Came across this article on The Intelligent Investor. The link can be found here. It provides a very interesting perspective on how CSL source their plasma and the competitive advantage they have over their competitors. And more importantly the large degree of vertical integration they have, which really improves their margins. I've held CSL since early 2015 and will continue to do so.
'It was forced upon us,' John D. Rockefeller said. 'We had to do it in self-defence.'Rockefeller was discussing his oil company's fiercely competitive strategy to buy out competitors, lock down suppliers and bully rivals out of the industry. 'The day of combination is here to stay,' he said.Some of the world's biggest companies - ExxonMobil and Chevron among them - descend from Rockefeller's Standard Oil company. Eventually declared an illegal monopoly, he built his empire by 'vertical integration' - where a company owns multiple stages of production such that it can control the entire supply chain. Standard Oil controlled everything from the wells pulling oil out of the ground, to the refineries processing it, to the petrol stations distributing it. There were no middlemen scraping a commission along the way - Standard Oil owned it all. The company earned higher margins and, in turn, could offer lower prices to muscle out rivals. It was a fabulously successful strategy. CSL's resource is more agreeable, but in many ways the company has replicated Standard Oil's playbook in its own industry - life-saving medicines extracted from blood plasma.Plasma is a tradeable commodity and other companies are happy to buy it on the open market, focusing instead on, say, fractionation or distribution. CSL, on the other hand, has taken the vertically integrated approach, controlling every step of production. Rockefeller's supply chain started at the oil well and, though management would never describe it this way, CSL has a well of its own: the human body. CSL's Plasma division is responsible for collecting blood from donors so that CSL's other big division - Behring - has an uninterrupted supply of raw plasma that can then be 'fractionated' into its medically valuable components. Some fine print in law means that antibodies sold in the US must have been sourced from local plasma. All plasma companies, therefore, mainly collect blood in the US, which accounts for 70% of global plasma production. CSL operates 221 collection centres in the US and a further 16 overseas.Collection centres are a fixed cost, so CSL needs as many people to pass through them as possible to keep the average collection costs low. This is where the ethics get messy. Unlike most countries, including Australia, the US permits paid donations. New donors get paid around US$50 per donation in their first month, but CSL has a canny setup to encourage repeat visits: the standard rate falls to US$15-20 for subsequent donations, but donors earn points that can then be redeemed for gifts and cashback cards. The more you donate, the more quickly your points accrue, and there are monthly bonuses too. These give a psychological nudge so people keep coming back, which is exaggerated by CSL targeting mainly low-income areas. (For more on the donor experience, see CSL: Australia's best resource stock.)CSL has mastered donor experience and repeat donations in a way no other provider comes close to matching. Although the industry's number two - Grifols - operates more collection centres worldwide (clocking 290 at last count) CSL's centres are more efficient and have a faster turnaround time for patients. An average CSL centre collects around 59,000 litres of plasma a year, compared to 43,000 litres for an average Grifols centre.CSL doesn't provide specifics, but it's reasonable to assume this extra efficiency gives the company an edge in production costs. On average, a litre of plasma costs around US$150 in donation and processing costs for the industry overall. We estimate that CSL's production cost is at least 10% below the industry average, possibly as much as 20%. Rockefeller knew that controlling production and distribution would save him money, and the same goes in this industry. To buy plasma on the open market, as smaller competitors do, typically costs US$350-500 a litre. CSL's plasma network saves it a tonne of money, and that translates into wider margins: the company has a gross profit margin of 56% compared to 45% for Grifols. Growing marketCSL's low-cost collection centre network has never been more valuable. With ageing populations and rising incomes in developing countries as a tailwind, demand for plasma has grown at around 10% a year over the past five years. To keep up with demand, companies have been opening collection centres as fast as they can get licences. Industry-wide, the number of US collection centres has grown from 478 in 2014 to 737 today, an 11% growth rate. This is where CSL's existing economies of scale have really paid off. The company was already the largest operator five years ago, accounting for 1-in-5 collection centres. However, with deep pockets and a McDonalds-style approach to automating and standardising centres, CSL has been able to roll them out faster than rivals. Of the 207 centres that have opened in the US since 2015, 109 of them - more than half - have been CSL branded. CSL now operates almost 1-in-3 collection centres, with a further 30 centres expected to open in 2019, and 40 flagged for next year. We've previously described the plasma industry as an oligopoly - and that's true for most aspects of it - but the collection segment specifically is heading towards a two-player duopoly. Since 2015, Grifols added 64 centres, with the rest of the industry together opening just 34. CSL and Grifols now control 60% of plasma collection centres, up from 49% in 2015.Although CSL and Grifols have equally matched collection centre networks, CSL is still the more efficient operation, sourcing more than 14 million litres of plasma each year compared to around 12 million for Grifols. CSL is also around three times larger overall. Whereas Grifols sells a significant amount of plasma to third parties at that US$350-500 rate mentioned above, CSL processes the bulk of its supply into proprietary therapies, some of which sell for thousands of dollars per gram. CSL's cheap, reliable source of plasma is a significant competitive advantage because manufacturing is rarely interrupted. As its collection centre network grows, it also becomes more efficient by spreading fixed costs across a larger number of donations. The lower average cost that results helps to boost CSL's gross margin, which has risen from 51% five years ago to 56% today. It's a virtuous circle.American journalist Ida Tarbell once said Rockefeller built Standard Oil 'by ruthless efficiency of organization.' CSL isn't the monopoly that Standard Oil was, but it is ruthlessly efficient. The company's dominance of its industry is growing and, with it, its competitive advantages and profitability. We're sticking with HOLD.
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