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I have been a bull on CSL for such a long time that I find the question “should I buy CSL at $330” a little too easy to dismiss. But I do want to answer it because I sense it is a question many investors are asking themselves right now.
While some retail investors did spectacularly well out of backing the privatisation of the Commonwealth Serum Laboratories in 1994 and paying just $0.77 per share (yes, 77 cents), many investors shunned CSL in part because of its very low dividend yield (around 1%) and absence of franking credits. This has also been the case in the institutional market, but more so because investors maintained that the stock was too expensive, particularly when compared to global health care peers.
It was easy to write CSL off when it was a small stock, but now that it is the second biggest stock on the ASX by market capitalisation, with a weight approaching 8% and on track to be the biggest, an underweight position is a big call by a fund manager. In the institutional funds’ management business, consistent underperformance relative to the benchmark index is death. An underweight position in CSL is a huge risk, even for defensive, income-oriented funds, and many managers have been forced into buying CSL to minimise the tracking risk. I think this has been a huge factor in CSL’s recent run up from $270.
An interesting example is Australia’s largest listed investment company, the $8.4bn Australian Foundation Investment Company (AFI). While it has always had a material shareholding in CSL, it disclosed the other week that as at 31 January, CSL was the second biggest holding in its portfolio, marginally behind the CBA, and weighing in at 8%.
Retail investors don’t have to worry about the pressure of institutional mandates and relative performance, and arguably have more time on their side. But that said, when a stock becomes so big, to ignore it is still a major call.
If you are long CSL, I think you just hang on for the ride because the adage “let your profits run” seems to work more consistently than “you never go wrong taking a profit”. If you don’t own any CSL shares or not many, you have three choices: do nothing and ignore; wait to buy in a dip; or get your feet wet and buy some now.
I will answer this shortly but first, what we learnt from CSL’s profit report last week; why many argue that CSL is too expensive; and what do the broker analysts say?
CSL reported a first half year profit of US$1,248m, up 7.5% or 11.3% in “constant currency” terms. This was on the back of a 26% growth in sales of immunoglobulins (blood plasma products) and a strong performance from the Seqirus influenza vaccine business.
Overall, sales revenue rose by 11% in constant currency terms. This included an (expected) fall in Albumin sales in China, as CSL transitions to a new distribution model.
Importantly, CSL raised its guidance for full-year profit from US$2,050m to $2,110m to a range of US$2,110m to US$2,170m. This represents growth over FY19 in constant currency terms of 10% to 13%, and growth in the second half (a weaker half due to the seasonality of influenza vaccines) of 8% to 16% over the same half in FY19.
Management saw continued strong demand for CSL therapies, particularly for immunoglobulins, where global demand exceeds supply. CSL plans to open 40 additional blood plasma collection centres this financial year. On the innovation side, CSL expects to spend around US$1bn on research and development – about 10% to 11% of sales.
Opponents say that CSL is too expensive. Firstly, because at 47.4 times forecast FY20 earnings and 40.2 times forecast FY21 earnings, it is out of kilter with other major companies on the ASX and even with some of its local healthcare peers.
But their main argument is that it is out of line globally with health care companies. They point out that the Australian health care sector is very expensive comparted to the USA. According to S&P, the projected PE (price earnings ratio) for the Australian health care sector is 32 times, while the average for the US S&P 500 health care sector is 17.5 times (as at 31 December).
US healthcare companies are more domestically focussed than those companies listed on the ASX (for example, CSL earns more than 90% of its revenue outside Australasia), or as specialized, so comparisons on this basis are a little fraught. But there are several global giants, such as Pfizer, Merck or Johnson and Johnson (the latter classified as health care, but also very involved in consumer products), which are trade on lower PE multiples.
The brokers are supportive of CSL, but in the main, see it as fairly valued. According to FN Arena, price targets from the major brokers vary from a low of $303.10 from Morgans to a high of $365 from Credit Suisse. While all are positive about CSL’s earnings momentum, the trajectory for growth with its newer products and its competitive advantages in plasma collection, it all comes down to the price. At 47.4 times forecast FY20 earnings and 40.2 times forecast FY21 earnings, it is pretty heady!
With the major brokers, there are 3 buy recommendations and 4 neutral recommendations. The consensus target price is $326.39, 1.5% less than Friday’s close of $331.19. The following table shows the individual broker recommendations.
On track record alone, CSL should be part of your portfolio. Very few companies can match its record of consistent, year-in, year-out sales growth, profit growth, earnings per share growth and dividend growth. If it is not Australia’s best company, it is the top handful.
It has always been viewed as expensive, with the recent run seeing its multiple expand from in the “thirties” to in the “fourties”. And while this looks high, there is nothing to say that the multiple can’t expand further.
While I would like to be “prudent” and say “wait for a market correction and buy it in the dip”, my sense is that there are many investors looking to employ the same strategy. When the market sells off, CSL doesn’t seem to move lower.
So, I think there are only two strategies if you don’t own CSL. Ignore it, or get your feet wet and buy some now around $330.
Important: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regard to your circumstances.