Investor favourite CSL delighted faithful shareholders recently with an upgrade to its 2017 earnings guidance. After five months of a sliding share price and earnings downgrades last year, mainly because the Sequirus influenza vaccine business acquired from Novartis would take longer to break even than initially expected, the upgrade reassured because it implies Sequirus is on track to break even in 2018 as guided by management. Previously the market had doubts about this timetable.
The main reason for the upgrade also showcases CSL’s superior execution in its core business of sourcing and fractionating blood plasma. In the December half competitors found themselves without sufficient collection centres after underinvesting in capacity. CSL in contrast had increased collection capacity so was able to meet growing demand for blood products for patients with compromised immune systems. So CSL currently has a temporary but important competitive advantage and will benefit throughout 2017.
We think the earnings downgrades are over and the risks are now to the upside. Our upgraded valuation of $116 allows for the consensus earnings upgrades we expect this year as some of last year’s downgrades unwind and as CSL’s hemophilia drugs Idelvion and Afstyla gain traction in major markets. Strong sales here would see the stock push past $120.
But all this is before the new and unfathomable risk of US President Trump’s promise to “save billions” by introducing competitive tendering for drugs. CSL is vulnerable to US regulatory change because 46 per cent of 2016 sales came from North America, so the stock sold off marginally in response to the latest rhetoric. How should value investors respond?
Although US patients undeniably pay high prices for drugs, so far there is no policy substance to Trump’s promise, which consists of a series of campaign announcements and tweets. This area of healthcare is not suited to sweeping executive orders; instead the newly elected Congress needs to agree with the administration on the general direction of change followed by alignment on legislation both within Congress and with the executive branch. This will take time.
Trump’s policy also cannot result in patients not receiving lifesaving drugs just because the supply chain refuses to provide them at an unacceptably low price, so direct pricing controls are unlikely. And some drugs are, at the discretion of prescribing doctors, superior for some patients regardless of price – which seems to rule out competitive bidding in those cases.
Furthermore, the pharmaceutical industry funds one of the most powerful lobbying machines in Washington and is particularly influential over the Republican Party. The industry will fight hard against any restrictions on its profitability, not least because the vast cost, high risk and long duration of drug development and clinical trials justifies superior profitability to compensate shareholders. Trump will require determination if he really wants to change the status quo.
So far Trump has moved swiftly to introduce other policies from the campaign. Investors should prepare for some kind of eventual action on drug prices, probably in the form of facilitating existing competitive pressures to bring down drug prices over time. The uncertainty and any announcements will cause volatility in pharma share prices, which could create entry points. We think the best way to consider CSL is to value the stock assuming no regulatory change in America but to require a larger discount to value before buying. A 10 per cent discount to our $116 valuation suggests a $104 buy price.
Originally published in The Australian on Tuesday 31 January 2017.
David Walker is Senior Analyst at Clime. Start making better investment decisions by registering for a trial at or call 1300 136 225.