CSL (CSL) 2016 AGM Voting Intentions

Company/ASX Code : CSL Limited (CSL)
Registry : Computershare Services
Poll/Show of Hands : Poll on all items
Webcast : Yes
Venue :
10am National Tennis Centre (Function Centre)
Melbourne Park, Batman Ave
Melbourne, Victoria
Monitor : Mr Don Hyatt
AGM Details / NoM : Wednesday 12th October, 2016

The company monitor had a pre-AGM meeting with the company in early October.

ASA Position
Not Applicable
Item 1: Consideration of accounts and reports

CSL conducts all business in US dollars and has reported in US dollars for the past few years. Only about 8% of CSL sales take place in Australia and as a consequence of this, and significant research being conducted in Australia, no franking credits are available as part of the distributions. Whilst the figures are reported in US dollars, ASA members deal in Australian dollars, the AUD/USD exchange rate becomes important when considering the value of CSL to Australian investors. In the last 2015-16 financial year the exchange rate remained fairly constant at $US0.75, so there has been little currency adjustment to take into account.

CSL had a good year in terms of sales up from $US5,459m to $US5,910m or 8.3% (assisted by the Novatis acquisition); however NPAT dropped from $1,379m to $US1,242m or -9.9% (or +5.2% ex-Sequiris), and EPS dropped from $US2.923 to $US2.689 or -8.0%. 

We note that Debt/Equity has risen from 62.8% to a quite high 100.8%, although the debt maturity profile is well spread to 2027 and cash flows are strong. Another $US500 million placement will be made this year.

The purchase of the flu vaccine component of Novartis for $US275m and subsequent establishment of Sequiris on 31 July 2015 has to be stripped out of these results making it difficult to establish a true picture of these results going forward. The ASA looks forward to Sequiris delivering positive results to CSL within the next two years.

Dividends were up 5.0% in the year to A$1.71464, Return on Equity has dropped from 49.4% to 41.54% and Net Margin from 24.9% to 18.04% (the Net Margin was unchanged ex-Sequiris). Much of this was due to the Novartis acquisition. For the financial year the share price rose from $86.47 to $112.18, resulting in a very handsome TSR of 31.7% for Australian shareholders.

Most major areas performed positively with sales growth in immunoglobulins (11%), albumins (12%), Specialty Products (11%), Haemophilia (4%) – each down slightly from the previous year’s growth. The vital Research and Development program has been ramped up significantly to $US613.8m from $US462.7m and has produced a strong pipeline of products moving through the trial phases with a number of important products and potentially lucrative products in Phase 3 Trials or ready for approval. The Outlook Statement for the year ahead is quite positive with an expected EBITDA of 14% and NPAT growth of 11%, both measured in Constant Currency.

The big questions are how long it will take Sequiris to deliver substantial profits; can CSL maintain its high level of debt; and how long the very large increase in R&D will take to produce results?

ASA Position
Item 2(a): Re-election of Ms Marie McDonald as a Director

Ms McDonald joined the board in 2013 and appears well credentialed. She has a background in commercial law and was formerly a partner at Ashurst. She holds CSL shares in excess of her base fees. 

ASA Position
Item 2(b): Election of Dr Megan Clark as a Director

Dr Megan Clark joined the board in February 2016. She is the former Chief Executive  of CSIRO. She is currently a Director of Rio Tinto and a member of the Australian advisory board of the Bank of America Merrill Lynch.

Pleasingly, she has started acquired some CSL shares since joining the board. 

ASA Position
Item 2(c): Election of Dr Tachi Yamada as a Director

Dr Tachi Yamada joined the board in September 2016 he has a strong background in the pharmaceutical industry. He is presently a Venture Partner at Frazier Healthcare Partners, a leading provider of growth capital to healthcare companies, a position that he has held since 2015.

ASA Position
Item 3: Approval of Remuneration Report

We note that payments have grown over the past year and have some concerns in relation to a number of items.

We note the LTIs are awarded in line with ASA supported award structure and are based on two measures: Earnings per Share growth (EPSg) and Total Shareholder Return (TSR). The vesting period is 4 years. The EPS hurdle ranges from 8% EPS growth to 13% EPS growth with a new tranche introduced to accommodate 13 – 15% growth. The benchmark for TSR is against a cohort of global Pharmaceutical and Biotechnology companies operating in the same space as CSL. This is graded beginning with 0% awarded at the 50th percentile up to 100% being awarded at the 75th percentile. The reality is that this has proven to be quite a challenging measure.

Concerns held by the ASA include:

•    STIs being awarded in cash and the removal of the mandatory STI deferral. CSL argues that this is in line with practices in the US, where 7 of 9 of CSL's KMP are based. 

•    Re-testing of the TSR-related tranche from 2011. We note re-testing ceased from the 2014 tranche.

•    STIs having a maximum of 150% (of FAR) rather than 100%.

•    The use of ‘fair value’ in determining the number of share rights to be awarded. Share rights are valued at $58.96. The ASA believes they should be valued at the current share price (VWAP). For the calculation of options, CSL has valued the options at $16.36 when the share price is around $107.

•    There is no table of actual remuneration for the Key Management Personnel. ASA has asked for one to be included next year.

It should be noted that the ASA prefers issued shares to be bought on market in order to not dilute shareholder value. As CSL has had a $950m share buyback in operation over each of the past 6 years and has flagged a $500m buyback for the year ahead this more than compensates for the number of shares issues to staff and will not dilute shareholders holdings.

ASA will support the Remuneration Report on the basis that we believe there is sufficient alignment with shareholders interests. We will continue to press for improvements.

ASA Position
Item 4: Grant of performance rights/options to Managing Director/CEO Paul Perreault

Our main concern relates to the use of ‘fair value’ for the valuation of performance rights ($58.96). With the CSL share price at around $107, these lead to an over inflated number of rights to be issued subject to vesting. See p21 of the CSL Notice of Meeting for a worked example. If the actual share price was used in the calculation the number of share rights would have been 16,563 (not 30,058). Clearly a considerable difference. As an operating principle, the ASA believes that if companies wish to pay their executives a certain amount then they should be clear and transparent about that amount.

The ASA notes that there is no table in the Annual Report that gives the actual salary of the Managing Director.

The final concern is the stated view that fixed annual remuneration (FAR) be increased by 5% pa (p.63 Annual Report). Superficially this would appear to match or even slightly exceed the salary increases of the general population. When the increase in proportion of the ‘At risk’ component is factored in this figure blows out considerably. By way of example:

•    2015 FAR 25%; LTI 50%; STI 25%

•    2016 FAR 18%; LTI 48%; STI 34%

However the 2016 FAR is 5% more than the absolute value of 2015. So using $1m 2015 FAR as an example. The maximum salary would be:

•    2015 FAR $1m; LTI $2m; STI $1m. Total = $4m

•    2016 FAR $1.05m; LTI $2.8m; STI $1.98m Total = $5.83m

Which is a potential 46% increase in remuneration. That is not close to the stated 5% increase in FAR and is misleading.

The ASA believes the change in the ‘at risk’ component of the salary should be offset by a reduction in the absolute value of the FAR. Our view is that the use of fair value as described above combined with the proposed changes to the remuneration structure could result in a significantly increased pay for the Managing Director. We intend to vote open proxies against this resolution.

ASA Position
Item 5: Increase to NED fee pool

This resolution seeks to increase the maximum aggregate fee pool for the non-executive directors by $1 million to $4 million. 

The previous increase was in 2014 (from $2.5 million to $3 million). Currently there are 9 non-executive directors on the Board, with one to retire. It appears that the current limit provides ample headroom for the board to appoint a new non-executive director as well as accommodate the 3%pa increase to NED fees.

At present, we intend to vote against this resolution on the basis that we believe that the requested increase is too excessive. We will discuss this with the company at our pre-AGM meeting.

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