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CSL hits a speed bump
Posted By Charlie Aitken On 08/09/2016 @ 1:22pm In Shares | No Comments
Now that the dust has settled on the FY16 ASX reporting season, it is time for further assessment of the season’s winners and losers.

The biggest share price de-ratings generally occur when a highly rated stock disappoints. This is particularly so when the stock in question has almost never disappointed. You tend to find the de-rating continues for the next six months, as investors wait and see whether the disappointing result was “one off” or the start of a trend.

CSL is one of the greatest performers ever listed on the ASX. However, that track record doesn’t stop the stock occasionally hitting a speed bump. When you are priced for perfection, you simply can’t hit speed bumps. There should be no doubt CSL hit a speed bump with its FY16 earnings and FY17 outlook.

CSL shares have dropped -15% from an all-time high of $120.86 in July. The vast bulk of that drop occurred after the FY16 earnings and outlook disappointment. My fund tactically shorted some CSL on that event.

At the same time, CSL completed a $1 billion on market share buyback and the stock has hit an “air pocket” in terms of the next marginal buyer. No doubt the CSL buyback being active has played a large role in CSL’s previous outperformance.

The chart below confirms CSL is in an earnings downgrade cycle. Over the last 12 months, the consensus analyst EPS forecast for CSL’s FY17 EPS has dropped from A$5.00 to A$3.68 today. That is a -26% negative earnings revision over 12 months as illustrated below.


Somewhat amazingly, over the same period, CSL’s FY17 P/E has RISEN from 18x to 28.3x. This is illustrated in the chart below


In effect, investors (and CSL themselves via the buyback) have paid an ever-increasing P/E forever decreasing FY17 earnings forecasts. I would suggest that isn’t sensible and I expect the next leg of this to be CSL experiencing a P/E de-rating to reflect the trajectory of its earnings.

Quite frankly, a P/E of 28x is simply too high for what CSL offers this year. It may well prove a year of no growth, and then growth returns in FY18, but, either way, the much larger likelihood is a P/E de-rating during the year of no growth.

The universal response by the analyst community to the result and guidance was downgraded forecasts for FY17, downgraded recommendations and downgraded 12-month price targets. However, that said, there are still 5 buys, 7 holds and one lonely sell recommendation on the stock. Despite short-term disappointment, most analysts are still giving CSL the benefit of the doubt that this is just a one-off “speed bump”. They may well be right, but they need to be.

While CSL delivered a solid underlying FY16 result, the confirmation that earnings will stagnate for another year was the clear disappointment. The poor reported result was almost entirely due to foreign exchange and the Seqirus acquisition.

While Seqirus is forecast to become a growth driver in FY18, the problem is FY17 becomes a “growth hole” for CSL. This occurs at the same time there are increasing competitive threats in the plasma business, increased regulatory uncertainty (US Presidential Election), and reduced buyback support for the stock itself.

While the 8% decline in CSL’s FY16 reported EPS was underwhelming, the decline was largely due to $115m of losses from FX and a $116m loss from the newly acquired flu business (Seqirus). If you stripped out these items, the underlying result was in line with the guidance supported by double-digit growth from the core plasma operations.

While the core plasma division grew volumes by +7.5% indicating it gained share in a buoyant market, there are known new competitive threats in subcu Ig and haemophilia that could slow overall plasma sales growth for CSL in FY17. This needs monitoring as the year progresses.

Obviously the key to whether this is just a one-year “growth hole” for CSL or not is the performance of Seqirus. The impact of the Seqirus acquisition continues to negatively exceed expectations. Its flu vaccine stockpile has impacted working capital costs and it requires $150m of capex in FY17. CSL management assures Seqirus will become profitable in FY18 noting high fixed costs hurdles and full year contribution of quad vaccine in FY18 creates a “hockey stick” recovery effect.

That “hockey stick” recovery is a leap of faith in management. I’d rather wait and see on that, as I never like buying “hockey stick” recovery projections from any management team. History suggests most “hockey stick” management forecasts turn out in reality to be “fish hooks”.

I do find it somewhat interesting that CSL’s first “speed hump” in many years was hit by new management. Long-serving, highly respected CEO Brian McNamee has retired and the new CSL leadership simply doesn’t have his impeccable track record. That doesn’t mean they won’t through time, but it’s fair to say Brian is a hard act to follow.

My concern is that CSL’s current P/E rating is too high for its sanguine growth outlook and execution risk in Seqirus. It’s also worth noting they are scaling their buyback programme down (next one probably $500m to be confirmed at AGM in October), and the buyback has been the major buyer of CSL stock over the last few years.

For the P/E to expand as earnings forecasts have been crushed confirms both the power of the daily buyback and the analyst community, giving CSL the benefit of the doubt that this is just a “blip”. It may well prove to be but we won’t know for sure for another 12 months.

I also continue to believe FX headwinds will be an issue for CSL

It’s also worth noting that from a technical momentum perspective, CSL has broken down through is 50,100 and 200 day moving averages. This suggests momentum is turning negative.


There is only a minute short position in CSL (0.39% of the register), which again suggests finding the next marginal buyer of CSL shares will be difficult until they find a level where that next marginal buyer sees relative value.

I believe that level is around 25x FY17 consensus EPS forecasts. At 25x FY17 earnings, CSL still commands a 10 P/E point premium to the ASX200 to reflect the long duration quality of its global business.

25 x A$3.68 EPS = $92.00.

At $92.00, CSL would be fair value in my view to reflect the uncertainty of this year.

It simply can’t be denied that CSL has hit a “speed bump”. That will be reflected in the share price being de-rated to reflect that event.

Putting all that together, I am of the view a better buying opportunity lies ahead for CSL this year.

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 regards to your circumstances.