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.