The CSL Limited (ASX: CSL) share price has fallen below $270 after an earnings outlook statement disappointed the market.
CSL share price
We previously discussed the reasons why we thought CSL was undervalued back in March (i.e. the recovery in plasma collections post-covid, Vifor acquisition looking good, and a valuation pullback).
The CSL share price proceeded to rally from ~$280 to a high of ~$313 at which point we trimmed some of our position in our Seneca Australian Shares SMA product for clients. The CSL share price has since retraced back to ~$263 today.
Why does the CSL share price deserve a valuation premium?
Despite biotechnology companies having a reputation of being poor investments, due to their ‘binary outcome’ nature, CSL has demonstrated strong returns on capital over its history. CSL benefits from having a diverse product portfolio which has enabled an average return on equity of 29.5% over the last 20 years.
CSL has an outstanding track record of growing dividends per share from $0.11 per share in 2004 to $3.38 per share in 2023.
CSL shares have typically traded on a forward price-earnings ratio (P/E) of 30-35x over the last few years due to this strong track record of delivering a mid-teens rate of earnings growth.
What’s the catch?
The near-term earnings outlook for CSL shares has investors spooked.
CSL released a profit guidance downgrade due to a foreign currency headwind of US$230m – $250m due to a recent spike in AUD vs USD, which is where CSL earnings are largely derived.
While a foreign currency headwind is nothing out of the ordinary and not too major (constant currency profit guidance was unchanged), management took the opportunity to sandbag growth expectations with FY24 earnings guidance falling 14% short of analyst expectations.
CSL’s management knows the company best, but earnings guidance given a year in advance should be treated with a level of scepticism – there’s a lot of water to go under the bridge between now and then!
The disappointing guidance stemmed from Behring, CSL’s plasma division, and the margin recovery taking longer than expected. CSL cited donor fees and labour cost inflation remaining higher than anticipated.
As a result, most analysts cut price targets 3-7%. We think management is being overly conservative on the Behring margin recovery and giving themselves room to surprise to the upside down the track.
Healthcare shocks
Healthcare stocks have felt the pressures of cost inflation, with the damage not limited to CSL. Hospital operator Ramsay Health Care Ltd Fully Paid Ord. Shrs (ASX: RHC) has also been caught in the crossfire with shares down -22% over the last 12 months, to levels not seen since the covid low.
Risks remain for CSL shares, but risk creates opportunity.
CSL’s gross profit margins have not bounced back as fast as the market expected. However, FY24 profit guidance is still solid, all things considered, with NPATA expected to grow ~13-18% to US$2.9b – $3b in constant currency.
Other concerns over a competitor product from argenx SE (EBR: ARGX) has put a dent in sentiment but could just be overplayed short-term noise.
CSL should also benefit from a key competitor Grifols SA Class A (BME: GRF) closing collection centres to cut costs and service its lofty debt bill, reducing competition for CSL’s collections.
Although there are risks that may take time to resolve, we think CSL is underearning with a balanced view.
Additionally, CSL has room to surprise to the upside in future periods from growth in their iron deficiency product, which is seeing good uptake, as well as improving immunoglobulin yields (higher productivity) and higher influenza vaccine uptake.
Takeaways for the CSL share price
Brokers see upside in the CSL share price, with two-thirds of ratings at a ‘buy’ and one-third at a ‘hold’ (no ‘sells’), and a median share price target of $332.
We think investors taking a long-term view should do well as CSL continues to grow its earnings, providing essential services.
