Rudi's View | Aug 15 2019
Dear time-poor reader: early update on corporate results, plus a longer-term assessment of CSL.
In this week's Weekly Insights:
-August Reporting Season: Early Progress Report
-CSL Challenge: The Key Ingredient
-Rudi On Tour
By Rudi Filapek-Vandyck, Editor FNArena
Question: what is a stock that has fallen by -90%?
Answer: that's a stock that falls by -80%, and then the share price halves.
August Reporting Season: Early Progress Report
August is local reporting season for Australian listed companies, but the pace of corporate results releases is so much skewed to the second half of the month that as half-way approaches on the calendar, it remains way too early to draw any definitive conclusions or make far-reaching assessments.
As at Monday, 12th August 2019, the FNArena Corporate Results Monitor still only contains 30 corporate updates. Considering that by month's end the total will have exceeded 300 updates, we have an urge to feel sorry for ourselves. After all, those 300 corporate releases will have to be covered, followed up, updated and summarised. And the slower the season ramps up… you get the idea.
A few early assessments won't go astray (we hope). Corporate Australia clearly is doing it tough. Corporate updates thus far either reveal declining profits, or negative sales growth, or downward pressure on margins, or all three combined.
Subsequent share price responses are often left to management's guidance for the year ahead, potentially supported or negated by hedge funds and other traders taking position prior to the results release.
As such we witnessed Suncorp ((SUN)) releasing a weak result, but with the share price moving higher, and on Friday REA Group ((REA)) missed market expectations, but its share price since put in a notable rally higher. In contrast, CommBank ((CBA)) shares were initially punished upon the release of a weak financial report card, but buyers have since shown themselves.
No such buyers' interest has revealed itself for Insurance Australia Group ((IAG)), whose shares are down quite heavily in a short time, including following the release of disappointing FY19 numbers, and the same observation can be made for Cimic Group ((CIM)), Janus Henderson ((JHG)) and GUD Holdings ((GUD)), whose share prices are all trading significantly below levels prior to the respective results releases.
In the lead-up to August, I predicted investors were most likely to witness a multi-layered experience. The first two weeks are already showing plenty of evidence for this thesis.
We also had a number of major beats, with subsequently solid share price rallies for James Hardie ((JHX)), Pinnacle Investment Management ((PNI)), and Navigator Global Investments ((NGI)). Both ResMed ((RMD)) and REA Group once again proved quality High PE stocks are not necessarily toast, as they have done for many years now.
Continuing on my forecast of a multi-layered August reporting season, Macquarie analysts note companies with direct exposure/leverage to the local housing market have all revealed "headwinds" and tough operational challenges, with each of James Hardie, REA Group, Transurban ((TCL)), CommBank, Mirvac ((MGR)) and Nick Scali ((NCK)) talking the same talk.
But not all housing related business models are similarly vulnerable or operationally exposed with James Hardie and REA Group arguably in a better position than CommBank and Nick Scali.
Macquarie, by the way, continues to recommend investors should buy the dip in selected housing-related businesses, including REA Group, Nine Entertainment ((NEC)), Stockland ((SGP)), James Hardie, CSR ((CSR)), National Australia Bank ((NAB)) and Westpac ((WBC)).
Macquarie's reasoning is that housing will stabilise and subsequently improve on the back of continued RBA rate cuts.
In continuation of recent years, reporting season these days is heavily coloured with capital management (special dividends and share buy backs), as well as with capital raisings. A-REITs in particular are once again using the opportunity to raise fresh capital, but Nufarm ((NUF)), Transurban and AMP ((AMP)) equally have announced fresh raisings.
In terms of general trends, FY19 average EPS growth might not come out too far off the zero mark, predominantly because of another booming performance from resources, in particular iron ore producers and gold miners.
Banks are expected to extend their negative growth period and international industrials are projected to perform significantly better than domestic industrials.
FNArena continues to provide daily updates on Australian corporate updates: https://www.fnarena.com/index.php/reporting_season/
The early data are far from encouraging with decisively more "misses" than "beats" (40% versus 30%) but, as every optimist will tell us, it remains early days.
"August Preview: Lower Rates & Lower Growth"
"Corporate Earnings Still Matter In 2019"
CSL Challenge: The Key Ingredient
The prior update for the CSL Challenge zoomed in on the significant rewards that await shareholders who are able to identify a high quality, structural growth story such as CSL ((CSL)), and then stay on board for the long run instead of losing focus because of temporary and intermediary distractions.
Ever since my share market research focused on finding those exceptional All-Weather Performers in the Australian share market, CSL has been a proud and prominent inclusion of my limited selection. As far as I am concerned, this is by far the greatest corporate success story that has ever sprung from Australian soil. Full stop.
Gamblers seldom decide upon which jockey will be riding the horse; instead they punt on which horse is most likely to win the race. Does anyone remember the names of any of the jockeys that had the pleasure to sit on top of Winx lately?
In similar vein, any quality company can only grow into a true All-Weather Performer thanks to a supportive industry structure. This does by no means imply that only monopolists and oligopolists, largely protected from disruptive competitors, can truly provide investors with sustainable longer term rewards.
But the best video shop can only achieve so much when the industry as a whole remains on its way to ultimate extinction. Similarly, if the world tomorrow would have significantly lesser need for blood plasma, that quality label that CSL has carefully built up over the past 25 years wouldn't account for much in the share market.
Luckily for my research, and for loyal shareholders, global demand for blood plasma has been strong over the past decades, and it is expected to remain strong. Because of ongoing strong demand, the industry as a whole is struggling to keep up with supply, which has exerted itself as one of the key growth limitations for the major players in this market.
CSL has developed into the true market leader in a global competitive segment of the healthcare industry that has been growing at circa 9% per annum in sales/revenues since 2007. At face value, there doesn't seem to be an economic moat to protect CSL's market leading position, but practice has shown otherwise.
Primary access to blood plasma remains key and CSL remains the sole top player who is able to source 100% of supply in-house. It operates the largest and most efficient network of collection centres, which apart from obvious sunk investment and operational costs, comes with above average security checks and regulations.
Moreover, it takes nine months between collection of the blood plasma, treating it and ultimately selling for it to be used for medical purposes. This implies ample of cash flows are required to keep the business running in the meantime.
On top of this all major players allocate circa 10% of annual revenues to R&D plus hundreds of millions on investments in new plants and collection centres. It should surprise no-one this industry has consolidated firmly since the time CSL listed on the ASX in 1994.
It still makes for a highly competitive, but rational environment. Such has been the platform that has allowed CSL to expand its market share and to showcase the qualities of management and staff, providing large and sustainable rewards for all stakeholders.
The continuous investments made in R&D are a key part in this success story as the industry continues to find and develop new treatments and medical products for often rare diseases and life-threatening medical conditions.
To understand the industry and CSL, it is important to appreciate the continuous drive towards new discoveries and further innovation. Outside of the CSL business, there is always someone somewhere trying to develop an alternative therapy or competing product.
The fact that CSL has managed to stay on top of the sector, and to retain largest market share in the two key market segments -immunoglobulins and albumin- is a major statement underlining the company's achievement since incorporation in 1991. CSL has now also become a top two player in the global market for flu vaccinations, which simply further complements the company's cabinet of medals and trophies.
For investors: note the key factors that make CSL a very different beast from, say, Telstra. CSL pays out less than 50% of its profits in the form of dividends to shareholders, but those dividends have steadfastly grown and are projected to continue growing in the years ahead on the back of ongoing improvements in sales and profits.
To keep the comparison with lower quality Telstra going for a little longer: a smart cookie elsewhere once established that if at the time of Telstra's initial ASX-listing in the late 1990s, investors had bought shares in CSL instead, and kept them until today, they would have collected more dividends over the period than loyal Telstra shareholders. And that's not mentioning the sharp difference in share price performances.
CSL spends a big chunk of the other half of the profits it doesn't pay out to shareholders on developing new products; effectively finding new avenues for growth and defending (or increasing) its margins and market share. This is not dissimilar from well-entrenched policies at companies including Cochlear ((COH)) and ResMed ((RMD)). No surprise thus, they too are included in my select list of ASX-listed All-Weather Performers.
Of course, an investment in CSL is by no means risk-free. The industry collects most of its supply in the USA, where it pays for donations. Irrespective, American donors couldn't possibly keep up with global demand increases into infinity. US donors already satisfy two-thirds of global demand. The limitations on supply are currently being examined by governments and regulators in Europe. A small group of European countries already allows for plasma donors to be paid.
China commands that all plasma is collected on the ground, not imported from elsewhere. Luckily for the industry, this is opening up a new source of supply (albeit directly linked to demand in one geographical region). The Chinese market is rapidly growing in importance for CSL and its peers. Rapid growth in China underpins current expectations for the sector globally. As China grows in importance, it also shifts the sector's risk profile.
According to a recent report by Citi analysts, the $4bn Chinese plasma protein market is expected to post a five-year sales CAGR of around 15%, versus less than 10% for the $10bn US plasma market, excluding recombinants.
As a rule of thumb, demand growth as it currently stands, is projected to average circa 8% per annum globally for the decade ahead. This is slightly down from 9% over the decade past. As blood plasma, and its many offshoots, enjoy a multiple in applications and therapies that feed into, and support such expectations, there seems to be a lesser chance for major disappointment attached to these projections.
Investors should note all major players in the industry are by now investing heavily in additional collection. If for whatever reason demand slows significantly, or is being disrupted, this would open up the risk for oversupply at some point in the future.
Again, it has to be noted, CSL has been planning and operating ahead of the curve, enjoying most of the industry benefits in years past when supply was unable to keep pace with growth in demand. On current forecasts, demand will be 40% greater by 2023 and current expansion plans industry wide would simply barely keep up. CSL's own expansion plans imply 40% larger capacity by 2023; plans involve opening 30-35 new centres each year.
Apart from continuously addressing new conditions and diseases, the industry's demand outlook continues to be underpinned by aging populations, and growing awareness still, while lower unemployment rates result in more people paying for health insurance in the largest market, the USA.
On simplistic assumptions, assuming supply keeps up with projected growth in demand, and prices continue to increase in line with inflation each year, while all else remains unchanged, then CSL should be able to grow its revenues by double digit percentage each year.
The task lays then with management to not overspend and keep the costs contained, and shareholders should see 10% or more growth coming their way, year-in, year-out.
Of course, things are never that simple. Products go in and out of fashion, or battle a new competitor or an alternative therapy. Not every major investment might generate the hoped for success or projected return on investment. Not every year delivers a nasty flu season. And so forth.
On current expectations, and with CSL expected to deliver yet another year of double digit percentage growth in FY19, stockbroking analysts are currently predicting FY20 will be a year of slow growth only. This is not that uncommon. It has happened in the past, and should by no means be interpreted as a bad omen for future years.
Analysts at Citi, for example, who have set the highest price target for CSL among the seven stockbrokers monitored daily by FNArena, at $239.60, anticipate virtually no growth next year, but then a jump to 24.5% EPS growth in FY21. Beyond the year ahead, Citi remains convinced CSL is ideally placed to grow faster than the industry, and thus take market share, on a three to five year horizon.
All shall be revealed and updated on Wednesday when CSL is scheduled to release FY19 financials.
In case you read this and you still haven't joined the CSL Challenge, do know you can join at any time, from any place of your own choosing.
Here's more info about it: https://www.fnarena.com/index.php/2019/01/14/rudis-view-join-the-csl-challenge/
Also, paid subscribers have access to my eBooks and other writings about CSL and All-Weather Performers, see the dedicated section on the FNArena website.
Video interview with Peter Switzer and Julia Lee on Monday last week:
Rudi On Tour In 2019
-AIA and ASA, Perth, WA, October 1
-ASA Hunter Region, near Newcastle, May 25
(This story was written on Monday 12th August 2019. It was published on the day in the form of an email to paying subscribers, and again on Thursday as a story on the website. There will be no Part Two this week).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena's – see disclaimer on the website.
In addition, since FNArena runs a Model Portfolio based upon my research on All-Weather Performers it is more than likely that stocks mentioned are included in this Model Portfolio. For all questions about this: email@example.com or via the direct messaging system on the website).
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(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions.)