ALTAIR'S SALLY WARNEFORD AND GERARD MINACK FEATURES IN AFR
CSL is worth $100 in a low growth world
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In case you were wondering, a litre of human blood costs a bit more than $100.
Of course, not everyone can rock up at the blood bank with their credit card and pick up a few bottles of the good stuff (sorry to disappoint the vampires and more ghoulish contemporary artists). But CSL can. And from that initial investment, the global healthcare giant generates hundreds of dollars of revenue from the products it creates via its plasma fractionation facilities here and abroad.
That handy bit of information was relayed this week by Altair Asset Management senior analyst Sally Warneford during the equities manager's annual catch-up with its investors, to which your correspondent was lucky enough to score an invite (provided he wear a tie). That was on Wednesday. The next day CSL shares broke above $100 for the second time ever (the first time being only a few months ago).
Investors, both at home and in office towers, are likely using this moment to re-evaluate the stock. After all, CSL's share price is up 15 per cent this year in a back-pedalling sharemarket. It's up 50 per cent over two years and doubled over three, and so on.
So does that mean it's time for lucky long-term shareholders to take profits and sell? No way. Is it too expensive to buy? Probably not, although in a volatile environment there will likely be better times to pick up more of one of the best-performing businesses on the ASX.
First, let's take a quick look at the valuation. The stock trades at 24 times estimated earnings for this financial year and 25 times the previous year's profits. High, but not crazily so. Particularly when you consider the company generates a return on equity of 47 per cent and a return on invested capital of 28 per cent. On a relative measure, the stock's P/E is 1.2 times the market's P/E, which is pretty much bang on the five-year average, points out UBS analyst Andrew Goodsell.
Healthcare spending on the rise
As one fund manager said this week, CSL always "seems" expensive but it always hits its milestones and targets. It can do that because it has a competitive advantage over its rivals and operates in an industry where demand for its products keeps getting bigger.
CSL is one of the largest producers of plasma products which are used to treat rare and life-threatening blood diseases. Thanks to a recent acquisition, it's also one of the world's biggest flu vaccine manufacturers. Healthcare spending, including on CSL's products, should continue to rise steadily in coming years as much of the western world gets older and as citizens of developing economies such as China grow more able to afford health services.
CSL is the lowest-cost operator in its field – in other words, it makes more cash out of that litre of blood than its competitors. Its rivals are finally getting their act together, but the Aussie company's lead looks unassailable over the medium term thanks to its efficiency and heavy research and development spending.
A company with high single-digit – and potentially double-digit – earnings growth prospects is likely to be too good an offer for investors to refuse.
The reason is that – and it has been written about extensively – developed economies are mired in a low-growth world. Or, as Gerard Minack of Minack Advisors would say – we are all turning Japanese.
Japan's economy effectively stopped growing around 15 years ago. Interest rates in the country fell and stayed down. Japanese 30-year bonds broke below 1 per cent in 2004 and have been "dead flat ever since", Minack says. He reckons the trajectory of German and US bonds since the American and European recessions in 2008 have been tracing a similar downward trajectory to Japanese equivalents following the country's bust in 1991.
Get used to low returns
"For investors the process of turning Japanese is a fantastic thing," Minack says. "We've all benefited from the declining rates and the re-rating of a lot of assets such as equities, such as credit, and, in Australia, even our houses."
That's because a lot of people compare equity markets with bond markets, and when yields in the latter fall they decide they can pay more for shares – the "re-rating" effect.
That phenomenon explains why you can have a 75 per cent global sharemarket rally since the lows of 2011, while at the same time corporate earnings going nowhere.
But from here, the view is less rosy.
"The trouble is once you've turned Japanese, returns are low," Minack says.
Shares are expensive, and the re-rating process has run its course, with rates bumping along the bottom.
Defensive stocks more appealing
The steady fall in Japanese bond rates during the 1990s generated an impressive total annual compound return to bond holders of 11 per cent. But once bond rates got about as low as they could later that decade, the total return figure dropped to 2.3 per cent.
For the record, Minack doesn't think the US Fed can push rates higher than 1 per cent; he doesn't think the world's biggest economy can handle it.
And this is why corners of the world – such as healthcare – that offer solid, and defensive, growth are so appealing.
It's also why the market will continue to reward companies such as aged care provider Estia Healthcare and private hospital operator Ramsay Health Care – both stocks that Altair's Warneford likes.
It's also why, in a world turning Japanese, spending $100 on a CSL share may be as good as the deal CSL gets on a litre of blood.
In the US, he argues that the market has got ahead of itself and there is no way that the Federal Reserve will have the means and specifically the kind of inflation to justify a higher Fed funds rate, indeed it will be "years" before it can get to 1.5 per cent. The rate of borrowing in the US is currently set at the zero bound but forecasters still tip the Fed to make it first hike in 2015.
