Talking Top Ten | Part 2: CSL, BHP & Wesfarmers

As promised, this week we continue to look through some of the key highlights, and my notes on the top end of the market (by market capitalisation). The securities this week are CSL, BHP, and Wesfarmers.

CSL Ltd (CSL.ASX)

This is one company with which we’re sure the vast majority of our readership has had a pleasant experience with through their investment careers. Despite the volatility, it continues to be one of the few consistent performers in the ASX50. The company and management has once again managed to surprise in releasing yet another round of stellar results. Numbers wise, revenue continued to grow by 11% and Covid, while impacting the supply chain in regards to the collection of Plasma, has not materially impacted revenues. 

The company remains well-capitalised with over $750m USD cash on the balance and available liquidity of close to $3.1bn USD. What was perhaps missing in the reporting, was an indication of how the Vitaeris Inc. acquisition was coming along. Although this seemed to be a small acquisition given the broader portfolio, it was interesting in that Vitaeris was conducting phase III clinical trials for a treatment for organ rejection within kidney transplant patients. Another niche but highly promising and potentially lucrative market. Perhaps not in the same way as haemophilia but arguably on par, with existing treatments in that particular instance ranging from anywhere between $300,000-$500,000 USD per patient (more than compensating for the small market size).

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Red Flags & Risks: Covid-19 has undoubtedly cost the supply chain in terms of plasma collection, something that remains central to CSL’s business model. While the company controls around 30% of collection centers globally, the current lockdowns and health concerns have inevitably led to supply constraints. The flip-side of this is that the economic damage caused as a result might force more people, especially from lower socio-economic stratas (in the US that is, you don’t receive compensation here),  to give more blood.

In terms of the competitive environment, the vast majority of the portfolio including the immunoglobulins and Seqirus related products are plasma based and, although CSL has a marked advantage in this area given the highly consolidated nature (oligopolistic structure with the closest competitor being Grifols), there is also potential for competition from recombinants (see below). The next phase of growth will very much rely on the Asian markets where cost will play a greater and more significant role. In other words they have to compete with recombinants in the developed world (i.e. recombinants being more expensive) and cost in the east. The product pipeline, including the acquisition of Vitaeris, is potentially a way to diversify the portfolio but this remains in its infancy.

"...recombinant product versions of plasma derived products are also available. These are manufactured by the expression of equivalent proteins from genetically engineered cell lines."

​- National Blood Authority, Australia

​Forgive the Wikipedia definition, but: "Recombinant DNA (rDNA) molecules are DNA molecules formed by laboratory methods of genetic recombination (such as molecular cloning) to bring together genetic material from multiple sources, creating sequences that would not otherwise be found in the genome."

That is all to say, plasma synthesised in a lab as opposed to collected from donations.

My Expectations: Management continues to deliver, with consistent expenditure on R&D. The haemophilia B market remains lucrative for the company with further expansion into the European markets providing long-term revenue growth. Covid, while having an impact on the supply-chain for plasma, will also potentially be beneficial as the company would be part of the equation for the distribution and commercialisation of Covid-related vaccines at least in Australia. The R&D pipeline looks solid with my bets on the transplant and hematology related aspects to deliver.

​Dividend Yield:  Current yield of 1% (assuming share price at $281 AUD).
We would expect the payout ratio to remain the same but on an absolute basis for dividends to grow at double digits over a long term horizon. 

​BHP Group Ltd (BHP.ASX)

Stellar results from BHP with FY20 NPAT of $9.1bn USD, EBITDA margin of 53% and, most importantly for the yield hunters, a 55c US p/s dividend, lower than expected but in my opinion prudent and a number which still represents a 72% payout ratio. As expected, the laggards were the petroleum and coal divisions. What was exciting (in my view) was the potential divestment of half of BHP’s coal production, especially thermal and PCI assets (didn’t necessarily expect the Bass Strait Gas assets to be included). But any demerger via a trade sale, especially a demerger when trying to get rid of thermal assets, would have to be sweetened.  

The company continues to look for oil acquisitions, in which they would of course be joining their global counterparts (Exxon et al.). My expectation is bolt-on acquisitions of juniors (maybe the Gulf of Mexico or, even more interesting, Horizon’s P&G interests which lie on the pipeline route of ExxonMobil and Oil Search). 

What was rather disappointing, however, was the copper division especially in a time of stellar copper prices. Underlying EBITDA of $4.35bn USD was less than impressive due to higher costs in Antamina and Olympic dam. This, I feel, is one division to which management could allocate some much needed resources, the existing pipeline of Tier-1 assets look less than stellar especially when compared with Rio’s Winu (this includes the LATAM assets where costs have been kept reasonably within range).

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Red Flags & Risks: While BHP has a diversified base in terms of commodities, the name of the game is pro-cyclicality. Weakening demand for steel production in China could hamper future growth and much will be contingent on maintaining cost discipline and hedging. Further delays in restarting Samarco and any weaknesses on project execution can be painful for shareholders. The divestment of coal assets could see some much needed focus, in my opinion, better allocated by getting a hold of copper assets which should have a longer runway and lessen the cyclicality of earnings (copper being central to electric vehicles as well as having a long-term secular growth story to it).

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My Expectations: Management has delivered some stellar results and navigated the Covid mess in a better then expected manner. The business has to be streamlined somewhat however  with the riddance of legacy assets as soon as possible, here I am thinking of thermal coal. The shifting of focus towards copper, rare-earths and oil will put the company in a better place over the long-run. Not a growth story but a yield story.

Dividend Yield: Assuming a share price of $37.5 AUD, then BHP has a great 4.5% dividend yield.
​BHP remains a credible substitute for the banks from an income perspective. 

​Wesfarmers (WES.ASX)

Wesfarmers results showcased fantastic performance across the retail segments. Bunnings was the standout with same store sales growing by 14%  through FY20 and delivering an overall EBIT of $1.8bn AUD (17.6% growth). Target remains the outlier (on the downside) continuing to be loss making while Kmart remains profitable. Revenues were cushioned primarily via strong online sales growth( coming in at close to 34%), with the major impact of Covid coming from supply-chain constraints (stock-outs). 

Officeworks, with an EBIT of $190m AUD, represented double digit growth (13.8%). What was surprising to me was the chemical, energy and fertilizer divisions which beat on expectations. Volumes continued to grow for both chemicals and fertilizers, though LPG was weaker within expectations. Overall this segment still delivered an EBIT of $450m AUD (not Bunnings type growth but nothing to cause concern). 

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​Red Flags & Risks: Though the company has maintained market share within an increasingly competitive environment (especially in online retail), the flip-side of this will be the margins. Unlike pure-play online retail, the existing store-footprint means that the cost base is substantially higher and uncertainty around Covid-19 as well as the  impact on supply chains remains uncertain. It will be incumbent on management to deliver an omnichannel experience to customers whereby the stores are effectively turned into distribution centres. That said, credit where it's due, the spin-off of Coles was a solid play and gives the company ammunition to go hunting for deals. For the moment, consumer sentiment and overall outlook will be the biggest factors impacting the business going forward. 

​My Expectations: Management has delivered for shareholders and remains a business that has consistency in terms of managing expectations as well as payout ratios for its shareholders. A lot of the reporting was however quite tactical and backward looking to do with the retail division and how the business was coping with Covid. No clear outline was given about where it was heading from here. In my view, a focus on their chemicals business will be interesting and the play for Lynas last year was an indication to me of where they were looking in terms of the future (though one wouldn't have known it from the commentary). 

Dividend Yield: Assuming a share price of $47 AUD, then WES has a stellar 3.6% dividend yield.
​With a proven consistency in terms of payout, a good yield for the income hunters. 

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Disclaimer
BHP is currently owned by the author of this article, Sid Ruttala. TAMIM has no current exposure to the three stocks mentioned in this article.