to extract more product and value per litre of plasma than its competitors, making CSL the lowest cost producer. This results in a higher profit margin and boosts its ability to invest in R&D for new products and therapies.
As mentioned, CSL reinvests a healthy chunk of cashflow back into R&D projects and history demonstrates a high hit rate in successfully commercialising this – a return on investment of over 25%. This goes not only to the talent of the researchers working on the science of each project, but also to CSL’s ability to select projects that have the most promise and the grit to shut a project down if it’s unlikely to stack up commercially.
New product launches to treat a variety of rare diseases as well as improvements on existing therapies have been an important driver of CSL’s profitability. There is a strong pipeline of R&D projects addressing unmet clinical needs. Not all will be successful and these opportunities are impossible to accurately value, but using track record as a guide, there are enough long dated opportunities in the pipeline to underpin good long-term growth.
As well as managing the operational aspects of the business exceptionally well, CSL management along with the board, also have an excellent track record of being good stewards of shareholder capital. CSL’s business is by nature highly capital intensive, however it has still been able to achieve a return on invested capital of well in excess of 20% consistently for many years.
CSL is a good example of how linking management long term incentives to return on capital (which not enough companies do) can benefit shareholders over the long term. This has resulted in CSL investing back in the business where the return justifies the capital and at times over the years, returning excess capital to shareholders.
The nature of biotechnology is that there will always be competing new products and new breakthroughs that may threaten current products. This is why continuing to invest in R&D is so important. There are various therapies in early stages that may threaten or at least change the demand curve for CSL’s products - two often mentioned are gene therapy and FcRn inhibitors.
Both are still in early trial phases and even if successful, the adoption profiles are unknown. It is worth noting that CSL is involved in its own research into these potentially competing therapies, for example acquiring gene therapy company Calimmune, demonstrating a willingness to disrupt itself if necessary.
COVID-19 has not changed CSL’s expected FY20 earnings. Guidance was recently affirmed by the company, however, FY21 presents both challenges and opportunities. Challenges regarding plasma collection volumes and opportunities regarding increased demand for the flu vaccine. The pandemic is likely to raise awareness of the flu vaccine and create a higher level of demand for it. Also, there is the potential to manufacture treatments and/or a vaccine for COVID-19 in the future.
Unlike many other companies through this crisis, CSL does not need to raise capital. Its balance sheet is solid and it has access to a further $1bn in liquidity if necessary.
CSL’s share price has outperformed the market in the recent sell off but is off its highs in absolute terms. Like many healthcare companies at the moment its headline PE is higher than its historic average but using valuation methods which take into account the duration of CSL’s growth prospects and current low interest rates as well as the current market and economic uncertainty, CSL remains an attractive long term investment opportunity.
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