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CSL trial fails to meet hoped for results

How our analyst views the shares after the clinical trial set-back.

Mentioned: CSL Ltd (CSL)

Narrow-moat CSL (ASX: CSL) announced top-line results from its Phase 3 clinical trial evaluating the safety and efficacy of CSL112 versus placebo in reducing the risk of major adverse cardiovascular events, or MACE, in patients following a heart attack.

This was CSL’s largest study to date, and while there were no major safety or tolerability concerns, the study failed to meet its primary efficacy endpoint of MACE reduction at 90 days. The company plans to fully analyze the complete data and determine potential further development. But there are no current plans for a near-term regulatory filing. Shares fell over 5% to $289 in trading on Monday in response to the announcement.

Accordingly, we decrease our likelihood of approval for CSL112 to 0% from 60% previously and lower our fair value estimate by 6% to $310. With CSL’s Hemgenix product recently launched, CSL’s remaining product pipeline is fairly immaterial in our view, contributing just 1%, or roughly $3 per share, of our fair value estimate.

Shares remain undervalued and Morningstar's Mark LaMonica recently wrote about why he finds the shares attractive. We still anticipate CSL Behring’s gross margin to recover to its prepandemic level of 57% by fiscal 2027, from 49% in fiscal 2023, consistent with management’s timeframe of three to five years.

CSL’s fiscal 2024 guidance for constant-currency group net profit after tax before amortization remains around USD 3 billion, implying ¬13% to 17% constant-currency growth on fiscal 2023. The guidance factors in gross margin recovery in CSL Behring and constant-currency group revenue growth of 9% to 11%, largely driven by immunoglobulins, or Ig. We forecast a five-year Ig revenue CAGR of 11% versus the coronavirus-affected three-year trailing Ig revenue CAGR of 5%.

We anticipate more granular details from CSL regarding its Phase 3 trial and interim fiscal 2024 performance on Feb. 13, 2024.

Business strategy and outlook

CSL is one of three tier one plasma therapy companies that benefit from an oligopoly in a highly consolidated market. All the players are vertically integrated as plasma sourcing is a key constraint in production. The plasma sourcing market is currently in short supply, however, CSL is well positioned having invested significantly in plasma collection centers, owning roughly 30% of collection centers globally.

One major threat to plasma products is recombinant products. Recombinants are quickly replacing plasma products in haemophilia treatment despite being more expensive. CSL has an excellent R&D track record and has developed recombinant products for haemophilia. However, we expect revenue growth to slow in the haemophilia segment based on competitor Roche’s successful launch of recombinant Hemlibra.

Immunoglobulin product sales are key to CSL. The use of immunoglobulins is currently growing due to improved diagnosis, rising affordability, and gaining approval for increased indications. This market is not yet impacted by recombinants although both CSL and competitors are pursuing R&D in Fc receptor-targeting therapy to treat autoimmune diseases.

However, gene therapy represents the biggest risk to the plasma industry as it aims to cure rather than treat diseases. While the potentially prohibitive cost may result in slow adoption, CSL has strategically expanded its scope via the acquisition of Calimmune in fiscal 2018 and licensing a late stage Haemophilia B gene therapy, EtranaDez, from UniQure in fiscal 2020.

CSL is the second largest influenza vaccine manufacturer, behind Sanofi, and is on the forefront of changes in influenza vaccines where manufacturing is shifting from egg-based to cell-based culturing. It’s also conducting preclinical testing of mRNA influenza vaccines.

The company has demonstrated good sense for R&D and evaluates spend based on the commercial outlook. The strategy for CSL Behring has been to target rare diseases, a typically low volume and high price and margin business. There is little reimbursement risk in this area or in the vaccine business, Seqirus.

Moat rating

Read more about how identifying a company with a moat impacts investment results.

We award CSL a narrow moat rating based on the cost advantage afforded by its large-scale plasma collection and fractionation, and intangible assets based on the intellectual capital in its existing products and the proven success of its R&D efforts over time.

The industry has high barriers to entry as plasma fractionation has long lead times, taking approximately seven years to be built and approved. Fractionation is also a complex process that requires significant expertise and scale to be performed cost-effectively.

The plasma therapies market is a three-player oligopoly held by CSL, Grifols and Takeda Pharmaceuticals. Together, the tier one companies have an estimated 80% market share and a cost advantage over smaller competitors.

Gross margins of the tier one trio are on average 20 percentage points higher than tier two players such as Octopharma. Much of this is driven by economies of scale that minimize the cost per liter to collect and process plasma. Processes such as purifying and testing are more efficient with higher volumes, as labor and overhead costs are leveraged.

Vertical integration across the top 3 also reduces the need to purchase plasma on the open market. CSL owns over 30% of global plasma collection centers, with Grifols notably ahead and Takeda having roughly half the share. Although pricing risk of end products is tempered by both the tight supply of plasma and constant demand from chronic indications, any reduced market pricing or donor fee inflation would have a greater effect on smaller competitors than the top 3.

Based on pre-pandemic fiscal 2019, CSL Behring earned revenue of $7.2 billion US versus $5.4 billion for Grifols and $3.8 billion for the plasma-derived therapies business within Takeda. This makes CSL’s plasma business a third larger than Grifols and close to double the size of the Takeda division.

CSL Behring’s gross and EBIT margins have been higher than Grifols’ by an average of over 10 percentage points over the last five years, further evidence of cost advantage. Having a broader product portfolio, we think CSL benefits from economies of scope and processes more of its plasma collections into proprietary therapies while Grifols sells a significant portion to third parties.

Despite having fewer collection centers than Grifols, CSL still claims to be the world’s largest plasma collector and thus collects more liters of plasma per center. It is likely that CSL has a faster turnaround time of repeat donors given its rewards program that incentivizes donors to earn redeemable points. This would aid the volume of plasma collected per center but also reduce blood donor screening. We also think CSL benefits from superior fractionation expertise and quality processes, enabling higher yields of plasma-derived proteins.

Due to its significant market share and high gross margins, CSL has posted a return on invested capital, or ROIC, above 19% in each of the last eight years. We anticipate the company’s ROIC to far exceed its weighted cost of capital of 7.4% over our 10-year explicit forecast period, even in our bear-case scenario.

Although plasma products are unable to be patented since the raw material is available for all, we think CSL’s relatively heavy R&D investment and consequent proprietary technology is another moat source given the complexity and long development times of its products.

CSL has a track record of R&D success with consistent major product launches that have contributed to higher than long-run average industry revenue growth. This includes its Hizentra product, which currently has 60% market share in subcutaneous immunoglobulin treatment.

The company spends roughly 10% of revenue on R&D compared with competitor Grifols’ 6% and benefits from a wide and diverse product portfolio with multiple key products in each segment. CSL has also expanded its R&D pipeline beyond plasma therapies, including recombinant products and gene therapies, and thus mitigating some risk from changing market dynamics.

While we think it’s unlikely emerging gene therapies and alternative recombinant therapeutics will cause significant disruption in the next decade, these potential threats still preclude us from assigning the CSL Behring division a wide moat. Gene therapies aim to cure underlying diseases that are currently being treated on an ongoing basis with plasma products. However, as gene therapies are only suitable to treat genetic disorders, the potential impact is limited to the primary immunodeficiency, or PID, portion of CSL’s immunoglobulin business, haemophilia, and hereditary angioedema, or HAE, which together made up roughly 30% of fiscal 2020 revenue.

Within PIDs, which made up roughly 12% of group revenue in fiscal 2020, there are over 350 chronic indications being treated by immunoglobulins. The most common is CVID, which we estimate to be 20% of PIDs. Potential new therapies would likely need to be individually developed for each disease type, with channel checks suggesting gene therapy for PIDs being particularly difficult given the range of genetic defects identified and possible mutations. Gene therapies targeting PIDs or HAE are very early in clinical stages. Gene therapies within haemophilia are a more near-term threat, but the segment is also a relatively small 12% of group revenue.

In addition, the exorbitant cost of currently approved gene therapies treating other medical conditions indicates that fast widespread adoption is unlikely. Moreover, CSL itself is investing R&D into gene therapies and has made a licence agreement with uniQure for haemophilia B gene therapy candidate, EtranaDez, which we factor in a 100% likelihood of approval to launch in fiscal 2024. CSL is also researching gene therapies for a few PIDs including Wiskott-Aldrich syndrome but clinical trials are still in early phases.

Firms such as argenx and Momenta are also aiming to treat a subset of autoimmune diseases with Fc receptor-targeting alternatives that offer significantly reduced dosage and are expected to launch within the next decade.

Accordingly, we forecast CSL’s immunoglobulins revenue growth to slightly slow from fiscal 2025, but overall think CSL will be largely undisrupted. First, the potential diseases these recombinant therapeutics can treat account for roughly 38% of CSL’s immunoglobulins revenue, or 15% of group revenue. However, two of these diseases, CIDP and MMN, are very early in clinical trials and have much less evidence that Fc receptor-targeting biologics will be effective. If these trials fail, only 4% of CSL’s group revenue is at risk.

Second, with industry demand strongly outpacing the current tight supply of immunoglobulins, we think CSL will still be left with significant demand remaining, particularly when the diagnosis and range of secondary immunodeficiency indications continues to expand. Third, CSL is in partnership with Momenta for its own Fc receptor products that are also in clinical trials. Finally, the commercial success and long-term safety and effectiveness of these products is unproven. Not all patients are responsive to this alternative therapy, dosage is still relatively high for recombinants, and competitors would need to compete with physicians already experienced with CSL’s proven products.

We assign the Seqirus vaccine segment a narrow moat also based on R&D strength and cost-effective scale. CSL has demonstrated operational excellence, having acquired the loss-making Novartis influenza vaccine business in fiscal 2015 and turning the business to profitability by improving manufacturing processes and scale. Seqirus is now the world’s second largest influenza vaccine business, only behind Sanofi, and has the only FDA approved cell-based influenza vaccine, Flucelvax. Seqirus is well-positioned for the shift starting in the influenza vaccine industry to replace egg-based production with cell-based production, which is more cost-effective and results in less variation from the start of the culturing process to the ultimate product.

Although CSL is conducting preclinical testing of mRNA influenza vaccines, potential advances in competing vaccines again preclude us from a wide moat for this segment. mRNA influenza vaccines could potentially have a shorter lead time than CSL’s current cell-based production, and as a result, may lead to better immunity for the forthcoming flu season. Clinical trials led by Moderna have just commenced in this area, although we do not think CSL is too far behind.

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