Reflections (not) on CSL

Probably the biggest surprise I have come across over the past year or so is the observation that so many investors are firm believers in the 'Market Knows All' narrative; this idea that share price moves are highly efficient, because someone out there, on the other side, hiding in obscurity, knows something you and I are as yet not privy to.

Yet most of us will specifically refer to sentiment, bullish and/or bearish, and money flows when we discuss markets generally. It's as if we have decided that trends and moves at the macro level occur through a two-way loop with human group sentiment, but at the individual stock level it all boils down to specific knowledge by those in-the-know.

Bizarre.

I've long held the belief the concept of the efficient market thesis was dreamt up by an academic who would observe and judge financial markets from afar. More than three decades of watching share prices move up and down has only galvanised my conviction.

To illustrate what's going on inside financial markets, my favourite parallel is with the Olympic games. Look to your left and you might see an athlete trained in weight lifting. The one on your right looks more like a swimmer or a future champion in gymnastics. Behind you stands a golfer and the back you see in front is that of a rugby sevens player.

The difference with the Olympics is all of you are competing in the same playing field, at the same moment, every single day. Which is why my favourite market description is:

The share market will eventually do the right thing, but not before it first has tried out all other options.

Goes without saying: we never ask further questions when the share price moves in our favour (that's our intelligence being rewarded). Plus, yes, the concept of holding on to your shares when the trend is bending south is not something we are naturally wired for.

Volatility only equals risk for the short-term trader who cannot "risk" the trend moving in the opposite direction, but coping with a falling share price triggers feelings of guilt and failure from most of us.

We have been "wrong", apparently. And the market, well, the market is always right, isn't it? Even if this means that kicking a rugby ball on the seventeenth green has prevented the golfer behind you from shooting a birdie.

In all fairness, sometimes the market is truly telling us we are wrong, at least in the here and now, while other times it is simply being silly and mercurial. And while share prices should not be front of mind constantly – all the legends in the industry tell us it should not be – our human brains are naturally wired for 'momentum'. That's why share prices guide our perception, our views, and even our forecasts and expectations.

To paraphrase the legendary Peter Lynch: the share price of a company should be the least concern for investors, yet it attracts the most attention. Share price down means it's a bad proposition. Share price up equals great management, running a fantastic franchise, and killing it.

Let's not beat around the bush: we've all been guilty of allowing the share price to colour our minds. Most of us would pay heed to Lynch's motto: "know what you own, and why you own it", but that's so much easier when the market follows the script we have in mind.

Nice one, Rudi, I suspect some of you are thinking now, but where exactly is this leading to?

To CSL (ASX: CSL), of course, one of Australia's most successful business stories from the past three decades, widely regarded the benchmark for 'quality' on the ASX, also because a share price growing from $2-something to $300 and beyond will seldom, if ever, trigger anything but admiration from investors, journalists and market commentators.

CSL is high quality simply because the share price tells us.

At least, such was the case until the pandemic hit in 2020 and CSL's safe haven status propelled the share price beyond $335. It later emerged blood plasma collection centres are not immune during societal lockdowns and the share price has found it difficult to stay above $300 since. More recently the shares temporarily dived below $230 for a total loss of -32% in market cap.

Now, of course, the question being asked is: is this yesterday's case study for why investors (including me) hold on too long to growth stories that, ultimately, cannot last forever?

Experiences with companies including a2 Milk (ASX: A2M), Appen (ASX: APX), Lendlease (ASX: LLC), and Ramsay Health Care (ASX: RHC), to name but a few, make asking the question all but justifiable.

Investors do hold on too long to yesterday's success stories because opinions don't change quickly, and neither do the embedded perceptions that are the foundation underneath investor views.

In most examples, and I am sure we can all come up with many more names, there's a relatively close correlation between what has happened to the share price and the undeniable deterioration inside the underlying business.

Profits, dividends and key financial metrics for Lendlease today are but a fraction of what they were many moons ago. The same observation stands for a2 Milk, Appen, Ramsay Health Care, and so many more others. Using the same label for CSL, however, looks like a stretch.

While it is true COVID and the $11.7 billion acquisition of Vifor have unmasked several vulnerabilities at the company and its operations, also weighing down a number of financial metrics, CSL's EPS is still forecast to grow this year between 13-17% in constant US dollar terms. And that's on a post-COVID margin that is yet to bounce back, with growth poised to continue in the years thereafter.

CSL spends the equivalent of a small to mid-cap company on capex & R&D each year and the company's pipeline of products under development has seldom looked as rich in potential as it does this year. This is not my personal assessment, but of sector analysts who are invited on site tours and investor days.

At this year's investor briefings, management at CSL expressed its confidence of achieving annual double-digit earnings growth over the medium term. This is driven by lower capex, higher operational yield (increased efficiencies), lower costs, margin recovery and a number of new initiatives and products.

But also, there's no denying the company's risk profile has risen post-2020. There's more competition for some of its specialised products, through ArgenX and others, and the company had to issue a profit warning ahead of its FY23 release, if only to correct the analysts who had too easily assumed rapid margin recovery.

More recently, CSL shares were dragged down because of the risk (speculation?) that popular GLP-1 anti-obesity drugs from the likes of Novo Nordisk and Eli Lilly could potentially impact on Vifor's dialysis drugs portfolio.

When it comes to explaining the share price performance over the past three years, I am sure we all have our views and opinion. We all carry along our biases and narratives, and if we thought CSL shares were too expensive back in 2020, then that's our explanation. Others like to look at price charts and draw support and resistance lines.

There's a whole group of investors who've never liked the company or its shares, and they are highly unlikely to change their stance. Backward-looking, simple PE ratios will never turn CSL into an attractive proposition.

There's literally no purpose in me trying to address all possible narratives and views, other than pointing out maybe the answers are not to be found with CSL itself?

One of my long-standing observations is most investors and market analysts cannot get their head around the premium valuation for CommBank ((CBA)), which as every investor hopefully realises, is the only bank in Australia that has been worth owning post-GFC.

This inability is because the answer does not lay in the dividend or in the mortgage book of CBA, but in the sector premium the shares have been rewarded with over the past two decades. In other words: to properly assess the prospects and 'valuation' of CommBank, one has to compare and measure against the rest of the sector domestically.

In similar vein, CSL's lagging share price performance post 2020 might be more explained by the fact the healthcare sector over that period has turned into a market laggard – globally. The S&P500 Health Care Index, for example, peaked in mid-2021 at the level of 2015, and has been in a downsloping trend since.

This becomes extra-remarkable if one realises this index includes Eli Lilly whose shares have almost quadrupled since 2020.

There's no denying the healthcare sector has been struggling with re-discovering its pre-covid mojo, as also yet again illustrated by last week's profit warning from Integral Diagnostics ((IDX)) in Australia.

Higher costs in combination with a slower-than-anticipated revenue recovery post covid generally has proven to be somewhat of a ball and chain for many industry stalwarts.

In the USA, the Biden administration is of the intent to address extreme price gauging that makes US healthcare unaffordable for many. This cannot be great news for major pharma companies.

In addition, defensive sectors on the share market have effectively stood still or have gone backwards over the past two years. Think supermarket operators such as Woolworths Group (ASX: WOW), staples such as Endeavour Group (ASX: EDV), and local telecommunication leader Telstra (ASX: TLS).

Clearly, shares in CSL, which has proven to be no longer as 'superior' as it was pre-COVID, have not been able to withstand the multiple pressures descending from the macro level. As investors, we cannot always accurately anticipate what is likely to happen next, but it's good to keep in mind nothing is ever permanent in finance.

This too shall change, eventually.

If CSL is indeed able to achieve those double-digit annual increases in the years ahead, the share price will pick up on this, and resume its uptrend. It's the response a young Warren Buffett received from his mentor, Benjamin Graham. It's also what history shows us, with the benefit of hindsight.

It's typical for humans to live in the moment, to be impatient and draw far-reaching conclusions on the basis of recent observations and experiences. Sometimes the share price follows its own scenario, and it doesn't match what we had in mind. The task at hand, however, doesn't change because of how the share price has performed.

A period of lacklustre disappointment is nothing unusual. In fact, it happens to the best. In CSL's case, two precedents are 2001-2006, as well as 2008-2012. You didn't seriously think shares in Microsoft or in Apple have only gone up over the decades past, do you?

One of the absolute outperformers on the local exchange over the past two decades is TechnologyOne (ASX: TNE). While total return generated has been nothing short of phenomenal, between 2016 and mid-2018 there was literally no appetite for the stock.

Now cue all the possible reasons and explanations you can think of: 

• Shares too expensive. 
• Growth is poised to slow down. 
• Foreign competitors have bigger balance sheets and more muscle. 
• The shares don't move!

Five years later the share price has tripled and if current market speculation proves correct, management is about to announce underlying growth is accelerating. This would be a bonus indeed for a premium-valued share price already.

CSL's business is a lot more complex, and for many an investor, it's too much of a challenge to properly understand its pros and cons and inner-business dynamics. Today's story is not a personal recommendation to buy or hold the shares. It's merely an invitation to re-appraise what happens on the market, and why.

If the share price and fundamental prospects of a company are out of sync, they will reconnect. It's what happened to Microsoft shares in 2012 and to TechnologyOne shares in 2018.

The worst narratives investors could have taken guidance from prior to those price pivots include "the share price doesn't move" and "the shares haven't moved since…"

Sounds familiar?

This story is about the share market as much as it is about us.

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