25 Years CSL: What Can We Learn?

This month marks the 25th anniversary of CSL (CSL) as a listed company on the ASX. In fitting fashion, shares in Australia's highest quality global success story surged to an all-time high of $253 in October.

Looking back, corrected for share splits, the initial opportunity to add some CSL shares to anyone's portfolio translates to circa 76.7c per share on the first day of public trading. In other words, regardless of what the immediate future holds, the investment return from owning CSL shares over the period has been nothing short of ginormous.

This realisation becomes even more so when one considers the share price graph over the period shows what looks like a steady, gradually rising uptrend unlike, say, Fortescue Metals which also reached a new all-time high in 2019.

That steady, almost un-natural looking performance has made CSL today's third largest component of Australia's leading share market index, the ASX200. Now also consider the fact that Commonwealth Bank shares peaked in May 2015, along with the other banks, and that BHP Group shares in 2014 were trading above $40, and one can only conclude CSL's performance has been even more impressive.

If it hadn't been for index heavyweights such as CSL, Macquarie Group, Transurban and Goodman Group it would have been near impossible for the ASX200 to reach for a new all-time high in 2019. Yet, the sad fact remains most investors don't own shares in CSL, though some may have owned shares at some point throughout those 25 years.

The usual explanations heard are "too expensive" and "cannot get my head around it". This goes both for the self-managing retail crowd as for professional fund managers. The logical observation to make here is that everybody who bought shares in the company, no matter when or at what price, is today sitting on a profit.

This story is not aiming to convert the masses. With the shares trading on FX adjusted, forward looking estimate of circa 37x FY20 earnings per share, it will nearly always be too "expensive" for typical value-seekers, while the implied 1.2% dividend yield is too low for the income hungry.

Maybe, without owning shares in the company, there are some valuable lessons to be learned from CSL for investors of all kinds and various levels of experience?

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For starters, it is easy to declare CSL Top of the Pops, King of all Kings, the Ultimate Performer in the share market when total return has once again exceeded 40%, or about double the index for calendar year 2019 thus far. In the perception of many an investor and/or market commentator, a positive view on a company goes hand in hand with the performance of its shares in the here and now.

While CSL management is highly regarded, as is the business itself, it is good to realise there are other forces at work in the share market that temporarily at least can hold back, or further stimulate share prices higher. In CSL's case, the easiest identifiable external factors at play are the Australian dollar (in particular against USD and Swiss Franc), the level and direction of global bond yields, and market sentiment generally towards the healthcare sector.

In 2019, all three major external factors have ultimately aligned to push CSL shares to a new all-time high. This is not necessarily always the case. When bond yields rise strongly in a short time-span, as they did in late 2016, the CSL share price temporarily faces a formidable headwind.

When the Aussie dollar strengthens against foreign currencies this too tends to create a headache, and similar underperformance follows when investors temporarily favour cheaper looking, beaten down cyclicals like they did when the GFC bear market ended in 2009-2010.

Another complicating matter is the fact that CSL is now the number three index component in Australia which makes the stock more susceptible to general market sentiment. Whereas in the past the shares were at times able to not necessarily follow general market sentiment down, such idiosyncratic behaviour is a lot more difficult when large sell orders aiming to replicate the index hit the local market.

Most importantly, however, is that 25 years from the past show that whatever external factor is holding back the stock at any given point, as long as the business continues to perform, its shares will ultimately perform too. As such, every period of weakness or stagnation in the share price ultimately proved a profitable entry point.

This takes us to the operational reliability that has become one of the trademark characteristics of CSL. How come most businesses cannot replicate the solidity and sustainability of CSL? Never a profit warning. Seldom an operational disappointment. This company, throughout various managers, has an almost alien-like track record in a share market that regularly shocks through corporate failures and mishaps.

The answer is two-fold. Firstly, CSL has managed to transform itself into the highest quality benchmark for the plasma industry globally. In concrete terms, it operates collection centres more efficiently than anyone else, which means it can open additional centres quicker and earn its investments back in a shorter time, while also enjoying a higher return on each centre, young and old.

In addition, in line with general industry practice, CSL invests circa 10% of annual revenues back into its business to expand through new centres and to constantly develop new products. It has a rich history for discovering and developing new therapies and medical solutions, which is necessary in the fast-moving and ever evolving biotech-medical world.

Also, CSL managers have built an admirable track record in acquiring new assets and turning them into future growth engines. The latest such acquisition was Novartis' flu vaccines business which was loss-making at the time of purchase in 2014. CSL has managed to integrate these assets into its own division much quicker than most thought possible, and those losses have now become profits, which are growing.

In line with CSL's high quality operational label, the flu vaccines business sits at the forefront of new innovations in this space.

And yet, what is equally important is that the global market for plasma is growing pretty much constantly. While it could be argued plasma is a commodity, like iron ore or wheat, its market dynamics are much more favourable because supply can hardly keep up with demand - a situation not expected to change anytime soon.

As a matter of fact, the current situation whereby the US provides most of the world's plasma supply, also because the country allows blood donors to be paid for their contribution, is simply not sustainable. Ultimately, other countries will have to change their laws and regulations so that more supply can come from non-US donors. China is an emerging new market on its own.

The sum-total of all of the above is that CSL should be able to continue its path of growth and further creation of shareholder value for as long as it retains its position as best in class inside the industry, and as long as nothing fundamental changes to the underlying dynamics for the global plasma market overall.

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So what important lessons can investors draw from 25 years of CSL on the ASX?

-It is much easier to create shareholder value when industry dynamics are supportive. This is why cyclical companies can have "quality", but they cannot have consistency and/or reliability.

-A good business is not the one that milks its current opportunity to the max. True quality shines through via the ability to add new avenues for growth. CSL today is not simply the ex-government organisation from the early nineties 25 years older. New geographies, new divisions, new products and new customers all make CSL a materially different proposition today. Investors can draw a comparison with the likes of Macquarie Group ((MQG)) or Aristocrat Leisure ((ALL)); large cap locally listed companies that have successfully added additional avenues for growth in recent times.

-A good company steadfastly invests in its business. This keeps it more resilient and in better shape when adversity hits. Or to put this in a better way: companies that do not invest in their business are essentially operating by the grace that nothing ever happens to their position or industry. This is arguably why many Australian companies are finding it so hard to grow these days. Research reports in response to corporate profit warnings (like Bank of Queensland last week) often mention the true reason as to why: structural under-investment over a long period.

-A high quality performer such as CSL will never trade at a cheap valuation a la Amaysim or Galaxy Resources, but this doesn't by definition prevent it from creating plenty of shareholder value. Good things befall good companies. Investors would be wise if they distinguished rapidly growing micro cap fly-by-nights from long-term, structural growth companies that (deservedly) trade on premium market valuations. ResMed ((RMD)), REA Group ((REA)), and Seek ((SEK)), to name but a few, share equal characteristics.

-Identifying a good investment does not equal a low Price-Earnings (PE) ratio, or a high yield, and certainly not backward looking or in isolation. It's all about understanding what makes a company tick, and whether it can be sustained. This is the true Warren Buffett way, which is also why I believe Berkshire Hathaway would be a major shareholder in CSL if Warren Buffet had been born in Australia.

-Technical analysis, on my observation, tends to work a lot better for small cap, low quality, cyclical stocks. All those predictions the CSL share price was on its way to below $100... It just reached $253 instead. Enough said.

-Don't automatically assume there is no potential left once your initial investment doubled, or tripled, or quadrupled. Admittedly, CSL is among the exceptions and its example cannot be used as a guide for most of its peers on the ASX, which is why we all have to admire those shareholders today who stuck by the company even during times when momentum was favouring others. Probably the most heard regrets among long term CSL shareholders today are "I wish I never sold part of my shares" and "I wish I had bought more".

-The human mind is extremely good at fooling us. Over the years, I have heard so many investors telling stories about how they narrowly missed out when the share price fell towards $90, or they sold when the share price doubled from $39, or when it reached $150. Harry Hindsight will tell each of you you could've bought back in, or additional shares, the next day, the next week, at the next pull back or during a general share market correction. You would still have profited handsomely.

-Small cap stocks are not by default better investments than large cap stocks.

-It never is too late to sell out of a bad investment (irrespective what your instinct tells you) and it never is too late to jump on board an excellent investment. Too many investors focus on what could possibly go wrong in the short term, and subsequently miss out on the positives long term. CSL is probably the best example of this. One strategy to circumvent this imaginary barrier is by waiting for the next share price or general market correction. When exactly is the best moment to buy? Well, how long exactly is a piece of string?

-It's always difficult to predict the future, but assuming the above cocktail of internal and external forces remains in favour, in aggregate, the CSL story about continuing to build value for shareholders should still have much longer to run. Pick your moment. Be ready.

Early in 2019 I launched the CSL Challenge: https://www.fnarena.com/index.php/2019/01/14/rudis-view-join-the-csl-challenge/

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