CSL (ASX:CSL) expects full-year underlying earnings to fall 4% on last year versus prior guidance of mid-single-digit growth, largely due to customer inventory of higher-margin products normalizing. The firm also plans to book a significant USD 5 billion in additional noncash impairments. Shares fell 16%.

Why it matters: The market was blindsided by full-year guidance well below the FactSet consensus, and the headwinds appeared structural. We cut our revenue and underlying NPAT forecasts by 3% and 9% on average over the next 10 years, respectively. There is much to do to turn CSL around.

  • We cut our forecast midcycle plasma gross margin by 100 basis points to 52%. Normalizing inventory levels of higher-margin products are weighing on margins. While CSL relays this is a one-off, with inventory levels stabilizing, we now expect the sales mix to be less favorable in the future.
  • We expect increasing generic competition in CSL’s iron portfolio and have cut our five-year revenue CAGR forecast for the Vifor business to 3% from 5% previously. The write-down is primarily due to generic competition and the carrying value of facilities likely to be underutilized.

The bottom line: We cut our fair value estimate for narrow-moat CSL by 21% to $165, given lower plasma profitability and fiercer competition. Shares are undervalued, but we see a wide range of outcomes, hence our High Uncertainty Rating. We are likely more optimistic on plasma demand and margins.

  • We forecast immunoglobulins to grow at a 10-year CAGR of 5% based on flat pricing but higher volumes from population growth, rising diagnosis rates, longer duration on therapy, less-mature markets, and expanding use in immunodeficiencies.
  • We forecast plasma gross margins to lift a modest 100 basis points over the 10 years to fiscal 2035. Most of this uplift is from efficiency initiatives that enable faster, higher yields and the rationalization of high-cost collection centers, offsetting pricing headwinds.

CSL’s plasma division facing stronger competition

CSL is one of three Tier 1 plasma therapy companies that benefit from an oligopoly in a highly consolidated market. All the players are vertically integrated as plasma sourcing is a key constraint in production. The plasma sourcing market is currently largely balanced with demand. CSL is well positioned, having rationalized its plasma collection centers.

One major threat to plasma products is recombinant products. Recombinants are quickly replacing plasma products in haemophilia treatment despite being more expensive. CSL has an excellent R&D track record and has developed recombinant products for haemophilia. However, we expect modest revenue growth in the haemophilia segment based on competitor Roche’s recombinant Hemlibra.

Immunoglobulin product sales are key to CSL. The use of immunoglobulins is currently growing due to improved diagnosis, rising affordability, and gaining approval for increased indications. CSL and competitors are pursuing R&D in Fc receptor-targeting therapy to treat autoimmune diseases.

However, gene therapy represents the biggest risk to the plasma industry as it aims to cure rather than treat diseases. While the potentially prohibitive cost may result in slow adoption, CSL has strategically expanded its scope via the acquisition of Calimmune in fiscal 2018 and licensing a late-stage Haemophilia B gene therapy, Hemgenix, from UniQure in fiscal 2020.

CSL is the second largest influenza vaccine manufacturer, behind Sanofi, and is at the forefront of changes in influenza vaccines, where manufacturing is shifting from egg-based to cell-based culturing.

CSL also operates an iron deficiency and nephrology business where the strategy is to increase global access to therapies, receive label expansions, and defend against generic competition.

The company evaluates R&D spend based on the commercial outlook. The strategy for CSL Behring has been to target rare diseases, a typically low-volume, high-price, and high-margin business. There is little reimbursement risk in this area or in the vaccine business, Seqirus.

Bulls say

  • CSL is investing in plasma yield initiatives, leaving it well positioned to take advantage of growth opportunities in the key immunoglobulins market.
  • The acquisition of Calimmune’s gene therapy platform in fiscal 2018 and UniQure’s late stage haemophilia B gene therapy candidate in fiscal 2020 will help defend against emerging competition.
  • CSL has a strong R&D track record and the ongoing rate of investment is ahead of major competitors.

Bears say

  • Areas of the plasma industry could be replaced by newer therapies, which would leave CSL overinvested in plasma collection and fractionation capacity that will be hard to repurpose.
  • Segments such as haemophilia face competitive pressure from Roche’s Hemlibra that offer more convenient delivery.
  • The R&D pipeline has a highly variable range of outcomes and R&D spending could ultimately amount to nothing.