Rudi's View | Nov 14 2019
Dear time-poor reader: why CSL continues enjoying upward momentum plus further updates on broker Conviction Calls
In this week's Weekly Insights (published in two parts):
-Positive Momentum Continues For CSL
–Focus On Index Changes
-Focus On Index Changes (2)
–Tickets to Conference on Agricultural and Veterinary Biotechnology [STILL AVAILABLE]
-Rudi On Tour
[The non-highlighted items will appear in Part Two on Friday]
Positive Momentum Continues For CSL
By Rudi Filapek-Vandyck, Editor FNArena
Margin pressure is emerging for collectors and fractionators of human plasma, and this means more good news for CSL ((CSL)), the best and lowest cost operator in the sector.
To understand the industry dynamics it is important to know that operational margins and returns are derived from so-called "last litre" economics. In practice, plasma fractionators end up with two proteins; immunoglobulin (IG) and albumin. Demand for the first continues to grow at 9%-10% per annum while for the latter growth is less than half that.
This is a problem as if a fractionator is left with unsold albumin, even with high demand for IG, the operating margin suffers (and potentially quite significantly too). The current environment is one wherein cost pressures are to the upside, so the combined effect of these two dynamics can be quite profound, if no action is taken by the industry.
UBS analysts on Monday alerted local investors to this. They also made the forecast the most likely decision by the industry is to increase the price for IG and accept that albumin's price will likely become even cheaper as just about everybody tries to collect more plasma to satisfy the high demand for IG. This too implies further upward pressure on costs.
The market for albumin might face the prospect of oversupply, unless China proves its saviour. UBS notes not every player in the industry has equal access to the Chinese market, which means oversupply might materialise in certain regional markets.
Combining these opposing dynamics, and their intertwined impact for the industry, UBS analysts believe the price of IG needs to rise by circa 7% to preserve current margins for major industry participants.
The upshot for CSL is that not only do the company's collection centres operate more efficiently than the competition, the company is also adding additional collection which should translate into enlarged benefits. In simple terms: CSL Behring's margin should expand while competitors are trying to preserve theirs. On top of this come increased revenues and more market share.
This is unlikely a short-term phenomenon and the compounding effect on projected profits and cash flows for CSL means UBS's valuation for the company has jumped to $295 (from $265) on what appear relatively benign upgrades to margin and volume forecasts. Apart from the projected impact that has now been incorporated into the broker's freshly updated modeling, this also implies there remains potential for further upside surprise.
UBS implicitly acknowledges this by explaining it has also modeled an outcome with more and additional upside surprises materialising. This scenario takes the CSL valuation to $319 per share.
Now, there is nothing wrong about getting excited by further upside potential for the quality operator that is CSL, but group profits and margins equally depend on other divisions to perform in the year(s) ahead and not everything tends to always go CSL's way. Some of its sales in the Specialty Products division are under pressure, and are likely to face more pressure.
This, by the way, is nothing unusual. Products come and go, peak in popularity and ultimately might be replaced, either by a new product developed in-house or by the next innovation developed by a competitor. Such has been the dynamic since the company listed on the ASX 25 years ago. This easily explains why 10% of annual sales is reinvested into the business every year.
For the short to medium term, at least, it appears the favourable context for the collection of human plasma is very much favouring more upside for CSL, even with the potential for some sales and margin erosion elsewhere in the group. This is also why UBS is not banking on the ultimate bullish scenario whereby everything plays out positively.
On Monday, CSL shares surged to a new all-time high of $270.56 on the back of the UBS research release. CSL's performance since 1st January has been roughly double the broader market's gain.
Investors should be aware that a sudden violent switch in market momentum between "Growth & Quality" and "Value & Laggards" -a la late 2016- can always put the stock temporarily out of favour with investors. Equally, a sudden bear market for the US dollar would represent a formidable headwind.
As far as operational dynamics are concerned, however, it doesn't look like the CSL success story is nearing its end anytime soon.
The guardians of Wilsons list of Conviction Calls made a few changes since September. GUD Holdings ((GUD)) is no longer on the list as the share price has rallied steeply since bottoming in August. In its place the list now includes Class ((CL1)) and ARB Corp ((ARB)).
Class has been added given Wilsons has turned more optimistic on forecast sales. ARB Corp's valuation had fallen far enough to be considered "compelling".
Other stocks included in the selection of Conviction Calls are EML Payments ((EML)), ReadyTech ((RDY)), Whispir ((WSP)), Ridley Corp ((RIC)), ImpediMed ((IPD)), National Veterinary Care ((NVL)), Countplus ((CUP)), EQT Holdings ((EQT)), Pinnacle Investments ((PNI)), Noni B ((NBL)), Perenti Global ((PRN)), Mastermyne ((MYE)), and Whitehaven Coal ((WHC)).
It has to be noted, Wilsons' list of conviction calls has absolutely smashed it over the past six months with a total combined return of 11.56% versus a Small Ordinaries Accumulation Index that could not muster a positive performance (-1.84%) over the half year ending on 31 October 2019.
Better not to mix up the two, but Wilsons also runs an Australian Equity Focus List. This list saw the removal of Medibank Private ((MPL)) following the health insurer's profit warning last week. Wilsons believes the sudden spike in claims inflation exposes the premium valuation multiple the stock has been enjoying.
National Australia Bank ((NAB)) was kept on the Focus List as Wilsons saw the strongest sector result of the three major banks reporting recently. The absence of a capital raising a la Westpac is seen as an opportunity for the NAB share price to reduce the valuation gap with its peers.
News Corp ((NWS)) equally did not lose its inclusion. Wilsons sees News Corp as a "corporate simplification strategy", which means further disappointment in short term earnings matters less.
Amidst all the market talk about "Value" coming back in favour, it remains remarkable -to put it mildly- portfolio strategists at Macquarie continue to preach caution. Macquarie very much favours a defensive bias with its Model Portfolio comprising some 40% of bond proxies and defensives.
Over at UBS, there is a lot of sympathy for the Macquarie view. UBS's Model Portfolio, however, has large overweights in CSL ((CSL)), REA Group ((REA)) and Altium ((ALU)); the strategists' three most preferred exposures for the twelve months ahead.
UBS does not like InvoCare ((IVC)), Sims Metal Management ((SGM)) or IOOF Holdings ((IFL)) and the Portfolio has made the tactical decision to move underweight AREITs for the month of November. At the same time, the portfolio reduced its underweight in Metals and Mining ex Gold.
UBS still doesn't like the banks and had increased the sector's underweight exposure.
Over at Morningstar, market analysts have updated their Best Ideas (read: stocks with most conviction) by adding G8 Education ((GEM)), Southern Cross Media ((SXL)), and Viva Energy ((VEA)). Domino's Pizza ((DMP)) and Nufarm ((NUF)) have been removed.
Morningstar's list of Best Ideas now contains ten stocks with the remaining seven being Ardent Leisure Group ((ALG)), Computershare ((CPU)), Iluka Resources ((ILU)), Link Administration ((LNK)), Pact Group ((PGH)), Telstra ((TLS)), and Woodside Petroleum ((WPL)).
Tickets to Conference on Agricultural and Veterinary Biotechnology
Pitt Street Research, whose work can also be found on the FNArena website: https://www.fnarena.com/index.php/pitt-street-research/, is organising its inaugural Life Sciences Conference with the focus on Agricultural and Veterinary Biotechnology.
The Conference takes place in Sydney's CBD on November 28th and runs from 8.45am till 1pm on the day. ASX-listed companies presenting include PainCheck, Anatara Lifesciences, Abundant Produce, PharmAust ltd, CannPal, EM Vision and Osteopore.
FNArena has ten tickets available for investors who'd like to attend this event at no cost; paying subscribers receive this opportunity first. If interested, send an email to email@example.com
Last week's audio interview about portfolio rotation and what it means for the Aussie share market:
We created a YouTube channel for such interviews, which was recently upgraded (technically speaking):
Rudi On Tour In 2020:
-ASA Hunter Region, near Newcastle, May 25
(This story was written on Monday 11th November 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. Part Two shall follow on Friday morning).
(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: firstname.lastname@example.org or via the direct messaging system on the website).
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