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Why CSL is a top 10 business

Local investors searching for world-class businesses have limited options. But in the area of health, Australia has managed to produce some truly world-class companies.

Sonic Healthcare, Cochlear and CSL have all graced our buy list (as has New Zealand-based Fisher & Paykel Healthcare) and CSL and Cochlear made it onto our coveted Australia’s 10 Best Businesses list.

Since floating in 1994 at $2.30 a share (the equivalent of 77 cents today, following a three-for-one share split in 2007) blood products manufacturer CSL’s share price has risen nearly 5000 per cent, to around $37.

Shareholders have also banked over $5 per share in dividends. This success is no accident.

We pay four times as much for Panadol than generic paracetamol because people are careful about what enters their body.

This is especially true with blood products, where without careful control viral infections such as human immunodeficiency virus (HIV) and hepatitis can easily spread.


That gives companies operating in this market strong pricing power. In addition, CSL enjoys two important barriers to entry.

First, strict licensing regulations make it costly for would-be competitors to enter the industry.

Second, even if a new entrant passes the first hurdle, it has to sustain large losses until volumes reach a point where it can compete with the incumbents—this is an industry with substantial economies of scale.

Most companies don’t make it, which explains why the market is equally divided between three big operators.
The story gets even better.

As countries become wealthier, they spend more on healthcare. With two thirds of CSL’s potential consumer base located in emerging markets, it’s almost certain that its market will continue to grow.

Usage is increasing for other reasons, too.

Up until the 1970s, hemophilia treatments were rudimentary; life expectancies were low.

Now, thanks to new treatments, sufferers live long enough to have children of their own, some of whom inherit the disease. This has significantly expanded CSL’s market.

Lastly, as is common in healthcare, new uses are found for existing products, which goes some way to explaining why CSL’s return on incremental capital employed has exceeded 50% per year for the past decade.

These factors alone make CSL an attractive investment proposition. The quality of its management is really icing on the cake.

Consider for a moment how unusual it is to find effective management in highly profitable industries.

Too often they become lazy, avoiding difficult short-term decisions at the expense of longer-term performance. CSL’s management hasn’t let success breed complacency.

It has waited patiently to capitalize on industry consolidation through a series of shrewd, strategic acquisitions.
Shareholders aren’t treated as patsies, either.

When the proposed buyout of Talecris (since acquired by Spanish-based Grifols) collapsed in 2009, CSL swiftly announced a share buy-back instead of splurging on an ill-conceived acquisition.

This is a management team with its collective ego in check.

What of the competitive environment?

The industry is split equally between Baxter, CSL and recently merged Grifols-Talecris.

New competition is unlikely but continued exceptional profitability relies on these players competing rationally, which means not too competitively.

There’s always a risk that landmark discoveries might create wholesale changes in industry dynamics but, thus far, research and development expenditure is producing incremental rather than revolutionary change.

Another potential threat to profitability comes from governments cutting back on healthcare spending.

Evidence from the US (CSL’s key market) suggests these cuts will allow only modest price increases, although the risks of more dramatic impacts remain.

Finally, there’s the operational risk of contamination of a product batch that could result in products being banned from sale, something that smaller rival Octapharma recently experienced.

The strength of CSL’s franchise, balance sheet and profitability mean it should carry these types of temporary setbacks with relative ease.

This is a company not subject to the whims of the economic cycle; CSL enjoys growing demand that should see earnings rise by around 5 per cent per year; and it can fund continued share buy backs from operating cash flow, further boosting earnings per share.

For these reasons, this is not a business one should sell lightly.

The share price of even the best blue chip stocks can move around much more than their intrinsic value and CSL is a case in point. Last year, there was a chance to purchase it for $28 per share.

Indeed, for most of 2011 we were able to recommend CSL as a "long-term buy" when it was trading at around 16 times earnings. Back then, it was the classic example of a good business at a fair rather than cheap price.

Should the share price dip back below $33, CSL would be worth serious consideration from growth investors.
This article contains general investment advice only (under AFSL 282288).

Nathan Bell is research director at Intelligent Investor. BusinessDay readers can enjoy a free trial offer. For more Intelligent Investor articles click here.