- CSL's revenue growth has slowed considerably - 2003-08 was a boom time for plasma - The end of the GFC will not mean a return to the boom

By Greg Peel

The period 2003-08 was quite simply a blood frenzy. That's the conclusion of the Macquarie analysts, having studied revenues in the global plasma industry from way back in 1994 to now. If you average revenue growth in the period 1994-2011 but omit the period 2003-08, the result is 3-5%. In the heyday period however, revenue growth was running at 15%.

In 2003-08, Macquarie notes, the demand for Ig grew significantly faster than the demand for the other plasma products of albumin and factor-VIII, and that meant the “last litre” of plasma fractionators could sell was invariably Ig. There was initially a shortfall of Ig product, and then Ig prices started rising sharply. For fractionators, this meant a windfall.

Last century, fractionators would collect their blood from public donation centres. Given donors are paid for their pint, donation numbers tend to surge in times of economic hardship and ebb in good times. This meant fractionators were often frustrated by an undersupply/oversupply cycle. That is until fractionators began to buy up blood collection centres in 2002-06 and then moved to smooth out the supply curve with inventory control. The real benefits of this vertical integration were derived in the period 2003-08.

A medical report in 1998 had declared albumin dangerous. In 2004, another medical report debunked that call. The result was an 89% surge in the albumin market in 2005-08.

Last century, two major plasma producers had been barred from the market by US health authorities. The ruling was lifted this century and from 2001 the two prodigal children swamped the market with product. The market did not return to equilibrium until 2003.

These are the four reasons Macquarie has provided to explain the great 2003-08 blood boom. All of these factors have now run their course, the analysts believe, suggesting the plasma market will return to previous low single-digit levels of revenue growth from here. Recent earnings results from leading Australian and global plasma player CSL ((CSL)) and its international peers support this theory, Macquarie offers.

Industry growth in 2010 was 0%, Macquarie notes, if one discounts the impact of the forced withdrawal of producer Octapharma from the global market and the subsequent impact on the market share of its peers. In the first quarter of this year, growth was only 3%. It may have been simple to assume that the drop off in revenue growth from 2009-11 was just a result of the GFC and its impact on demand, but Macquarie feels the situation is more structural than cyclical.

There has been an awful lot of debate among analysts since Octapharma's banishment as to what might transpire. Clearly the company's exit left a hole that benefited the other players, but there were two subsequent factors to consider. One was the timing, as in just how long Octa would be gone, and the other was what might happen when Octa returned.

The likelihood was that Octa would return all fired up about losing its market share and then start dumping its inventory at steep discounts to get it back. This would negate any benefit accrued to peers in its absence. But there was also the possibility the end-market would shy away from the disgraced Octa, such that its market share would remain suppressed for some time. Most analysts tend to favour the latter theory, and the theory has become important in valuations given Octa is now due back a lot quicker than everyone first thought.

Macquarie has studied the history. It appears that the re-entry of previously barred product to the market has historically been “quite detrimental” to industry profitability. Macquarie expects the same to occur when Octa's Octagam product returns shortly. There will be significant price and volume pressure placed on the plasma market.

There is little doubt that CSL is the clear leader in the plasma industry, Macquarie suggests. It boasts a superior Ig suite, a strong albumin franchise, manufacturing efficiency and the tail-winds of product mix. But no matter how dominant CSL might be, it is still a hostage to its own industry.

On the assumption of subdued plasma industry revenue growth from here on, Macquarie cannot justify CSL's current price/earnings of 19.3x. Macquarie has trimmed its earnings forecast for CSL out to 2013 and dropped its price target to $32.90 from $35.00. Macquarie already had an Underperform rating, but that has now been underlined.

Macquarie is the only broker in the FNArena database applying an effective Sell rating to CSL. There are four Hold ratings, representing the uncertainty of Octapharma's return, the impact the strong Aussie is having on CSL's earnings, and the high PE multiple still afforded the stock. Two others have Buy ratings, but they've been quiet since April.

Early this month, Citi upgraded CSL to Buy from Hold following an increase in the broker's Aussie dollar forecast which it applied across the whole healthcare sector. This seems counter-intuitive, given a stronger currency impacts on AUD earnings. However, Citi noted that the impact was not that material given the CSL share price had already fallen sufficiently to accommodate the currency move.

Moreover, Citi is part of the group that is assuming the re-entry of Octapharma will not ultimately prove significant. The analysts assume a short-term impact on CSL, but see this as an opportunity to buy the stock at a good price. Hence the recommendation upgrade.

That leaves Macquarie as the proverbial stick in the mud, given CSL's Buy/Hold/Sell ratio now stands in the FNArena database at 3/4/1. Macquarie's new $32.90 target price is the lowest in a range that stretches to UBS at $44.00. The consensus average is $37.88.

On the current trading price, that implies 11% upside. Macquarie's target represents 3.6% downside. Macquarie has looked at the history and waved the flag. It's now up to the market to decide if history provides a lesson.

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