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FINM2416 NGOC HUYEN NGUYEN 45481486

CSL limited ASX: CSL

MAY 4

FINM2416 - Financial Analysis STUDENT: NGOC HUYEN NGUYEN NO. 45481486 1

FINM2416 NGOC HUYEN NGUYEN 45481486

CONTENT Part I.

INTRODUCTION......................................................................................3

Part II.

ANALYSIS (2014-2019)............................................................................3

1.

Financial report analysis...............................................................................3

2.

Profitability..................................................................................................3

3.

Liquidity.......................................................................................................4

4.

Leverage.......................................................................................................4

5.

Asset utilization............................................................................................4

Part III.

VALUATION.............................................................................................5

1.

General Assumptions...................................................................................5

2.

DDM (Dividend Discount Model)..................................................................5

3.

DCF (Discounted Cash Flows)........................................................................6

4.

Valuation of DDM and DCF...........................................................................6

5.

Multiple-based valuation.............................................................................7

6.

Conclusion....................................................................................................7

Part IV.

SENSITIVITY ANALYSIS............................................................................7

Part V.

RECOMMENDATION...............................................................................8

References...............................................................................................................9 Appendix 10

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FINM2416 NGOC HUYEN NGUYEN 45481486

Part I.

INTRODUCTION

CSL limited is a global biotechnology company that researches and develops products to treat and prevent serious human diseases. Their products range from blood plasma derivatives, vaccines, antivenoms to cell culture reagents, making CSL one of the most innovative companies in the healthcare industry. By becoming the first mover and then implementing patent protection on new biotech products, CSL has shown a robust growth in recent years and become the biggest firm by market capitalization on ASX200. CSL stock has experienced a stable upward trend since 2010, being deemed “outperform the market” by several financial analysts. However, a comprehensive analysis is necessary to fully evaluate their future potentials as well as detect some underlying issues that might dampen their growth in the long run.

Part II.

ANALYSIS (2014-2019)

1. Financial report analysis Overall, CSL ltd. has been through a steady growth over the years, which is assessed as “outperforming” by analysts (UBS, 2019). Recent financial reports reveal some noticeable points. Profit/Loss statements show that CSL operating revenue has risen exponentially as more than doubled within the last 6 years. Earnings, accordingly, were on the rise, except for 2016 when expenses surged by almost 30%. Balance Sheets display that CSL acquired their assets at incredible speed. However, there was a significant drop of $164M in cash amount in 2019 whilst receivables soared by 32%, indicating a potential issue about cash cycle. It is also noted that CSL compiled substantially more inventories since 2018, probably because of the rising chronic diseases. Most capital flowed to PPE, accounting for over 66% of 2019 non-current assets. “A big chunk of CSL’s cash gets fed back into R&D” (Pearson, 2020); this explains as biotechnology requires various facilities for researching and developing. Nevertheless, debts are high and rising in capital structure as 2019 total debt was 3 times the 2014 amount and solely long-term debt comprised 60% of total liabilities. This poses a high risk for equity investors as the company depends heavily on debt utilization and dividend is hardly guaranteed if CSL cannot maintain liquidity. Cash flow statements represent an ascending trend of cash receipts from customers. This could be explained by CSL’s prestige pricing and a higher demand from chronic disease patients. However, there has been a net decrease in cash since 2018, which would negatively affect liquidity in the long term.

2. Profitability CSL profit has been steadily increasing and is generally higher than industry average. ROA slightly decreased over time due to accumulation of new assets rather than dropping earnings. Specifically, 2019 ROA was 20.33, far exceeding the healthcare industry benchmark of 4.29 (CSImarket, 2019). Compared to Cochlea (COH) and Sonic (SHL) whose ROAs were 19.54 and 6.03, CSL seemed to better

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FINM2416 NGOC HUYEN NGUYEN 45481486 utilize their assets for revenue. ROE, despite dropping by 7% in 2019, was 3 times higher than industry average. This shows that CSL was exploiting equity funds more efficiently than most health companies were doing. There is quite a gap between CSL profit margin (29.42%) and that of Sonic healthcare (12.96%). Thanks to the patent protection of Immunoglobulin products, CSL has a competitive advantage against their competitors and thus could charge their medicines at premium.

3. Liquidity The figures show decreasing liquidity over time. Current ratio and quick ratio gradually dropped, revealing lower efficiency in repayments and a higher risk of default. CSL quick ratio in 2019 was 1.14, slightly lower than Cochlea at 1.22. Meanwhile, cash ratio has halved during 2014-2019. Poor cash management, in the long run, could become a major problem, leading to failure in meeting obligations. Without sufficient cash, the company is forced to borrow more capital, which then demand higher repayments and further deplete their liquidity.

4. Leverage CSL holds noticeably more debts than their competitors as their A/E ratio struck 2.35 in 2019. Interest coverage decreased by more than 34 from 49.76 (2014) to 15.37 (2019), proving lower liquidity across time. Cochlea, on the other hand, had a coverage of 79.84 (2019), mostly because this company has much lower leverage in their capital structure. High debt proportion may discourage risk-averse equity investors meanwhile attracting risk-takers who expect high returns.

5. Asset utilization Up to 2019, CSL has well utilized their asset for sales despite a loophole in receivable control. Total asset turnover and fixed asset turnover declined while sales climbed annually. However, this is not necessarily a pessimistic sign as turnovers dropped due to enormous accumulation of assets, especially PPE. CSL has been focusing on researching and developing new treatments for Immunology, Neurology and Respiratory diseases (CSL, 2019) and their approach has put them forward other competitors. In parallel, inventory turnover has slightly reduced. In 2015, it took them 247 days to sell off their stock; this figure rose to 295 days in 2019. This could be attributed to increasing number of chronic disease cases; and the company, as it grows, needed to stock up for unexpected events like COVID-19. Due to thorough preparation, CSL is not facing any supply shortages so the virus has made no impact on current sales. Therefore, CSL’s dropping inventory turnover should not be evaluated as inefficient management. However, the actual problem might regard longer operating cycle. CSL has got more delayed in collecting their receivables as it took extra 10 days in 2019 compared to 2014. While CSL credit sales were paid within 73 days, Sonic received their cash in roughly 50 days. This might be the driving force behind negative cash changes and would cause higher bad debts in the future.

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FINM2416 NGOC HUYEN NGUYEN 45481486

Part III. VALUATION 1. General Assumptions Based on CSL’s past and current performance as well as the overall economic context, it is expected that CSL would continue their robust growth in 5 years’ time ( 2020-2024) and enter terminal growth at year 6 (2025). There are various reasons to justify this view. The main one is that CSL’s retention rate seems to stabilize above 50% in foreseeable future, declaring a clear intention of business expansion. Also, according to a recent market research in healthcare industry, the demand for Immunoglobulin and Albumin – two of CSL’s protected products – remains strong and CSL’s EBIT is to steadily rise to US$3,999M over upcoming 5 years (UBS, 2019). Additionally, “the flywheel effect” (Appendix 1) of CSL would help compound growth, deliver increasing returns and give CSL the capacity to endure economic busts. The fact that CSL has a history of acquiring smaller yet growing businesses – Aventis Behring, U.S. plasma collector Nabi and Novartis influenza vaccine business – would also help CSL dominate the industry in the long run (Pearson, 2020). In terms of industry forecast, health services will continue growing strongly due to Australia’s ageing population and “increasing prevalence of chronic diseases” (IBISworld, 2019). This is not to mention CSL’s recent entrance into China domestic plasma market, which becomes a long-term opportunity for revenue boost (Morgans, 2019).

6. DDM (Dividend Discount Model) a. Specific Assumptions: Dividends are expected to go up rapidly from 2020 to 2024 and enter mature phase in 2025. Therefore, two-stage DDM is adopted. Short-term growth rate ( 17.32%) is generated from average of growth rates within the last 6 years (2014-2019). Despite some boom and bust, the growth rates are quite balanced and form a reasonable average. This rate is chosen also because it shows a parallel trait with revenue growth. Long-term growth rate ( 3.8%) is justified by the estimated healthcare growth. In the past 5 years, on average the industry expanded by 3.6% annually and the rate is forecast to hit 4% during 2020-2024. However, the average of 3.6% and 4% is chosen to account for uncertainties as over-optimism could drive irrational investment choices. Terminal growth cannot be based on sustainable growth/EPS growth/revenue growth because those numbers are unrealistically high for perpetuity. Cost of equity ( 6.2%) is calculated by CAPM. Risk-free rate is taken from Australia 10-year bond yields and market return is taken from ASX200 portfolio return.

b. Outcome: Intrinsic value (DDM)

Market Price

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FINM2416 NGOC HUYEN NGUYEN 45481486 207.24 Overvalue

215 7.76

7. DCF (Discounted Cash Flows) a. Specific Assumptions: Cash flows are expected to rise quickly from 2020 to 2024, then undergo perpetual growth from 2025. Cost of capital ( 5.97%) is calculated using WACC. Terminal rate ( 2.8%) is based on expected GDP growth (Austrade, 2019). According to financial analysts, perpetual rate for cash flows typically ranges between inflation rate (2-3%) and average GDP growth rate (4-5%) at mature stage so 2.8% is seemingly realistic. Revenue growth (18.76%) is the average of past rates, excluding 2016 figure as it was an outlier. Cost of sales and operating expenses are estimated as proportion of revenue as the percentage has not changed much during last 5 years. Tax rate ( 30%) equals Australia corporate tax level while Depreciation and Amortization conceivably rises by 41.11% annually. This could be reasoned by the requirement of facilities for R&D and how quick CSL historically accumulated their assets. Capital expenditure would account for 11.67% of revenue due to the past relationship between these two categories. Also, it is advised that CSL control their CapEx around 11.67% or else the company might encounter problem with cost overrun. Other figures are assumed to be averages of recent 5 years, including debtors and prepay as % of revenue, inventory and creditors as % of COGS, etc. because there is little change in the historical numbers.

c. Outcome: Intrinsic value (DCF) 203.85 Overvalue

Market price 215 11.15

8. Valuation of DDM and DCF There is not much gap between the two intrinsic values generated by DDM – 207.24AUD and DCF – 203.85AUD. They both consistently show that CSL stock was being overpriced. However, it is vital to incorporate some other valuations to get a comprehensive assessment.

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FINM2416 NGOC HUYEN NGUYEN 45481486 9. Multiple-based valuation a. Price/Book value CSL’s 2019 Market-to-book value ( 13.01), far exceeded the industry benchmark of 4.45, showing that market participants have a positive view on CSL stock. P/B and ROE shared a similar pattern during 2014-19 so it is safe to conclude CSL performance has been satisfying the shareholders.

d. P/E ratio The trailing P/E ratio for 2019 was 35.68. It was not too high from biotechnology sector’s benchmark of 30.14. Cochlea, a competitor, had much higher P/E ratio at 44.89. Therefore, it can be said that CSL stock might be overpriced, but probably not too far from its intrinsic value.

e. Earnings yield Although E/P ratio dropped in 2016, CSL has kept the yield stable at around 0.028 ever since. The yields have declined because of the ascending stock price, not because of dropping earning.

10.Conclusion CSL stock seemed to be traded at premium according to DDM, DCF as well as multiple valuation methods. This conclusion was also supported by analysts who targeted the price around 198AUD (Bloomberg, 2019). However, it is likely that CSL investors are willing to pay extra with belief in CSL’s product exclusivity as well as qualitative values that cannot be quantified.

Part IV.

SENSITIVITY ANALYSIS

The sensitivity test implements changes in cost of equity and long-term growth rate as 0.5% increase/decrease on two models: DDM and DCF model. Cost of equity is chosen because it has direct impact on cost of capital and can thus significantly change the calculated intrinsic values in both DDM and DCF. As seen in sensitivity analysis, the higher Re hits, the lower the price becomes and so the scale of impact constantly gets smaller. Long-term growth rates, on the other hand, could decide the current value of not only the stock but also the firm value. Obviously, a higher long-term growth rate leads to a higher intrinsic value and the scale of impact is accordingly greater. The sensitivity analysis has shown how sensitive DDM and DCF are to discount and long-term rates. This is of utmost importance since intrinsic value is the key factor in buy-or-not decision. For example, an investor might undervalue the intrinsic amount, choose to buy a stock and end up in losses. Therefore, investors need to choose the realistic rates through information update and market research.

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FINM2416 NGOC HUYEN NGUYEN 45481486 a. DDM:

f. DCF:

Part V.

RECOMMENDATION

Although CSL might be trading at higher value than its intrinsic amount, the stock has become a “bluechip” that is highly recommended for long-term investors. Approximately 64% of analysts has a “buy” rating on CSL (Bloomberg, 2019) and the historical prices have formed a steep upward trend in the past 6 years. Nevertheless, given the premium stock price, investors should be fully aware of the default risk rising with leverage as well as CSL’s long cash cycle. A person could either choose to invest short-term, buying in as soon as the price drops by 10-15% and sell out later while long-term investors should be prepared to “hold” for years. They should stay updated especially on new debts and how managers spend those debts, along with observing cash flows frequently. It is also recommended that investors with low capital avoid CSL stock as it is hard to get high profits without buying in bulk. On the other hand, for those who could afford, CSL is deemed a safe choice in portfolio as hardly any companies could perform this steady on ASX.

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FINM2416 NGOC HUYEN NGUYEN 45481486

References Austrade. 2020. Why Australia Benchmark Report 2018. [online] Available at: [Accessed 4 May 2020]. Csimarket.com. 2020. Healthcare Sector Management Effectiveness Information And Trends By Quarter, ROE, Return On Assets, Return On Investment From 1 Q 2020 To 1 Q 2019 - Csimarket. [online] Available at: [Accessed 4 May 2020]. Fenebris, F., 2020. AU - Market Risk Premia. [online] Market-risk-premia.com. Available at: [Accessed 4 May 2020]. Hall, K., 2020. Are CSL Shares A Foolproof ASX Buy?. [online] MSN. Available at: [Accessed 4 May 2020]. Ibisworld.com. 2020. Ibisworld - Industry Market Research, Reports, And Statistics. [online] Available at: [Accessed 4 May 2020]. Investing.com. 2020. Australia 10-Year Bond Yield - Investing.Com. [online] Available at: [Accessed 4 May 2020]. Limited, M., 2020. CSL Ltd Going Direct In China | Morgans. [online] Morgans.com.au. Available at: [Accessed 4 May 2020]. Pearson, R., 2020. Is CSL One Of The Best Companies In The World? // Motley Fool Australia. [online] Motley Fool Australia. Available at: [Accessed 4 May 2020]. Rickard, P., 2020. Should I Buy CSL?. [online] Nabtrade.com.au. Available at:

[Accessed 4 May 2020]. Statista. 2020. Australian Inflation Rate 2024 | Statista. [online] Available at: [Accessed 4 May 2020]. Walton, S., 2020. Is The CSL Share Price Still A ‘Buy’?. [online] IG. Available at: [Accessed 4 May 2020].

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Appendix 1. CSL “Flying wheel” (A working cycle)

2. CSL stock target prices

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