One of my goals in 2014 is to improve my ability to analyse biotech companies, and as a result, I'm gradually reading through the last 16 years of CSL Limited (ASX:CSL) annual reports. I hope to learn to recognise the signs that may have indicated to savvy investors that CSL would be a great long-term investment. And it certainly has been: the share price in 1999 was under $6. Today, shares trade around $70. In 15 years, that's a return of around 1,100%, excluding dividends. $10,000 invested in those days would be worth a cool $110,000 at today's prices, a return that makes this company worth studying, especially as there is almost certainly more growth to come.
CSL Limited's FY 1998 results (released August 1999) reported a 27% increase in profit to $44 million off an increase in sales of 13%, indicating improving margins. The company had under $3 million in cash on the balance sheet and relatively modest debt of about $13.5 million. Impressive cashflow was the biggest giveaway of the company's quality, with operating cashflow coming in at $67.3 million. Subtracting the capital expenditure of $21 million, analysts would have found about $46 million in free cashflow. At the time the report for FY 1998 was released, there were around 133 million shares on issue and shares were trading at $6, with the company's market capitalisation around $800 million.
Plugging in this historical data to my valuation method, I get an indicative buy price of around $3.60, assuming no growth for the next decade. By the time the results were out in calendar-year 1999, the share price was around $6, as the chart below shows. The only way I would have bought shares is if I had predicted substantial future growth. Given the company's expansion plans and ample free cash flow, I'd like to think I would have. However, I doubt many would have predicted the growth eventually achieved.
The chairman's address at the AGM covering the FY 1998 results paints the picture of a company beginning the process of international growth. To quote then chairman, Colin Harper, it wanted to build "a globally competitive business with particular emphasis on plasma products" as one of its four main goals for FY 1998.
In that address, the chairman claimed that the most noteworthy development for the bioplasma division was the "major collaborative agreement with the American Red Cross," which could lead to "accreditation for the Broadmeadows plant by the US Food and Drug Administration" allowing CSL to manufacture "products in Australia from plasma supplied by the American Red Cross." In retrospect these remarks may have been an indication that the company was en route to developing an international blood plasma network. Today, the scale of CSL's network is its most significant competitive advantage – it is always able to supply plasma products to those in need, and few, if any, competitors can say the same.
The agreement which took place in FY 1999 included an undertaking to develop the Red Cross's fibrin sealant bandage, a bandage that would help with blood clotting. At the time many analysts appear to have considered this the most important feature of the agreement, suggesting they viewed new products as more important than the distribution network itself.
Indeed, just a few years later, in February 2003, the Sydney Morning Herald would report: "The haemorrhaging at CSL continues with news overnight the blood fractionation company was beaten in the race to get its trauma bandage to market." This bad news would coincide with an excellent buying opportunity, as the market appears to have missed the greater significance of the international blood plasma distribution network. But now, I'm getting ahead of myself.
Foolish takeaway
In retrospect, I believe that there were indications of the excellent business CSL would become in 1999. As I have argued in the past, CSL has huge leverage over governments, putting it in a powerful position. However, as the chart above shows, investors would have another excellent opportunity to buy CSL shares several years later, which I'll cover in due course.
In the meantime shares have increased by well over 1,750% in the 15 years since 1999, excluding dividends. For all the ups-and-downs on the way, long-term holders of this superstar stock have done very well indeed. If there's one lesson to take from this snapshot of CSL in 1999, it's that investors who focused on cashflow were more likely to have bought shares than investors who focused on earnings. I believe this focus on cashflow is also justified when considering far more speculative biotech companies.